Adjusting entries - Assignment Example

One of the steps included in the accounting cycle is the recording of adjusting entries. Adjusting entries are always needed every time a company prepares financial statements. At the end of the accounting cycle the four financial statements are ready to be prepared and published for the users of financial information. “Adjusting entries are needed to ensure that the revenue recognition and matching principles are followed” (Weygandt & Kieso & Kimmel, 2003, pg. 91). Adjusting entries are necessary because they are one of the steps of the accounting cycle.

The fourth step of the accounting cycle is to journalize and post adjusting entries (Cliffnotes, 2011). Accounting entries exist to make sure revenues are recorded in the period in which they are earned, and expenses are recognized in the period in which they are incurred (Weygandt, et al. 2003). Accounting results are supposed to be reliable and accurate. The use of adjusting entries adds validity to the claim of accuracy in accounting work. A financial statement that benefits from adjusting entries is the balance sheet because adjusting entries allow accountants to adjust the assets, liabilities, and equity accounts.

The four types of adjusting entries are prepaid expenses, unearned revenues, accrued expenses and accrued revenues. Prepaid expenses are expenses that are paid in cash by a company before they are consumed. These types of transactions occurred for a variety of reasons including contractual obligations. In the insurance industry it is common practice for insurance coverage to be signed in yearly contracts that must be paid in full prior to coverage starting. In this type of transaction the company receives benefits as time passes.

An adjusting entry is necessary to record the actual consumption of the expense. These types of adjusting entries are typically recorded on a monthly basis. The journal entry to record this adjusting entry is a debit to insurance expense and a credit to prepaid expenses. Another example of a prepaid expense is the recording of depreciation. Depreciation is recorded through the passage of time on a monthly basis. The second type of adjusting entries is unearned revenues. Unearned revenues occur when a client pays in cash for a service that has not been provided to them.

An unearned revenues account is considered a liability because the company that took the payment owes the service to the client. A practice in which unearned revenues are a common occurrence is in the law practice. A lot of companies pay corporate lawyers retainers to be on call for any legal problem that may occur in the future. The lawyer must record the transaction when they are originally paid as unearned revenue. When the lawyer provides a legal service for the client the liability is reduced through an adjusting entry.

The adjusting entry to record a service rendered to a client that had an unearned revenue pending is a debit to unearned revenue and a credit to service revenue. The third type of adjusting entry is accrued revenues. Accrued revenue refers to transactions in which the business earned an income, but has not yet received payment for the work. Accrued revenues can accumulate over time in cases such as unpaid rent. Sometimes accrued revenues occur as a consequence of the company not billing the customer at the time the service is rendered.

The typical adjusting entry for accrued revenues once service is provided is a debit to account receivable and a credit to service revenue. Companies that always receive payment in the form of cash at the moment the service is provided would not accumulate any accrued revenues. The fourth type of adjusting