Step-by-Step Method for Understanding Adjusted Entries
A business accounting cycle involves certain monthly entries to adjust account balances. This ensures each account reflects the accurate balance and activity at the end of each accounting period. Adjustments fall into one of two categories: accruals or prepayments.
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Instructions
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Review the asset section of the balance sheet, looking for expenses the company has paid, but has not yet received benefit from. The account name should mention "prepaid." Accountants record prepaid items as assets, such as a prepaid insurance policy. The prepaid insurance account receives an adjustment each month, with a portion of the balance moved over to the insurance expense account on the income statement.
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Identify any liabilities on the balance sheet that have accounts with the name "unearned." For example, some firms accept prepayment for a product or service. Companies may allow customers to "lock in" a specific price now for goods needed in the future. Because the company has not yet delivered the goods, the company records revenue from the sale as an "unearned revenue" liability on its balance sheet. This obligation stays on the balance sheet until the company delivers the goods. If the firm delivers goods or services over the span of several months, an accountant makes an adjusting entry each month to reflect the portion of earned revenue on the income statement, leaving the remainder of the obligation on the balance sheet.
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Locate accounts on the balance sheet with "accrued" or "payable" in the account name. These accounts track expenses over time, until the firm actually pays money out. For example, employees earn wages each workday, but only receive payment twice a month. Each day, the accountant records wages on the balance sheet as an accrued wages or wages payable liability. Once the firm issues paychecks to employees, the accountant adjusts the account, moving the balance to the payroll expense account on the income statement.
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Review the balance sheet for any other accruals. If an accrual account exists for something with which you are not familiar, the best course of action is to follow up with the person who adjusts the entries each month. If this is not possible, review each month's adjusting entries, looking for corresponding accounts on the income statement. For example, an accountant adjusts unearned revenue from the balance sheet, moving it to the revenue account on the income statement. Prepaid accounts include insurance, wages, rents or legal retainers. Look on the income statement for expense accounts that receive adjustments each month as the company uses up portions of these prepaid assets.
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References
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