Question

Explain the need for adjusting entries and list the four adjusting entries that will be covered this week in class. If we failed to make the adjustments what effect will this have on the Income Statement? The statement of Owners Equity? and The Balance Sheet?

Answer 1

Adjusting entries are very important at the end of the year to have correct balances in individual accounts so that financial statements will have accurate details or have no errors.

Some adjusting entries are -

1) Rent of $6,000 for 3 months is paid, the initial entry would be -

Debit Prepaid Rent $6,000

Credit Cash $6,000

When first month gets over then the adjusting entry at the end of the period is -

Debit Rent Expense $2,000

Credit Prepaid Rent $2,000

2) Charging Depreciation/write off of Fixed Assets for a particular period at the end of the year-

Debit Depreciation Expense

Credit Accumulated Depreciation

3) Accrual Income - Revenue earned but not received -

Debit Accounts Receivable

Credit Service Revenue

When received -

Debit Cash

Credit Accounts Receivable

4) Expenses incurred but not paid -

Debit Insurance Expense

Credit Accounts Payable

When Paid -

Debit Accounts Payable

Credit Cash

If we failed to record the expenses stated as examples above,

Impact on Income Statement, net income will show more and it will also result more in retained earnings in the owners equity statement.

On balance sheet, the prepaid rent will show under assets and it will continue to appear under current assets though the period is expired.

Even, it is the same case with depreciation results into more expense and since it is not recorded then net income will show more, thus, it will also show more in retained earnings in owners' equity.

On balance sheet, fixed assets like plant & equipment, property etc. will show more due to no depreciation deduction in the assets account.

In the same way, if the adjusting entries relating to expenses are not made then net income will show more that result into increase in retained earnings in owners equity. On balance sheet, the relevant asset shows more in balance.

On other way, if the adjusting entries relating to income are not made then net income will show less that result into decrease in retained earnings in owners equity. On balance sheet, the relevant liabilities/assets show more/less in balance as the case may be.