Introduction
- Adjusting entries are accounting journal entries
- that convert a company's accounting records to the accrual basis of accounting.
- An adjusting journal entry is typically made just prior to issuing a company's financial statements.
- Adjusting entries assure that both the balance sheet and the income statement are up-to-date on the accrual basis of accounting.
- A reasonable way to begin the process is by reviewing the amount or balance shown in each of the balance sheet accounts.
There are 2 scenarios where adjusting journal entries are needed before the financial statements are issued:
- Nothing has been entered in the accounting records for certain expenses or revenues, but those expenses and/or revenues did occur and must be included in the current period's income statement and balance sheet.
- Something has already been entered in the accounting records, but the amount needs to be divided up between two or more accounting periods.
Adjusting entries almost always involve a
- balance sheet account (Interest Payable, Prepaid Insurance, Accounts Receivable, etc.) and an
- income statement account (Interest Expense, Insurance Expense, Service Revenues, etc.)
Choose the correct answer
- What type of entry will increase the normal balance of the general ledger account Service Revenues?
________ Debit
_________ Credit
* The right answer is Credit
- Since revenues cause stockholders' equity to increase, revenues are increased with a credit entry.
- [Stockholders' equity appears on the right side of the accounting equation. Credit entries appear on the right side of a T-account.]
- What type of entry will increase the normal balance of the general ledger account that reports the amount owed as of the balance sheet date for a company's accrued expenses?
__________Debit
_________ Credit
* The right answer is Credit
- The amount owed for accrued expenses is reported in a liability account such as Accrued Expenses Payable.
- Since a liability account is expected to have a credit balance, a credit entry will increase the normal balance.
- [Recall that liabilities are on the right side of the accounting equation. Credit entries appear on the right side of a T-account.]
- An accrued expense journal entry is a year-end adjustment to record expenses that were incurred in the current year but weren't actually paid until the next year. The matching principle dictates that all revenue and expenses need to be matched according to the year they were earned and incurred.
- Example: A company pays its employees' salaries on the first day of the following month for services received in the prior month.
3. What type of entry will increase the normal balances of the general ledger accounts Electricity Expense, Insurance Expense, Interest Expense, and Repairs Expense?
_________Debit
_________ Credit
* The right answer is Debit
- Expenses are recorded in expense accounts with a debit entry.
- The reason is that expenses will cause a decrease in stockholders' (or owner's) equity.
4. What type of accounts are Interest Receivable and Fees Receivable?
__________ Asset
__________Liability
__________Equity
__________Revenue
__________Expense
* The right answer is Asset
- Receivables are asset accounts. Assets appear on the left side of the accounting equation and asset accounts will normally have debit balances.
interest receivable definition
- The current asset that represents the amount of interest revenue that was reported as earned, but has not yet been received.
- The usual journal entry used to record this transaction is a debit to the interest receivable account and a credit to the interest income account.
5. What type of entry will decrease the normal balances of the general ledger accounts Interest Receivable and Fees Receivable?
________Debit
_________ Credit
* The right answer is Credit
- Receivables normally have debit balances. Therefore to decrease the debit balance in a receivable account you will need to credit the account.
6. What type of accounts are Deferred Revenues and Unearned Revenues?
_________ Asset
__________ Liability
__________ Equity
__________ Revenue
* The Right answer is Liability
- Accounts such as Deferred Revenues, Unearned Revenues, and Customer Deposits are liability accounts.
- As with liability accounts, the normal balance will be a credit balance.
- Unearned revenue is money received by an individual or company for a service or product that has yet to be provided or delivered.
- It is recorded on a company’s balance sheet as a liability because it represents a debt owed to the customer.
- Once the product or service is delivered, unearned revenue becomes revenue on the income statement.
7. What type of entry will decrease the normal balances of the accounts Deferred Revenues and Unearned Revenues?
________ Debit
________ Credit
* The right answer is Debit
- Since Deferred Revenues is a liability account, the normal credit balance will be decreased with a debit entry.
- For example, when some of the deferred revenues become earned, the company will debit the Deferred Revenues and will credit a revenue account such as Service Revenues.
8. What type of accounts are Prepaid Insurance, Prepaid Advertising, and Prepaid Expenses?
__________ Asset
__________Liability
__________Equity
__________Revenue
__________Expense
* The right answer is Asset
- Prepaid expenses that have not been used up or have not yet expired are reported as assets.
- In other words, prepaid expenses are unexpired costs. When the costs expire (or are used up) they become expenses.
9.What type of entry will decrease the normal balances of the accounts Prepaid Insurance and Prepaid Expenses, and Insurance Expense?
________ Debit
________ Credit
* The right answer is Credit
- Since Prepaid Insurance and Prepaid Expenses are asset accounts, their normal debit balance will be decreased with a credit entry.
10. What type of accounts are Accumulated Depreciation and Allowance for Doubtful Accounts?
___________Contra Asset
___________Equity
___________Expense
___________Liability
___________Revenue
* The right answer is Credit
- Contra asset accounts will have credit balances.
- The word contra indicates the balances in these two accounts will be contrary to the debit balances that are expected in asset accounts.
11. What type of entry will increase the balances that are normally found in the accounts Accumulated Depreciation and Allowance for Doubtful Accounts?
________Debit
__________Credit
* The right answer is Credit
- Since contra asset accounts have credit balances, the credit balance will become larger when a credit entry is recorded.
12. In the case of a company's accrued interest expense, which of the following occurs first?
__________ Incurring The Interest Expense
__________ Paying The Interest To The Lender
* The right answer is Incurring The Interest Expense
- An accrued expense is an expense (and a liability) which was incurred by a borrower but the interest has not been recorded.
13.In the case of a bank's accrued interest revenues, which occurs first?
____________Earning The Interest Revenues
____________ Receiving The Interest From The Borrower
* The right answer is Earning The Interest Revenues
- Accrued revenues are recorded because the bank has earned both the interest revenue and a related receivable and neither has yet been recorded by the bank.
14. In the case of a company deferring insurance expense, which occurs first?
______________Incurring The Insurance Expense
_____________Paying The Insurance Company
* The right answer is Paying The Insurance Company
- Deferred insurance expense is the result of paying the insurance premiums at the start of an insurance coverage period.
- The amount of insurance premiums that have not expired as of the balance sheet date should be reported in an asset account such as Prepaid Insurance.
- [As the prepaid insurance premiums expire an adjusting entry should be written to credit the asset Prepaid Insurance and debit Insurance Expense.]
15. In the case of a company's deferred revenues, which occurs first?
____________Earning The Revenues
____________ Receiving The Money From The Customer
* The right answer is Receiving The Money From The Customer
- Deferred revenues indicate that a company has received money from a customer before it has been earned.
16. Which of the following will be included in the adjusting entry to accrue interest expense?
_____________A Debit To Cash
____________A Credit To Interest Payable
____________A Debit To Interest Payable
____________ A Debit To Prepaid Interest
* The right answer is A Credit To Interest Payable
- When interest expense has been incurred by a company but no payment has been made and no related paperwork has been processed,
- the company will need to accrue the interest with a debit to Interest Expense and a credit to Interest Payable.
17. Which of the following will be included in the adjusting entry to accrue interest income or interest revenues?
____________ A Debit To Cash
____________A Debit To Interest Income
____________A Credit To Interest Receivable
____________ A Debit To Interest Receivable
* The right answer is A Debit To Interest Receivable
- When interest has been earned but no cash has been received and no billing paperwork has been processed in the accounting records, a company will need to accrue
1) interest revenue or interest income, and
2) an asset such as Interest Receivable.
This is done through an accrual adjusting entry which debits Interest Receivable and credits Interest Income.
18. The adjusting entry that reduces the balance in Prepaid Insurance will also include which of the following?
___________ A Credit To Cash
___________ A Credit To Insurance Expense
___________ A Debit To Insurance Expense
___________A Debit To Insurance Payable
* The right answer is A Debit To Insurance Expense
- As the debit balance in the asset account Prepaid Insurance expires, there will need to be an adjusting entry to :
1) debit Insurance Expense, and
2) credit Prepaid Insurance
19. The adjusting entry that reduces the balance in Deferred Revenues or Unearned Revenues will also include which of the following?
_____________ A Debit To Cash
_____________A Credit To Fees Earned
_____________A Debit To Fees Earned
_____________A Credit To Fees Receivable
* The right answer is A Credit To Fees Earned
- As the deferred or unearned revenues become earned, the credit balance in the liability account such as Deferred Revenues needs to be reduced.
- Hence, the adjusting entry to record these earned revenues will include
1) a debit to Deferred Revenues, and
2) a credit to Fees Earned.
20. The ending balance in the account Prepaid Insurance is expected to report which of the following?
_____________ The Accrued Amount Of Insurance Expense
____________ The Original Amount Of The Insurance Premiums Paid
____________The Expired Portion Of The Insurance Premiums Paid
____________The Unexpired Portion Of The Insurance Premiums Paid
* The right answer is The Unexpired Portion Of The Insurance Premiums Paid
- The ending balance in the asset account Prepaid Insurance should be the cost of the insurance premiums that have been paid and which have not yet expired (or have not yet been used up).
21. The ending balance in the account Deferred Revenues (or Unearned Fees) should report which of the following?
____________The Accrued Amount Of Fees That Have Been Earned
____________The Original Amount Of Fees Received In Advance From A Customer
____________The Fees Received In Advance Which Are Not Yet Earned
____________The Amount Of Fees Received In Advance And Which Are Now Earned
* The right answer is the Fees Received In Advance Which Are Not Yet Earned
- When customers pay a company in advance, the company credits Unearned Revenues.
- Then as the company earns some of the revenues, the account Unearned Revenues will be debited and an income statement account such as Service Revenues or Fees Earned will be credited.
- Thus, the remaining credit balance in Unearned Revenues is the amount received but not yet earned.
22. Which type of adjusting entry is often reversed on the first day of the next accounting period?
____________ Accrual
____________Deferral
____________Depreciation
* The right answer is Accrual
- For example, if a company has incurred commissions expense on December's sales, but will not pay the commissions until January 25, the company will write an accrual type adjusting entry for December’s financial statements.
- On January 25 the company will write a check to pay those commissions. To avoid having two entries for December's commissions, it is common practice on the first day of the month following the accrual adjusting entry to record a reversing entry. (Deferrals do not pose the risk of double counting expenses or revenues.)
23. Typically an adjusting entry will include which of the following?
____________ One Balance Sheet Account And One Income Statement Account
____________Two Balance Sheet Accounts
____________ Two Income Statement Accounts
* The right answer is one Balance Sheet Account And One Income Statement Account
- Nearly all adjusting entries involve a minimum of one balance sheet account and a minimum of one income statement account.
Use the following information to answer questions 24 - 29:
A company borrowed $100,000 on December 1 by signing a six-month note that specifies interest at an annual percentage rate (APR) of 12%.
No interest or principal payment is due until the note matures on May 31.
The company prepares financial statements at the end of each calendar month.
The following questions pertain to the adjusting entry that should be entered in the company's records.
24. What date should be used to record the December adjusting entry?
* The right answer is 31 December (the last day of the accounting period)
25. How many accounts are involved in the adjusting entry?
* The right answer is Two
26. What is the name of the account that will be debited?
* The right answer is Interest Expense (an income statement account)
27. What is the name of the account that will be credited?
* The right answer is Interest Payable (a balance sheet account)
28. What is the amount of the debit and the credit?
* The right answer is $1,000.
Computation:
12% per year is 1% per month X $100,000 = $1,000 per month.
Another method is Principal X Rate X Time = $100,000 X .12 X 1/12 = $1,000.
- As of December 31 the company owes just one month of interest. When the note becomes due, the company will have to remit six months of interest for a total of $6,000 ($100,000 X .12 X 6/12).
29. What would be the effect on the financial statements if the company fails to make the adjusting entry on December 31?
* The right answer is
- If the company fails to make the December 31 adjusting entry there will be four consequences:
1) Interest Expense will be understated (too little expense being reported) by $1,000.
2) Net Income will be overstated (too much net income being reported) by $1,000.
3) Owner's equity will be overstated by $1,000.
4) Interest Payable will be understated by $1,000.
The accounting equation and balance sheet will show liabilities (Interest Payable) understated by $1,000 and owner's equity overstated by $1,000.
Reference
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