Accrual accounting requires companies to identify the accounts that experience unrecorded changes during the period. The accountant determines the amount of the unrecorded change and records an adjusting entry to recognize those changes. This adjustment allows the financial results to more accurately represent the financial position of the business.
Revenue accounts represent everything that the company earns through its business operations. At the end of each period, the accountant reviews these accounts to determine whether an adjusting entry needs to be recorded. Accountants record two types of adjusting entries for revenue accounts: accruals and deferrals. Accrual entries that impact revenue accounts recognize an increase in revenues which has not been recorded. An example of this would be recognizing an increase in revenue and an increase in accounts receivable for services provided and not billed. Deferral entries that impact revenue accounts recognize that revenues recorded must be split between multiple periods. An example of this would be recognizing that revenue received in one accounting period applies to several accounting periods.
Expense accounts represent everything that the company uses and must pay for through its business operations. The accountant reviews these accounts at the end of each period to determine whether an adjusting entry needs to be recorded. Similar to revenue accounts, there are two types of adjusting entries for expense accounts: accruals and deferrals. Accrual entries that impact expense accounts recognize an increase in expenses which has not been recorded. An example of this would be recognizing an increase in utilities expense and an increase in accounts payable for electricity used that the company has not been billed for yet. Deferral entries that impact expense accounts recognize that expenses recorded must be split between multiple periods. An example of this would be recognizing that supplies received and paid for in one accounting period will be used in several accounting periods.
Adjust Account Balances
At the end of each period, the accounting staff reviews each revenue and expense account to determine if any adjusting entries must be recorded. The accounting staff reviews the transactions in those accounts and identifies accrual and deferral entries that must be made. After identifying which accounts require adjustments, the accounting staff records each adjusting entry in the financial records.
Benefits of Adjusting Account Balances
Adjusted entries allow the financial statements to include all activities for the period. By including these amounts in the financial statements, users of those statements can understand the full picture of what occurred during the accounting period. Without those amounts included, financial statement users lack some information regarding activity that occurred and make decisions based on that partial information.
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