Understand & explain the Accounting Equation and its components - Essay Example

Understand & explain the Accounting Equation and its components Furthermore, it makes sure that financial statements reflect acrual basia of accounting. Adjusting entries are necessary because a single transaction may affect revenues or expenses in more than one accounting period and also because all transactions have not necessarily been documented during the period. The determination of an objective net income as well as the correct balances on the Balance Sheet. There are two types of adjusting entries the deferrals or the prepayments and the accruals.

They are further categorized into four types of adjusting entries which includes accrued revenues, prepaid revenues, accrued expenses and prepaid expenses. Accrued revenues which are also referred to as accrued assets refers to revenues whichhave already been earned but have not been paid for and thus have not been posted in the general ledger. These are adjusted in the financial statements by debiting the asset accounts recievable and crediting the the relevant revenue account. An example of accrued revenue may occur when an architecutral firm offers consultancy services of $ 1300 to a manufacturing enterprise but fails to bill its services untill next accounting period.

An adjusting entry to record the income in the correct period would be done by Accounts Reciavable $ 1300 Consultancy Income $ 1300 Prepaid income refers to revenues or money recieved from clients before the services has been earned. The effect of this transaction is at first when the cash is received; cash account is debited and credited as unearned fees or customer deposits. When a Cleaning services company receives $ 1000 being payment for its services for 5 months in advance which includes two months of the next accounting period is an example of a prepaid income.

The adjusting entry at the end of the accounting period would be Cleaning Income $ 600 Prepaid Income $ 600 Accrued expenses relates to expenses which have been incurred by a firm but have not been paid paid for. An illlustration of an accrued expense usually occurs when company pays its rent expense for rent relating tothe previous month. Thus if the rent expense amounts to $ 12000 a month. While recording the last salary payment at the end of an accounting period the adjusting entry will appear as follows; Rent Expense $ 12000 Accrued Rent $ 12000 Prepaid expenses relates to the expenditures which have been paid for recorded as assets which are paid for in advance.

An example of a prepaid expense may arise when a company prepays $ 2000 relating to advertising and promotion expense, which relates to the next accounting period. To make adjustment entry in the general ledger the journals will be as follows; Prepaid Advertisement and Promotion $ 1300 Advertisement and Promotion $ 1300 There are other adjusting entries which may bad debts, depreciation allowances and stock or inventory adjustments. One example of such adjustment may arise when a manufacturing company purchases a motor vehicle for $ 0.

65 million which is assumed to depreciate by straight-line method for 5 years then at the end of the first accounting period to adjust the motor vehicle value to ensure there is no balance sheet overstatement will be done as follows; Depreciation Expense $130,000 Accumulated Depreciation – Motor Vehicle $ 130000 Finance officers to ensure that they record adjustment entries in a computerized accounting system usually conduct a comprehensive mothly examination- cut-off procedures- of trial balance.

This is done to ensure that all incomes and