Question

What are adjusting entries? Why are they needed?

Adjusting entry examples are appreciated.

Answer 1

Answer

• Adjustment entries are the journal entries that are required to complete the accounts based on ‘accrual’ concept of accounting.
  Without these adjusting entries, the financial statements will not portray a true and correct picture.
  Adjustments entries that are to be made may relate to:
  >Accrued expense (expenses incurred, not yet paid)
  >Accrued revenue (revenue earned, not received)
  >Depreciation expense and amortisation
  >Adjustment of defferals.
• Example:
  Lets consider a situation where before adjustment entries, the position is like this:
  Total revenues $ 10000, Total expenses (excluding interest expense and depreciation) = $ 5000, Depreciation provided for 6 months only $ 500, and interest expenses are not adjusted for the year are $ 1500.

In the above example, if we prepare income statement, the net income would be
= Revenues – Expenses
= $ 10000 – 5000 – 500 = $ 4,500

Now, consider the effect of following adjusting entries:

Adj#	Accouts title	Debit	Credit
#1	Depreciation expense	$500
	Accumulated Depreciation		$500
	(to ADJUST remaining 6 month depreciation)
#2	Interest Expense	$1,500
	Interest Payable		$1,500
	(to adjust interest accrued but not paid)

Now, after adjustment, the Net Income
= Revenues – Expenses
= $ 10000 - $ 5000 other expense - $ 1000 depreciation - $ 1500 interest expense
= $ 2,500

• Now you can see the importance of adjusting entries.
  had these not been recorded, the Net Income would be $ 4500 (OVER STATED and wrong)