Adjusting Entries in Accounting
Mentoring a new accountant is an exciting new work opportunity. New accountants in a medium sized manufacturing firm need to know the basics of the firms recording procedures and why adjusting entries is necessary.
After creating a trial balance in an accrual based accounting system it is important to adjust entries. Accrual based accounting systems record revenues when earned and expenses when incurred. (Godwin 2010) Since there is a time lapse in the accounting steps, accountants must adjust the entries in the journal to reflect the time at which the transactions pertaining to an entry that is out of balance will take place.
There are four types of entries that are adjusted. The firm will adjust entries when they receive money before it is earned as revenue or sometimes after it is earned as revenue. Other times the firm may pay out money before the expense is incurred and sometimes they use credit and defer the expense payment. This is considered a deferred revenue. It is a revenue for jeans that have not yet been sent to the buyer. We would have an asset entry for receiving the cash and a liability entry for the goods yet to be made.
For example, the firm manufactures denim jeans and in March receives an earnest payment from a designer to manufacture goods to be made before the holidays. At the end of March the company still hasn’t started the project yet but its asset and revenue accounts are credited for the payment of goods. The trial balance is offset the amount of the earnest payment. The entry would be adjusted by the creating a liability account for the shipment of the goods.
Earnest payments $25,000
Payments Liability $25,000
The next scenario refers to an account where the firm receives cash after the delivery of the goods. Since the designer paid some money upfront the firm sent him the jeans with the rest of the payments to be made at a later date. So, in November during the holidays they sent the jeans and the designer owed the company another 25,000 dollar payment. Novembers trial balance showed the revenue from the jeans on the asset and revenue accounts so it must also be credited the cash payment as a receivable.
Jeans sold $25,000
Account receivable 25,000
Another example of an adjusted entry would be a deferred expense. The company must keep denim material in stock, so they keep an account with a nearby denim material manufacturer who sends them material. As per their arrangement the firm pays the company a lump sum for many bolts of fabric. They buy enough fabric that it supplies the firm for several months. They purchased fabric last month in the amount of $18,000 and the payment was recorded on the liability and expense accounts for December. However, the firm didn’t use the material until the beginning of January the next year and then continued to utilize that fabric over a period of 6 months. To fix this issue December trial balance should be adjusted.
Materials Expense $18,000
Materials Carryover Balance $18,000
The final type of adjusted entry happens when the firm purchases zippers on credit. They order and receive zippers at the beginning of the month and then pay for them at a later time. So the supplies account gets credited for receipt of the zippers before the asset and expense accounts are docked for the payment of the zippers. When the firm runs its trial balance it fixes this issue by creating an accrued expense account. The firm received a shipment of 500 zippers for December that cost $500.
Account payable $500
These numbers must be fed into the database which is linked to the computerized accounting system. The accounting system draws the numbers from the database records to create the trial balance and other financial statements. (Computer and Computerized Accounting Systems n.d.)
When adjusting these entries an accountant must avoid the temptation to “cook the books.” An accountant or other person might be tempted to not go back and adjust some entries which might make the company appear better off than it actually is. This would make it look like the company has more income or fewer liabilities. (Haws 2007)
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