Hello in this presentation we’re going to talk about types of adjusting journal entries. When considering adjusting journal entries we want to know where we are at within the accounting process within the accounting cycle. all the entries the normal adjusting entries have been done the bills have been paid the invoices have been entered for the month we have reconciled the bank accounts. Now we are considering the adjusting process. Those adjusting journal entries are needed in order to make the adjusted trial balance so that we can create the financial statements from them. The adjusting journal entries being used to be as close to an accrual basis as possible. those categories of adjusting journal entries, which will then have more types of adjusting entries within each category will include prepaid expense, unearned revenue, accrued expenses and accrued revenue. Let’s consider each of these we have the types of adjusting entries first type prepaid account expenses. prepaid expenses are items paid in advance.
Although we have the word expenses in prepaid expenses, prepaid expenses is an asset. That can be confusing considered when we have the word expenses. But the prepayment means we paid for the expense we paid for something which will eventually be an expense. However, it’s not an expense under the matching principle, the accrual principle of matching until we have consumed it in order to help us generate revenue in the same time period, meaning in this case, we paid for it in some way. Either we bought it on like a credit card or an account or we paid cash, but we haven’t yet consumed it. Therefore, we can’t consider it an expense. Most common example is prepaid insurance. Whenever you think of prepaid expenses. First one you want to consider is insurance because by its nature, insurance is always prepaid. We always pay for insurance before we get coverage from the policy. Now it could be possible More than we pay month to month, and we’re pretty close in time.
But more More likely, most likely, most of the time. Most businesses pay for more than just one month of coverage at a time, half a year or four year, multiple years. And in those cases, we have clearly paid for something before consuming it. And we want to have an even allocation of those expenses throughout the use of the insurance rather than putting it all at the time of the payment. When we pay for it then it’s going to be an asset. Other types of prepayment could be anything that we pay for in advance. So this is going to be anything that we pay for that we will have an eventual expense, we will prepay it, a common one that you’ll see in textbooks is going to be prepaid rent, because that’s another one where we oftentimes might set up an arrangement for whatever reason that we’re going to pay for multiple months now and pay before we actually consume the the use of a rental property. And in so doing, we’re going to end up with prepayment.
You can consider this happening with anything we can happen with a utility bill or any other expense that we have, it’s possible for us to pay for it before consuming it and make an agreement and arrangement for that. If that were the case, it would be an asset. Other types of premium payments that aren’t quite as clear include supplies doesn’t have the word prepayment in it, but it’s the same concept supplies is our introduction to inventory. And what we’re doing is we’re paying for something that we’re going to consume in the future as we consume the supplies in order to help us generate revenue. Therefore, it’s a prepayment because we bought something we haven’t yet consumed. It’s an asset until that time that it is consumed to help us generate revenue. We also have depreciation. Now we put depreciation here in the slide. It could also just be called property, plant and equipment. depreciation is typically what we call the adjusting journal entry related to depreciation and accumulated depreciation.
But really we’re talking about the prepayment happened when we bought property, plant and equipment. When we buy something like equipment just as a similar way as when we bought the supplies, we bought something that’s going to help us generate revenue in the future. According to the matching principle, we cannot use that or show it as an expense until it has been consumed. We do that because we need an estimate, not with equipment expense, but with depreciation expense. So depreciation expense is integrally related to property, plant and equipment, property, plant and equipment when being purchased is an asset for the same reason as supplies. The type of just an entry would be something like this always going to be a balance sheet account and an income statement account for all adjusting transactions.
This one is an example for prepaid insurance, the most common pre payments, and we’re going to have insurance on the books here at 12,000 in this case, and we’re typically going to Write down the insurance because we’re writing down the portion of that insurance that has been consumed over the time period now being reported bringing the prepayment down to whatever it is. So the typical accounting department is going to just put everything in a prepayment, we’re going to write it down and record what has been consumed by lowering the prepayment and recording the related expense. When we do that, it will typically bring down the net income. Same idea will be for when we record accumulated depreciation, it’s going to decrease the net book value of the equipment and we’re going to record the related expense increase in expenses. bringing down net income supplies is on the books as an asset. We’re going to decrease the supplies and we’re going to record the related expense which will increase the expenses and decrease net income. next type of adjusting journal entry is unearned revenue. Payment received in advance of services performed.
This is a case would run talking about the revenue side rather than the expense side. And therefore we’re going to be considering the revenue recognition principle, the accrual principle related to revenue. And we’re here we’re talking about revenue we got paid for it before we do the work. unearned revenue can be a little bit confusing, because we’re talking one about something that many businesses don’t often have meaning many most businesses get paid at the same time they do the work or they do the work before they get paid. For example, a bookkeeper or a law firm, they’re going to receipt they’re going to do work, Bill the client then get paid in the future for a food service, a restaurant, we typically do the work we get paid at close to the same time. But some companies are going to get paid beforehand, like a newspaper company gonna get subscriptions before delivering the newspaper, anything that’s on subscription now, so something like Netflix or everything that’s going to be subscription Paste typically will get paid before the service is performed.
And therefore, we’re going to have to record those payments not as revenue under the revenue recognition principle them not having yet been earned. And therefore, we’re gonna have to record it on the books as a liability. So we got unearned revenue, it’s going to be the account we will be using for that that’s kind of like the generic name for revenue. And it’s going to be a liability account revenue that had not yet been earned. And it’s going to be a liability account, not a revenue account, not an income statement account. We also might have a down payment, which is kind of a type of an unearned revenue. And that if we sell a big product or we have a big project or have a construction projects coming up, we might get money up front, even though typically we would get paid at the end of the job. We might say, Hey, we need money now before the job is done.
Or if we’re selling a large product if we’re selling cars, and we need to make an order On the car, before we deliver the car, we might get a down payment, that’s going to be payment before we delivered the vehicle. And therefore we cannot recall it revenue even though it will be revenue in the future once we do the rest of the work until that rest of the work has been done. We could also have a security deposit if we think about rent, not exactly the same, because we think that we’re going to give the security deposit back but it’s possible we don’t give the security deposit back depending on the condition of the of the premises. And it’s the same idea in that if we got money for the security deposit, we’re going to debit cash and we can’t credit revenue because we didn’t earn the revenue, we got to credit some type of liability account representing that we owe it back. So those are going to be some examples. Here’s the typical journal entry. We’ve got unearned revenue on the books that the bookkeeper put on the books because when they’re we’re going to record the money.
They’re going to put it on the books as a debit to cash and a credit to the line. Ability unearned revenue. That’s how we set up the system. Then in the adjusting process, we will go in there analyze how much of that 11,000 event has been put into the liability unearned revenue account has now been earned, right? That liability down to the amount we calculated it to be to have been earned. We’re going to do that with a debit here. So record the debit, decreasing this and then we’re going to record the related income now having been earned increasing the income in this case with a credit so we credit here increasing the amount of revenue increasing net income as we can see here. next type of adjusting journal entry is going to be accrued expenses. So accrued expenses are both unpaid and unrecorded, as of the cutoff date, remember always thinking about as of the cutoff date trying to make the financial statements correct. As of that final day of the month, could include accrued wages. This is going to be the most typical Example of accrued expenses.
And we’re going to call it accrued wages, we could call it wages payable, that being the liability account. And what this means is that there’s going to be some accounts and wages is going to be one of them, that it just does not make sense for us to record wages on a perfectly accrual basis. Instead, we’re going to basically record the payroll transaction closer to when we actually pay the payroll. Otherwise, to be in a perfectly accrual system, we would have to accrue the fact that we owe money and people have worked for us every hour, every minute or even every second, if we want it to be on a perfectly accrual system. That would not make sense. Therefore, we’re just going to say, hey, let’s be closer to a cash basis with let payroll do what payroll can do in order to make things easy for payroll because payroll is different, difficult enough already. And then at the end of the month, we’re just gonna make everything correct on an accrual basis as of the cutoff date.
So wages payable always going to be something that the cutoff date will not always land that will never pretty much land on the same date as the payroll. And therefore, there’s going to be some days that have been worked by the employees that have not been recorded as expenses. And we’re going to have to record them. Same idea for accrued taxes. So taxes are going to accrue as we earn money for thinking income taxes. every dollar we earn, we have the Silent Partner wanting their share Uncle Sam, and therefore we’re going to have to record that bad expense at some point as well. There’s nothing that really triggers that. So we’re just going to have to make that part of our adjusting journal entry process and figure out how much is owed based on how much we have earned. accrued interest is typically another form. Interest is something that we’re going to have to pay periodically, based on any agreement within the loan terms that we have made.
Those loan terms might be that the payments are right close to the end of the year or the end of the month. They might won’t line up perfectly perfectly meaning we make the payment, we record the interest at the time we made the payment and everything lines up. But very often, that’s not the case, the interest payment schedule, the amortization schedule, the way the loan is set up, the accrued interest, those are going to be some interest that we’ve accrued, meaning we’ve used money through a loan and have not yet recorded the rent on that money, the interest expense and we’ll have to record that as part of our adjusting process. So the adjusting process will typically look something like this with this would be the wages payable, where we’re going to debit wages payable and credit. I mean, we’re gonna debit wages expense, and credit wages payable for the amount of wages that workers have earned, but have not yet been recorded as of the end of the time period.
So for example, if we pay people every Friday payroll pays them on Friday records five days of work on Friday and if the end of the The time period landed on Thursday, we’ll say, then we got we’ve got four days that happened in the prior month, and then one day’s gonna gonna happen after the end of the year. So they’re gonna get paid after the cutoff date. But most of the time work happened before that cutoff date. Therefore, we got a represent as of the cutoff date, the date of the financial statements, that there’s a liability and an added related expense, increase in the liability, increasing the expenses for the day’s work that have not yet been paid. As of the cutoff date, last day of the month or year. We all we then have next type of adjusting journal entry, accrued revenue, revenue earned but not recorded. So that’s typically going to be a look this one is confusing many times in that the journal entry is going to look just like a normal journal entry, and therefore it often looks like an error. It’s not an error.
It’s could be A typical part of the process of the accounting process meaning that something like we could think of a law firm or a bookkeeping firm, that has to basically compile information before they send out the invoice. Just like with payroll, we don’t want to mess with that process. It’s difficult enough already, just let the process be what it is the invoice goes out, when it goes out, we record the revenue at that time. Then in the adjusting process, we’re going to say, hey, all those invoices that went out the first, you know, week after the cutoff date, when was the work done was it worked on before the cutoff date? If it was, we’re going to have to do that same journal entry and bring it before the cutoff date. The same is going to be true for accrued interest revenue.
And that’s going to be something if we have investments and stocks and bonds, then it’s very possible that those investments have accrued interest that has not yet been paid to us and therefore we have not yet recorded it as of the adjustment date. And we’re going to have to record for that. So here’s the journal entry. Typical journal entry, we’re going to debit accounts receivable and credit revenue. And for a service company, that’s that’s just the normal transaction when we give out an invoice, and we just do work. So again, it looks normal, we increase the amount of people owing us money with the debit, and we increase revenue. When we invoice a client, that’s just our normal journal entry. So the question often is, why didn’t the accounting department do this? Why is this an adjusting entry? What’s the difference between this as an adjusting entry and just the normal journal entry that looks just like this. The only difference is timing.
The only difference is this invoice that we recorded was sent out after the cutoff date, even though the work was done before the cutoff date. And again, that’s not may not be an error on the accounting departments side. But in the adjusting process, we have to bring that back and we got to record it as of the end of the financial statement. And therefore we’re doing the same journal entry as of the end of the financial statement. By the way, you might be saying Hey, that’s gonna cause a problem later on. And as of the financial statement dates, we’re just trying to make them correct on an accrual basis. And we’ll talk about how to fix fix the problem of having this recorded twice as of as of the date of the invoice here and with payroll and some of the other entries that you might be asking that question about. Right now we’re just trying to get the financial statements, right, we’re gonna have to deal with that kind of tension between the adjusting process and the normal accounting process later.
So the types of adjusting journal entries are going to include prepaid expense, unearned revenue, accrued expenses and accrued revenue. If this has been helpful to you and you want to know more about the adjusting process, we suggest taking a look at accounting instruction reference number 301 of the principle advantages being that it’s going to list out the topics in a logical order so you can find what you’re looking for and you can find related topics and then be guided to free resources related to those topics. Including instructional videos, more reading other games and test banks that could help to get this stuff down. Also, it’s going to have links that will link to some of these other resources so you can have an easy guide to get to what you need.