The primary aim of preparing accounting records is to provide various stakeholders with useful information. The above information requires being up to date and sufficiently accurate. In the process of accounting, some transactions take place but it is not possible to record them generally. If the accountants prepare final documents without taking such factors into consideration, the ledgers will portray incomplete information. However, there is a planned technique for correcting the accounting information to date. The above involves the use of adjusting entries. Therefore, adjusting entries refer to particular journal entries that are prepared at the end of an accounting period for the purpose of adjusting expense and income accounts in accordance with the accounting principle of accrual. For the purpose of completeness and reflection of accrual based accounting in any company’s financial statements, the accountants should process the adjusting entries before issuing the final financial statements (Heintz & Parry, 2010).
The use of adjusting entries in financial statement records is important for a couple reasons. First, preparing adjusting entries upholds the matching rule required in financial accounting. In light of this, adjusting entries become significant in determining income and financial position more accurately. The management and the stakeholders alike are interested in knowing the exact amount of income a company makes in a particular period. Thus, the preparation of adjusting entries in such a case helps in showing the real and actual position of the company to the stakeholders. Still under the matching rule, adjusting entries help in making it possible to compare financial statements prepared for past and future accounting periods. In light of the above, the management gets the ability to map the company’s progress and improvement in relation to its financial position (Albrecht, Stice, Stice, & Swain, 2007).
It is not all accounts that undergo the adjusting process. Apparently, for an account to qualify for adjusting, it must be a balance sheet account or an income statement account that has a contra entry in the income statement of the balance sheet respectively. The main reason for the above provision is because adjusting entries are prepared to help in measuring the actual financial position of a company. As a result, the accounts that matter are those directly related to the balance sheet and the income statement since it is these two statements that indicate a company’s financial standing. In the pursuit of illustrating how adjusting entries are useful as stipulated above, below are two examples.
Example 1: I assume that my company receives 5,000 dollars on June 10 for services it will provide later. The accountants must determine how much of the 5,000 dollars will be used by the time my company issues the financial statements for the period ending June 30. If the company will have used 3,000 dollars, the Service Revenue account must reflect 3,000 dollars with the unearned amount of 2,000 dollars being deferred to the next accounting period. The entire amount of 5,000 dollars was debited to the Service Revenue account on June 10. The adjusting entry will involve crediting the Service Revenue account with the unearned amount of 2,000 dollars and debiting Deferred Revenue account with the same amount. The Deferred Revenue account features as a liability in the balance sheet.
Example 2: The above example illustrated deferred revenues. This one shows the adjustment of accrued expenses. On June 20, my company outsourced expertise labor. The company anticipates the invoice of 500 dollars from the expert on July 5. However, the expense happened in June and thus should reflect on the end June financial statements. As a result, the accountants should prepare an adjusting entry to include an accrued expense that should feature as a liability in the June 30 balance sheet records. The subsequent adjustment entry involves debiting Outsourced Labor account with and 500 dollars and crediting the Accrued Payments account with the same amount.
From the above illustration, adjusting entries are useful for showing the fair value of the company. However, they harbor one challenge. Preparing adjusting entries is relatively difficult since it calls for additional workings especially when compared to the amount of work required in the simple cash-basis accounting technique (Guilding, 2014). Additionally, several adjusting entries must be prepared at the end of each period if the accountants use the accrual accounting method.
Albrecht, W., Stice, J., Stice, E., & Swain, M. (2007). Accounting: Concepts and Applications. Mason, OH: Cengage Learning.
Guilding, C. (2014). Accounting Essentials for Hospitality Managers. New York, NY: Routledge.
Heintz, J., & Parry, R. (2010). College Accounting. Mason, OH: Cengage Learning.