Lesson 017 - Adjusting Entries 1: Prepaid Expenses (Basic Approach)

Summary

This video lesson covers the concept of adjusting entries in accounting, which are made at the end of the accounting period to update balances for assets, liabilities, revenues, and expenses. The instructor explains the importance of adjusting entries in preparing accurate financial statements, using practical examples like prepaid transportation cards. Different types of adjustments, such as prepaid expenses, accrued revenues, and depreciation, are discussed. The video emphasizes the application of key accounting principles such as completeness, matching, and revenue recognition. A step-by-step example of adjusting entries for office supplies is also provided.

Takeaways

• 📊 Adjusting entries are made at the end of an accounting period before closing procedures to update balances of assets, liabilities, revenues, and expenses for accurate financial reporting.
• 📆 Adjusting entries must be done at the end of each accounting period, whether it's monthly or annually, to ensure the balances are correct for financial statement preparation.
• 💡 Adjusting entries update accounts like prepaid expenses, deferred revenue, accrued revenue, accrued expenses, and depreciation, ensuring that all transactions are properly reflected in financial statements.
• 🚉 An analogy is used involving a prepaid transportation card to explain how adjusting entries work, showing how prepaid amounts decrease as they are used.
• 📜 Common types of adjusting entries include prepaid expenses, deferred revenue, accrued revenue, accrued expenses, asset depreciation, and bad debts (uncollectible accounts).
• 🏢 Prepaid expenses start as an asset (like prepaid insurance or office supplies) and are gradually expensed as they are consumed or expired over time.
• 💼 Deferred revenue occurs when a company receives payment for services not yet rendered; it starts as a liability and is later recognized as revenue once the service is provided.
• 📝 Accrued revenue and accrued expenses are recorded when a service has been provided but payment has not been received (for revenue) or when expenses are incurred but not yet paid.
• 🏗 Asset depreciation is systematically allocated over time, reducing the value of long-term assets like machinery and furniture as they age or are used.
• 📈 Adjusting entries adhere to key accounting principles like completeness, matching principle, and accrual basis of accounting, ensuring all financial transactions are accurately recorded and matched to the correct period.

Q & A

What are adjusting entries in accounting?

Adjusting entries are journal entries made at the end of the accounting period before closing procedures to update balances of asset, liability, revenue, and expense accounts. These adjustments ensure that account balances are accurate and ready for the preparation of financial statements.

Why are adjusting entries necessary?

Adjusting entries are necessary to accurately reflect the financial status of a business by ensuring that assets, liabilities, revenues, and expenses are reported correctly. This allows for the correct preparation of financial statements at the end of the accounting period.

Can you provide an example of an adjusting entry?

An example of an adjusting entry involves prepaid transportation. If you purchase a prepaid transportation card for 100 pesos and use 30 pesos for transportation during the period, an adjusting entry is made to recognize the 30 pesos as a transportation expense and the remaining 70 pesos as a prepaid transportation asset.

What are the different types of adjusting entries?

The different types of adjusting entries include prepaid expenses, deferred revenue, accrued revenue, accrued expenses, depreciation of assets, and adjustments for uncollectible accounts.

What are prepaid expenses, and how are they adjusted?

Prepaid expenses are expenses paid in advance, such as prepaid insurance. Initially, they are recorded as an asset. Over time, as the service is consumed, part of the prepaid amount is recognized as an expense. For example, if you prepaid 100,000 for office supplies and used 60,000 by the end of the year, you would adjust by debiting 60,000 to office supplies expense and crediting 60,000 from the prepaid office supplies account.

What is the difference between accrued revenue and deferred revenue?

Accrued revenue refers to revenue that has been earned but not yet received in cash, while deferred revenue is money received in advance for services or goods yet to be delivered. Accrued revenue is recorded as income even if cash is not yet received, while deferred revenue starts as a liability and is recognized as revenue when the service or product is delivered.

How is depreciation of assets handled in adjusting entries?

Depreciation of assets is an adjustment made to allocate the cost of tangible fixed assets, like machinery or furniture, over their useful life. This is done systematically over time, and an adjusting entry is made to record the depreciation expense and reduce the asset's book value.

What is the matching principle, and how does it relate to adjusting entries?

The matching principle states that expenses should be recorded in the same period as the revenues they help generate. Adjusting entries adhere to this principle by ensuring that all related expenses and revenues are matched properly to measure a company's net income or net loss accurately.

What happens if adjusting entries are not made?

If adjusting entries are not made, the financial statements will not accurately reflect the company's financial position. This can lead to misstated income, over- or under-stated assets and liabilities, and incorrect net income or loss calculations.

How are adjusting entries recorded in a journal?

Adjusting entries are recorded in a journal by debiting and crediting the appropriate accounts. For example, in a case where prepaid expenses are used, the expense account is debited, and the related asset account is credited to reflect the consumption of the asset.