Question

Explain the purpose of adjustments and analyze the adjustments necessary at the end of the period to update balance sheet and income statement accounts.

Answer 1

The adjustments are incorporated in the financial statements at the end of an accounting period to account for the items which affect the revenues and expenses of the business in more than one accounting period. For example, advance received from customers for providing services in future requires adjustment because the amount of advance has been received without providing the services and it is recognized as revenue in the period in which services are actually provided and not in the period in which it is received. Other examples include outstanding salaries, prepaid expenses etc. Adjustments are needed to be recorded to follow the matching concept of accounting which states that the revenues earned in a period should be matched with the expenses incurred in the same period.

Following are the adjustments which are generally needed to update the financial statements (a) Outstanding Expenses These are the expenses which are incurred but not paid in the current period and hence, they are shown as a liability because the benefit has been derived by the firm but payment has not been made (b) Unearned Incomes These are the items of revenue which are received in advance by the firm and are recorded as liabilities by way of adjustments because the product or service is yet to be provided to the customers (c) Accrued Incomes These are the revenue items which have been earned by a firm in the current accounting period but have not been received till the end of period. These items are adjusted as assets because the work has been performed by the firm and the amount has not been received. (d) Prepaid Expenses These are the expenses which are paid by the firm in advance, without actually deriving the benefit of them. These items are also adjusted as assets because their benefit is yet to be received and the amount has been already paid Apart from the above listed items, there are some other items also which require adjustment because these are not recorded as a financial event or transaction during the period but affect the profitability of the firm. Examples include depreciation expense, supplies expense, change in value of investments etcl