The Basics of Adjusting Entries
¾ Under the accrual basis of accounting, adjusting entries are needed to ensure that the
revenue recognition and matching principle are followed
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income/loss
Types of adjusting entries
Prepayments
Accruals
Estimates
Prepaid expenses ± expenses
paid in cash and recorded as
assets before they are used or
consumed
Accrued expenses ± expenses
incurred buy not yet paid in
cash or recorded
Amortization ± allocation of
the cost of capital assets to
expense over their useful lives
Unearned revenues ± revenues
received in cash and recorded
as liabilities before they are
earned
Accrued revenues ± revenues
earned but not yet received in
cash or recorded
Adjusting entries for prepayments
¾ Adjusting entries are used to record the portion of the prepayment that is for the
expense incurred or the revenue earned in the current accounting period
¾ If an adjustment is needed for prepayments, the asset and liability are overstated and
the related expense and revenue are understated until the adjustments are made
Prepaid Expenses
¾ Prepaid expenses expire either with the passage of time (e.g. rent and insurance) or
through use and consumption (e.g. supplies)
¾ Thus, the prepaid expense adjusting entry results in a debit (increase) to an expense
account and a credit (decrease) to an asset account
Unearned Revenues
¾ The adjusting entry for unearned revenues results in a debit (decrease) to a liability
account and a credit (increase) to a revenue account
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