a) Explain why adjusting entries are necessary.
Adjusting journal entries are made at the end of each closing period to adjust the account balances. Most times, this is necessary in order to achieve a clean cut-off at the end of the accounting period and to ensure the accounts are complete and accurate. Current account balances may not represent correct balances because mistakes were identified in the posting of transactions and/or the accounting records are not updated to reflect new transactions or amount changes in previous transactions. Examples would include amounts posted to the wrong accounts and timing differences in recognizing revenues and expenses between the accrual and the cash basis of accounting. (Adjusting JE, 2010) Adjusting entries can be either temporary or permanent. If the entry is temporary at some point the adjusting entry will be reversed or another adjusting entry will be made to the account.
b) Describe the 4 types of adjusting entries, and provide a manufacturing industry example of each.
Basic types of adjusting journal entries:
- Accrued revenues (also called accrued assets) are revenues already earned but not yet paid by the customer or posted to the general ledger. An example of accrued revenue would be for a custom ordered machine that has been shipped FOB shipping point on the day the accounts receivable module is closed and the approval to bill the customer has not been received by the billing clerk. An adjusting entry would be recorded to recognize the revenue in the correct period. This entry will reverse when the customer is appropriately invoiced.
- Unearned revenues (or deferred revenues) are revenues received in cash and recorded as liabilities prior to being earned. Unearned revenue is a liability to the entity until the revenue is earned. An example of unearned revenue would be if the customer paid a deposit for a custom ordered machine that has not been delivered, the deposit would be recorded as unearned revenue. This type of adjusting entry will be adjusted by another entry.
- Accrued expenses (also called accrued liabilities) are expenses already incurred but not yet paid or recorded. Examples of these types of adjusting entries could be for payroll that has been earned by employees on the last day of the period but not paid until the next payroll date. These types of entries generally reverse the next month.
- Prepaid expenses (or deferred expenses) are expenses paid in cash and recorded as assets prior to being used. The most common form of an adjusting entry for prepaid expense would be for the used portion of an insurance premium. These types of adjusting entries are usually permanent.
- Other adjusting entries include depreciation of fixed assets, allowances for bad debts, and inventory adjustments.
- Bad Debt Expense 50
- Allowance for Bad debt 50 (Adjusting EN, 2010)
c) Describe how these entries would be recorded in a computerized accounting system.
At the end of each closing period, usually monthly, a thorough analysis of the trial balance is preformed. This analysis includes performance budget to actual and month to month to ensure all of the accounts are correctly stated. When an adjusting entry is identified, a journal entry input form is prepared. This form should be supported with source documents that justify the entry and reviewed and approved by the appropriate level of accounting management. Once the approval has been obtained, the journal entry is keyed into the general ledger system as either a standard or self reversing journal entry. The journal entry is than posted to the general ledger.
d) Describe 2 ethical issues that could result from the preparation of these manufacturing entries?
Adjusting journal entries are a good way for management to manipulate financial results by either accruing more revenue or expense than appropriate and for fraudsters to hide skimming, which is the misappropriation of cash. It is extremely important to understand that each adjusting journal entry must be fully supported and approved.
Adjusting, JE. (2010). Adjusting journal entries
. Retrieved from http://accountinginfo.com/study/je/aje/index.htm
Adjusting, EN. (2010). Adjusting entries in accounting
. Retrieved from http://www.college-cram.com/study/accounting/accounting-cycle/adjusting-entries-in-accounting/
Edited by Karla on 11/17/2010 at 8:09 PM EST