For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.
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Introduction
Adjusting entries are accounting journal entries that convert a company’s accounting records to the accrual basis of accounting. An adjusting journal entry is typically made just prior to issuing a company’s financial statements.
To demonstrate the need for an accounting adjusting entry let’s assume that a company borrowed money from its bank on December 1, 2023 and that the company’s accounting period ends on December 31. The bank loan specifies that the first interest payment on the loan will be due on March 1, 2024. This means that the company’s accounting records as of December 31 do not contain any payment to the bank for the interest the company incurred from December 1 through December 31. (Of course the loan is costing the company interest expense every day, but the actual payment for the interest will not occur until March 1.)
For the company’s December income statement to accurately report the company’s profitability, it must include all of the company’s December expenses—not just the expenses that were paid. Similarly, for the company’s balance sheet on December 31 to be accurate, it must report a liability for the interest owed as of the balance sheet date. An adjusting entry is needed so that December’s interest expense is included on December’s income statement and the interest due as of December 31 is included on the December 31 balance sheet. The adjusting entry will debit Interest Expense and credit Interest Payable for the amount of interest from December 1 to December 31.
Another situation requiring an adjusting journal entry arises when an amount has already been recorded in the company’s accounting records, but the amount is for more than the current accounting period. To illustrate let’s assume that on December 1, 2023 the company paid its insurance agent $2,400 for insurance protection during the period of December 1, 2023 through May 31, 2024. The $2,400 transaction was recorded in the accounting records on December 1, but the amount represents six months of coverage and expense. By December 31, one month of the insurance coverage and cost have been used up or expired. Hence the income statement for December should report just one month of insurance cost of $400 ($2,400 divided by 6 months) in the account Insurance Expense. The balance sheet dated December 31 should report the cost of five months of the insurance coverage that has not yet been used up. (The cost not used up is referred to as the asset Prepaid Insurance. The cost that is used up is referred to as the expired cost Insurance Expense.) This means that the balance sheet dated December 31 should report five months of insurance cost or $2,000 ($400 per month times 5 months) in the asset account Prepaid Insurance. Since it is unlikely that the $2,400 transaction on December 1 was recorded this way, an adjusting entry will be needed at December 31, 2023 to get the income statement and balance sheet to report this accurately.
The two examples of adjusting entries have focused on expenses, but adjusting entries also involve revenues. This will be discussed later when we prepare adjusting journal entries.
For now we want to highlight some important points.
There are two scenarios where adjusting journal entries are needed before the financial statements are issued:
Nothing has been entered in the accounting records for certain expenses or revenues, but those expenses and/or revenues did occur and must be included in the current period’s income statement and balance sheet.
Something has already been entered in the accounting records, but the amount needs to be divided up between two or more accounting periods.
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Adjusting Entries – Asset Accounts
Adjusting entries assure that both the balance sheet and the income statement are up-to-date on the accrual basis of accounting. A reasonable way to begin the process is by reviewing the amount or balance shown in each of the balance sheet accounts. We will use the following preliminary balance sheet, which reports the account balances prior to any adjusting entries:
The Cash account has a preliminary balance of $1,800—the amount in the general ledger. Before issuing the balance sheet, one must ask, “Is $1,800 the true amount of cash? Does it agree to the amount computed on the bank reconciliation?” The accountant found that $1,800 was indeed the true balance. (If the preliminary balance in Cash does not agree to the bank reconciliation, entries are usually needed. For example, if the bank statement included a service charge and a check printing charge—and they were not yet entered into the company’s accounting records—those amounts must be entered into the Cash account. Visit our Bank Reconciliation Explanation for a thorough discussion and illustration of the likely journal entries.)
Accounts Receivable $4,600
To determine if the balance in this account is accurate the accountant might review the detailed listing of customers who have not paid their invoices for goods or services. (This is often referred to as the amount of open or unpaid sales invoices and is often found in the accounts receivable subsidiary ledger.) When those open invoices are sorted according to the date of the sale, the company can tell how old the receivables are. Such a report is referred to as an aging of accounts receivable. Let’s assume the review indicates that the preliminary balance in Accounts Receivable of $4,600 is accurate as far as the amounts that have been billed and not yet paid.
However, under the accrual basis of accounting, the balance sheet must report all the amounts the company has an absolute right to receive—not just the amounts that have been billed on a sales invoice. Similarly, the income statement should report all revenues that have been earned—not just the revenues that have been billed. After further review, it is learned that $3,000 of work has been performed (and therefore has been earned) as of December 31 but won’t be billed until January 10. Because this $3,000 was earned in December, it must be entered and reported on the financial statements for December. An adjusting entry dated December 31 is prepared in order to get this information onto the December financial statements.
To assist you in understanding adjusting journal entries, double entry, and debits and credits, each example of an adjusting entry will be illustrated with a T-account.
Here is the process we will follow:
Draw two T-accounts. (Every journal entry involves at least two accounts. One account to be debited and one account to be credited.)
Indicate the account titles on each of the T-accounts. (Remember that almost always one of the accounts is a balance sheet account and one will be an income statement account. In a smaller font size we will indicate the type of account next to the account title and we will also indicate some tips about debits and credits within the T-accounts.)
Enter the preliminary balance in each of the T-accounts.
Determine what the ending balance ought to be for the balance sheet account.
Make an adjustment so that the ending amount in the balance sheet account is correct.
Enter the same adjustment amount into the related income statement account.
Write the adjusting journal entry.
Let’s follow that process here:
The adjusting entry for Accounts Receivable in general journal format is:
Notice that the ending balance in the asset Accounts Receivable is now $7,600—the correct amount that the company has a right to receive. The income statement account balance has been increased by the $3,000 adjustment amount, because this $3,000 was also earned in the accounting period but had not yet been entered into the Service Revenues account. The balance in Service Revenues will increase during the year as the account is credited whenever a sales invoice is prepared. The balance in Accounts Receivable also increases if the sale was on credit (as opposed to a cash sale). However, Accounts Receivable will decrease whenever a customer pays some of the amount owed to the company. Therefore the balance in Accounts Receivable might be approximately the amount of one month’s sales, if the company allows customers to pay their invoices in 30 days.
At the end of the accounting year, the ending balances in the balance sheet accounts (assets and liabilities) will carry forward to the next accounting year. The ending balances in the income statement accounts (revenues and expenses) are closed after the year’s financial statements are prepared and these accounts will start the next accounting period with zero balances.
(It’s common not to list accounts with $0 balances on balance sheets.)
Although the Allowance for Doubtful Accounts does not appear on the preliminary balance sheet, experienced accountants realize that it is likely that some of the accounts receivable might not be collected. (This could occur because some customers will have unforeseen hardships, some customers might be dishonest, etc.) If some of the $4,600 owed to the company will not be collected, the company’s balance sheet should report less than $4,600 of accounts receivable. However, rather than reducing the balance in Accounts Receivable by means of a credit amount, the credit amount will be reported in Allowance for Doubtful Accounts. (The combination of the debit balance in Accounts Receivable and the credit balance in Allowance for Doubtful Accounts is referred to as the net realizable value.)
Let’s assume that a review of the accounts receivables indicates that approximately $600 of the receivables will not be collectible. This means that the balance in Allowance for Doubtful Accounts should be reported as a $600 credit balance instead of the preliminary balance of $0. The two accounts involved will be the balance sheet account Allowance for Doubtful Accounts and the income statement account Bad Debts Expense.
The adjusting journal entry for Allowance for Doubtful Accounts is:
It is possible for one or both of the accounts to have preliminary balances. However, the balances are likely to be different from one another. Because Allowance for Doubtful Accounts is a balance sheet account, its ending balance will carry forward to the next accounting year. Because Bad Debts Expense is an income statement account, its balance will not carry forward to the next year. Bad Debts Expense will start the next accounting year with a zero balance.
The Supplies account has a preliminary balance of $1,100. However, a count of the supplies actually on hand indicates that the true amount of supplies is $725. This means that the preliminary balance is too high by $375 ($1,100 minus $725). A credit of $375 will need to be entered into the asset account in order to reduce the balance from $1,100 to $725. The related income statement account is Supplies Expense.
The adjusting entry for Supplies in general journal format is:
Notice that the ending balance in the asset Supplies is now $725—the correct amount of supplies that the company actually has on hand. The income statement account Supplies Expense has been increased by the $375 adjusting entry. It is assumed that the decrease in the supplies on hand means that the supplies have been used during the current accounting period. The balance in Supplies Expense will increase during the year as the account is debited. Supplies Expense will start the next accounting year with a zero balance. The balance in the asset Supplies at the end of the accounting year will carry over to the next accounting year.
Prepaid Insurance $1,500
The $1,500 balance in the asset account Prepaid Insurance is the preliminary balance. The correct balance needs to be determined. The correct amount is the amount that has been paid by the company for insurance coverage that will expire after the balance sheet date. If a review of the payments for insurance shows that $600 of the insurance payments is for insurance that will expire after the balance sheet date, then the balance in Prepaid Insurance should be $600. All other amounts should be charged to Insurance Expense.
The adjusting journal entry for Prepaid Insurance is:
Note that the ending balance in the asset Prepaid Insurance is now $600—the correct amount of insurance that has been paid in advance. The income statement account Insurance Expense has been increased by the $900 adjusting entry. It is assumed that the decrease in the amount prepaid was the amount being used or expiring during the current accounting period. The balance in Insurance Expense starts with a zero balance each year and increases during the year as the account is debited. The balance at the end of the accounting year in the asset Prepaid Insurance will carry over to the next accounting year.
Equipment is a long-term asset that will not last indefinitely. The cost of equipment is recorded in the account Equipment. The $25,000 balance in Equipment is accurate, so no entry is needed in this account. As an asset account, the debit balance of $25,000 will carry over to the next accounting year.
Accumulated Depreciation – Equipment is a contra asset account and its preliminary balance of $7,500 is the amount of depreciation actually entered into the account since the Equipment was acquired. The correct balance should be the cumulative amount of depreciation from the time that the equipment was acquired through the date of the balance sheet. A review indicates that as of December 31 the accumulated amount of depreciation should be $9,000. Therefore the account Accumulated Depreciation – Equipment will need to have an ending balance of $9,000. This will require an additional $1,500 credit to this account. The income statement account that is pertinent to this adjusting entry and which will be debited for $1,500 is Depreciation Expense – Equipment.
The ending balance in the contra asset account Accumulated Depreciation – Equipment at the end of the accounting year will carry forward to the next accounting year. The ending balance in Depreciation Expense – Equipment will be closed at the end of the current accounting period and this account will begin the next accounting year with a balance of $0.
Notes Payable is a liability account that reports the amount of principal owed as of the balance sheet date. (Any interest incurred but not yet paid as of the balance sheet date is reported in a separate liability account Interest Payable.) The accountant has verified that the amount of principal actually owed is the same as the amount appearing on the preliminary balance sheet. Therefore, no entry is needed for this account.
Interest Payable $0
(It’s common not to list accounts with $0 balances on balance sheets.)
Interest Payable is a liability account that reports the amount of interest the company owes as of the balance sheet date. Accountants realize that if a company has a balance in Notes Payable, the company should be reporting some amount in Interest Expense and in Interest Payable. The reason is that each day that the company owes money it is incurring interest expense and an obligation to pay the interest. Unless the interest is paid up to date, the company will always owe some interest to the lender.
Let’s assume that the company borrowed the $5,000 on December 1 and agrees to make the first interest payment on March 1. If the loan specifies an annual interest rate of 6%, the loan will cost the company interest of $300 per year or $25 per month. On March 1 the company will be required to pay $75 of interest. On the December income statement the company must report one month of interest expense of $25. On the December 31 balance sheet the company must report that it owes $25 as of December 31 for interest.
The adjusting journal entry for Interest Payable is:
It is unusual that the amount shown for each of these accounts is the same. In the future months the amounts will be different. Interest Expense will be closed automatically at the end of each accounting year and will start the next accounting year with a $0 balance.
Accounts Payable is a liability account that reports the amounts owed to suppliers or vendors as of the balance sheet date. Amounts are routinely entered into this account after a company has received and verified all of the following: (1) an invoice from the supplier, (2) goods or services have been received, and (3) compared the amounts to the company’s purchase order. A review of the details confirms that this account’s balance of $2,500 is accurate as far as invoices received from vendors.
However, under the accrual basis of accounting the balance sheet must report all the amounts owed by the company—not just the amounts that have been entered into the accounting system from vendor invoices. Similarly, the income statement must report all expenses that have been incurred—not merely the expenses that have been entered from a vendor’s invoice. To illustrate this, assume that a company had $1,000 of plumbing repairs done in late December, but the company has not yet received an invoice from the plumber. The company will have to make an adjusting entry to record the expense and the liability on the December financial statements. The adjusting entry will involve the following accounts:
The adjusting entry for Accounts Payable in general journal format is:
The balance in the liability account Accounts Payable at the end of the year will carry forward to the next accounting year. The balance in Repairs & Maintenance Expense at the end of the accounting year will be closed and the next accounting year will begin with $0.
Wages Payable is a liability account that reports the amounts owed to employees as of the balance sheet date. Amounts are routinely entered into this account when the company’s payroll records are processed. A review of the details confirms that this account’s balance of $1,200 is accurate as far as the payrolls that have been processed.
However, under the accrual basis of accounting the balance sheet must report all of the payroll amounts owed by the company—not just the amounts that have been processed. Similarly, the income statement must report all of the payroll expenses that have been incurred—not merely the expenses from the routine payroll processing. For example, assume that December 30 is a Sunday and the first day of the payroll period. The wages earned by the employees on December 30-31 will be included in the payroll processing for the week of December 30 through January 5. However, the December income statement and the December 31 balance sheet need to include the wages for December 30-31, but not the wages for January 1-5. If the wages for December 30-31 amount to $300, the following adjusting entry is required as of December 31:
The adjusting journal entry for Wages Payable is:
The $1,500 balance in Wages Payable is the true amount not yet paid to employees for their work through December 31. The $13,420 of Wages Expense is the total of the wages used by the company through December 31. The Wages Payable amount will be carried forward to the next accounting year. The Wages Expense amount will be zeroed out so that the next accounting year begins with a $0 balance.
Unearned Revenues is a liability account that reports the amounts received by a company but have not yet been earned by the company. For example, if a company required a customer with a poor credit rating to pay $1,300 before beginning any work, the company increases its asset Cash by $1,300 and it should increase its liability Unearned Revenues by $1,300.
As the company does the work, it will reduce the Unearned Revenues account balance and increase its Service Revenues account balance by the amount earned (work performed). A review of the balance in Unearned Revenues reveals that the company did indeed receive $1,300 from a customer earlier in December. However, during the month the company provided the customer with $800 of services. Therefore, at December 31 the amount of services due to the customer is $500.
Let’s visualize this situation with the following T-accounts:
The adjusting entry for Unearned Revenues in general journal format is:
Since Unearned Revenues is a balance sheet account, its balance at the end of the accounting year will carry over to the next accounting year. On the other hand Service Revenues is an income statement account and its balance will be closed when the current year is over. Revenues and expenses always start the next accounting year with $0.
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Accruals & Deferrals
Adjusting entries are often sorted into two groups: accruals and deferrals.
Accruals
Accruals (or accrual-type adjusting entries) involve both expenses and revenues and are associated with the first scenario mentioned in the introduction to this topic:
Nothing has been entered in the accounting records for certain expenses and/or revenues, but those expenses and/or revenues did occur and must be included in the current period’s income statement and balance sheet.
Accrual of Expenses
An accountant might say, “We need to accrue the interest expense on the bank loan.” That statement is made because nothing had been recorded in the accounts for interest expense, but the company did indeed incur interest expense during the accounting period. Further, the company has a liability or obligation for the unpaid interest up to the end of the accounting period. What the accountant is saying is that an accrual-type adjusting journal entry needs to be recorded.
The accountant might also say, “We need to accrue for the wages earned by the employees on Sunday, December 30, and Monday, December 31.” This means that an accrual-type adjusting entry is needed because the company incurred wages expenses on December 30-31 but nothing will be entered routinely into the accounting records by the end of the accounting period on December 31.
A third example is the accrual of utilities expense. Utilities provide the service (gas, electric, telephone) and then bill for the service they provided based on some type of metering. As a result the company will incur the utility expense before it receives a bill and before the accounting period ends. Hence, an accrual-type adjusting journal entry must be made in order to properly report the correct amount of utilities expenses on the current period’s income statement and the correct amount of liabilities on the balance sheet.
Accrual of Revenues
Accountants also use the term “accrual” or state that they must “accrue” when discussing revenues that fit the first scenario. For example, an accountant might say, “We need to accrue for the interest the company has earned on its certificate of deposit.” In that situation the company probably did not receive any interest nor did the company record any amounts in its accounts, but the company did indeed earn interest revenue during the accounting period. Further the company has the right to the interest earned and will need to list that as an asset on its balance sheet.
Similarly, the accountant might say, “We need to prepare an accrual-type adjusting entry for the revenues we earned by providing services on December 31, even though they will not be billed until January.”
Deferrals
Deferrals or deferral-type adjusting entries can pertain to both expenses and revenues and refer to the second scenario mentioned in the introduction to this topic:
Something has already been entered in the accounting records, but the amount needs to be divided up between two or more accounting periods.
Deferral of Expenses
An accountant might say, “We need to defer some of the insurance expense.” That statement is made because the company may have paid on December 1 the entire bill for the insurance coverage for the six-month period of December 1 through May 31. However, as of December 31 only one month of the insurance is used up. Hence the cost of the remaining five months is deferred to the balance sheet account Prepaid Insurance until it is moved to Insurance Expense during the months of January through May. If the company prepares monthly financial statements, a deferral-type adjusting entry may be needed each month in order to move one-sixth of the six-month cost from the asset account Prepaid Insurance to the income statement account Insurance Expense.
The accountant might also say, “We need to defer some of the cost of supplies.” This deferral is necessary because some of the supplies purchased were not used or consumed during the accounting period. An adjusting entry will be necessary to defer to the balance sheet the cost of the supplies not used, and to have only the cost of supplies actually used being reported on the income statement. The costs of the supplies not yet used are reported in the balance sheet account Supplies and the cost of the supplies used during the accounting period are reported in the income statement account Supplies Expense.
Deferral of Revenues
Deferrals also involve revenues. For example if a company receives $600 on December 1 in exchange for providing a monthly service from December 1 through May 31, the accountant should “defer” $500 of the amount to a liability account Unearned Revenues and allow $100 to be recorded as December service revenues. The $500 in Unearned Revenues will be deferred until January through May when it will be moved with a deferral-type adjusting entry from Unearned Revenues to Service Revenues at a rate of $100 per month.
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Avoiding Adjusting Entries
If you want to minimize the number of adjusting journal entries, you could arrange for each period’s expenses to be paid in the period in which they occur. For example, you could ask your bank to charge your company’s checking account at the end of each month with the current month’s interest on your company’s loan from the bank. Under this arrangement December’s interest expense will be paid in December, January’s interest expense will be paid in January, etc. You simply record the interest payment and avoid the need for an adjusting entry. Similarly, your insurance company might automatically charge your company’s checking account each month for the insurance expense that applies to just that one month.
Where to Go From Here
We recommend taking our Practice Quiz next, and then continuing with the rest of our Adjusting Entries materials (see the full outline below).
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The accounting method under which revenues are recognized on the income statement when they are earned (rather than when the cash is received). The balance sheet is also affected at the time of the revenues by either an increase in Cash (if the service or sale was for cash), an increase in Accounts Receivable (if the service was performed on credit), or a decrease in Unearned Revenues (if the service was performed after the customer had paid in advance for the service).
Under the accrual basis of accounting, expenses are matched with revenues on the income statement when the expenses expire or title has transferred to the buyer, rather than at the time when expenses are paid. The balance sheet is also affected at the time of the expense by a decrease in Cash (if the expense was paid at the time the expense was incurred), an increase in Accounts Payable (if the expense will be paid in the future), or a decrease in Prepaid Expenses (if the expense was paid in advance).
Usually financial statements refer to the balance sheet, income statement, statement of cash flows, statement of retained earnings, and statement of stockholders’ equity.
The balance sheet reports information as of a date (a point in time). The income statement, statement of cash flows, statement of retained earnings, and the statement of stockholders’ equity report information for a period of time (or time interval) such as a year, quarter, or month.
A word used by accountants to communicate that an expense has occurred and needs to be recognized on the income statement even though no payment was made. The second part of the necessary entry will be a credit to a liability account.
One of the main financial statements (along with the balance sheet, the statement of cash flows, and the statement of stockholders’ equity). The income statement is also referred to as the profit and loss statement, P&L, statement of income, and the statement of operations. The income statement reports the revenues, gains, expenses, losses, net income and other totals for the period of time shown in the heading of the statement. If a company’s stock is publicly traded, earnings per share must appear on the face of the income statement.
Costs that are matched with revenues on the income statement. For example, Cost of Goods Sold is an expense caused by Sales. Insurance Expense, Wages Expense, Advertising Expense, Interest Expense are expenses matched with the period of time in the heading of the income statement. Under the accrual basis of accounting, the matching is NOT based on the date that the expenses are paid.
Expenses associated with the main activity of the business are referred to as operating expenses. Expenses associated with a peripheral activity are nonoperating or other expenses. For example, a retailer’s interest expense is a nonoperating expense. A bank’s interest expense is an operating expense.
Generally, expenses are debited to a specific expense account and the normal balance of an expense account is a debit balance. When an expense account is debited, the account credited might be Cash (if cash was paid at the time of the expense), Accounts Payable (if cash will be paid after the expense is recorded), or Prepaid Expense (if cash was paid before the expense was recorded.)
One of the main financial statements. The balance sheet reports the assets, liabilities, and owner’s (stockholders’) equity at a specific point in time, such as December 31. The balance sheet is also referred to as the Statement of Financial Position.
Obligations of a company or organization. Amounts owed to lenders and suppliers. Liabilities often have the word “payable” in the account title. Liabilities also include amounts received in advance for a future sale or for a future service to be performed.
This account is a non-operating or “other” expense for the cost of borrowed money or other credit. The amount of interest expense appearing on the income statement is the cost of the money that was used during the time interval shown in the heading of the income statement, not the amount of interest paid during that period of time.
This current liability account reports the amount of interest the company owes as of the date of the balance sheet. (Future interest is not recorded as a liability.)
A record in the general ledger that is used to collect and store similar information. For example, a company will have a Cash account in which every transaction involving cash is recorded. A company selling merchandise on credit will record these sales in a Sales account and in an Accounts Receivable account.
A current asset which indicates the cost of the insurance contract (premiums) that have been paid in advance. It represents the amount that has been paid but has not yet expired as of the balance sheet date.
A related account is Insurance Expense, which appears on the income statement. The amount in the Insurance Expense account should report the amount of insurance expense expiring during the period indicated in the heading of the income statement.
Fees earned from providing services and the amounts of merchandise sold. Under the accrual basis of accounting, revenues are recorded at the time of delivering the service or the merchandise, even if cash is not received at the time of delivery. Often the term income is used instead of revenues.
Examples of revenue accounts include: Sales, Service Revenues, Fees Earned, Interest Revenue, Interest Income. Revenue accounts are credited when services are performed/billed and therefore will usually have credit balances. At the time that a revenue account is credited, the account debited might be Cash, Accounts Receivable, or Unearned Revenue depending if cash was received at the time of the service, if the customer was billed at the time of the service and will pay later, or if the customer had paid in advance of the service being performed.
If the revenues earned are a main activity of the business, they are considered to be operating revenues. If the revenues come from a secondary activity, they are considered to be nonoperating revenues. For example, interest earned by a manufacturer on its investments is a nonoperating revenue. Interest earned by a bank is considered to be part of operating revenues.
Asset, liability, and owner’s equity accounts. Also referred to as permanent or real accounts.
A current asset resulting from selling goods or services on credit (on account). Invoice terms such as (a) net 30 days or (b) 2/10, n/30 signify that a sale was made on account and was not a cash sale.
A revenue, expense, gain, or loss account.
The amount of insurance that was incurred/used up/expired during the period of time appearing in the heading of the income statement. The amount of insurance premiums that have not yet expired should be reported in the current asset account Prepaid Insurance.
A current asset account which includes currency, coins, checking accounts, and undeposited checks received from customers. The amounts must be unrestricted. (Restricted cash should be recorded in a different account.)
That part of the accounting system which contains the balance sheet and income statement accounts used for recording transactions.
The process of comparing the amounts in the Cash account in the general ledger to the amounts appearing on the bank statement. The objective is to be certain that there is consistency between the amounts and that the company’s amounts are accurate and complete.
A bill issued by a seller of merchandise or by the provider of services. The seller refers to the invoice as a sales invoice and the buyer refers to the same invoice as a vendor invoice.
A revenue account that reports the sales of merchandise. Sales are reported in the accounting period in which title to the merchandise was transferred from the seller to the buyer.
A sorting of a company’s accounts receivables by the age of the receivables.
Under accrual accounting an item has been “earned” and is reported as revenue when a service has been performed or the ownership to a product has been transferred from the seller to the buyer (not when cash is received).
The 500 year-old accounting system where every transaction is recorded into at least two accounts. To learn more, see Explanation of Debits and Credits.
The accounting term that means an entry will be made on the left side of an account.
A visual aid used by accountants to illustrate a journal entry’s effect on the general ledger accounts. Debit amounts are entered on the left side of the “T” and credit amounts are entered on the right side.
The entry made in a journal. It will contain the date, the account name and amount to be debited, and the account name and amount to be credited. Each journal entry must have the dollars of debits equal to the dollars of credits.
Things that are resources owned by a company and which have future economic value that can be measured and can be expressed in dollars. Examples include cash, investments, accounts receivable, inventory, supplies, land, buildings, equipment, and vehicles.
Assets are reported on the balance sheet usually at cost or lower. Assets are also part of the accounting equation: Assets = Liabilities + Owner’s (Stockholders’) Equity.
Some valuable items that cannot be measured and expressed in dollars include the company’s outstanding reputation, its customer base, the value of successful consumer brands, and its management team. As a result these items are not reported among the assets appearing on the balance sheet.
Allowance for Doubtful Accounts is a contra current asset account associated with Accounts Receivable. When the credit balance of the Allowance for Doubtful Accounts is subtracted from the debit balance in Accounts Receivable the result is known as the net realizable value of the Accounts Receivable.
The credit balance in this account comes from the entry wherein Bad Debts Expense is debited. The amount in this entry may be a percentage of sales or it might be based on an aging analysis of the accounts receivables (also referred to as a percentage of receivables).
When the allowance account is used, the company is anticipating that some accounts will be uncollectible in advance of knowing the specific account. As a result the bad debts expense is more closely matched to the sale. When a specific account is identified as uncollectible, the Allowance for Doubtful Accounts should be debited and Accounts Receivable should be credited.
A balance on the left side of an account in the general ledger. Typically expenses, losses, and assets have debit balances.
A balance on the right side (credit side) of an account in the general ledger.
In the context of inventory, net realizable value or NRV is the expected selling price in the ordinary course of business minus the costs of completion, disposal, and transportation.
In the context of accounts receivable it is the amount of accounts receivable that is expected to be collected. This should be the debit balance in Accounts Receivable minus the credit balance in Allowance for Doubtful Accounts.
You could think of NRV as the cash realizable value.
This is an operating expense resulting from making sales on credit and not collecting the customers’ entire accounts receivable balances.
A current asset representing the cost of supplies on hand at a point in time. The account is usually listed on the balance sheet after the Inventory account.
A related account is Supplies Expense, which appears on the income statement. The amount in the Supplies Expense account reports the amounts of supplies that were used during the time interval indicated in the heading of the income statement.
Equipment is a noncurrent or long-term asset account which reports the cost of the equipment. Equipment will be depreciated over its useful life by debiting the income statement account Depreciation Expense and crediting the balance sheet account Accumulated Depreciation (a contra asset account).
The contra asset account which accumulates the amount of Depreciation Expense taken on Equipment since the equipment was acquired. As a contra asset account it will have a credit balance.
An asset account which is expected to have a credit balance (which is contrary to the normal debit balance of an asset account). The contra asset account is related to another asset account. For example, the contra asset account Allowance for Doubtful Accounts is related to Accounts Receivable. The contra asset account Accumulated Depreciation is related to a constructed asset(s), and the contra asset account Accumulated Depletion is related to natural resources.
The net of the asset and its related contra asset account is referred to as the asset’s book value or carrying value.
The systematic allocation of the cost of an asset from the balance sheet to Depreciation Expense on the income statement over the useful life of the asset. (The depreciation journal entry includes a debit to Depreciation Expense and a credit to Accumulated Depreciation, a contra asset account). The purpose is to allocate the cost to expense in order to comply with the matching principle. It is not intended to be a valuation process. In other words, the amount allocated to expense is not indicative of the economic value being consumed. Similarly, the amount not yet allocated is not an indication of its current market value.
The income statement account which contains a portion of the cost of plant and equipment that is being matched to the time interval shown in the heading of the income statement. (There is no depreciation expense for land.)
The amount of a long-term asset’s cost that has been allocated to Depreciation Expense since the time that the asset was acquired. Accumulated Depreciation is a long-term contra asset account (an asset account with a credit balance) that is reported on the balance sheet under the heading Property, Plant, and Equipment.
The amount of principal due on a formal written promise to pay. Loans from banks are included in this account.
This current liability account will show the amount a company owes for items or services purchased on credit and for which there was not a promissory note. This account is often referred to as trade payables (as opposed to notes payable, interest payable, etc.)
The supplier of goods or services.
Also referred to as a “p.o.” A multi-copy form prepared by the company that is ordering goods. The form will specify the items being ordered, the quantity, price, and terms. One copy is sent to the vendor (supplier) of the goods, and one copy is sent to the accounts payable department to be later compared to the receiving ticket and invoice from the vendor.
A current liability account that reports the amounts owed to employees for hours worked but not yet paid as of the date of the balance sheet.
A liability account that reports amounts received in advance of providing goods or services. When the goods or services are provided, this account balance is decreased and a revenue account is increased.
One of the types of adjusting entries that are made at the end of the accounting period in order to report (1) revenues that have been earned but have not yet been entered into the accounting records, and/or (2) expenses that have been incurred but have not yet been entered into the accounting records.
In accounting this means to defer or to delay recognizing certain revenues or expenses on the income statement until a later, more appropriate time. Revenues are deferred to a balance sheet liability account until they are earned in a later period. When the revenues are earned they will be moved from the balance sheet account to revenues on the income statement.
Expenses are deferred to a balance sheet asset account until the expenses are used up, expired, or matched with revenues. At that time they will be moved to an expense on the income statement.
One of the types of adjusting entries that are made at the end of the accounting period in order to report (1) revenues that have been earned but have not yet been entered into the accounting records, and/or (2) expenses that have been incurred but have not yet been entered into the accounting records.
Also known as a CD. A bank time deposit (savings deposit) that cannot be withdrawn until a specified date. For example, a CD might mature in 6, 9, 12, or 18 months. If the amount deposited in a CD needs to be withdrawn prior to its maturity date, a penalty is assessed by the bank.
The amount of insurance that was incurred/used up/expired during the period of time appearing in the heading of the income statement. The amount of insurance premiums that have not yet expired should be reported in the current asset account Prepaid Insurance.
Under the accrual basis of accounting the account Supplies Expense reports the amount of supplies that were used during the time interval indicated in the heading of the income statement. Supplies that are on hand (unused) at the balance sheet date are reported in the current asset account Supplies or Supplies on Hand.
Under the accrual basis of accounting, the Service Revenues account reports the fees earned by a company during the time period indicated in the heading of the income statement. Service Revenues include work completed whether or not it was billed. Service Revenues is an operating revenue account and will appear at the beginning of the company’s income statement.
The bank account on which checks are written or drawn. A bank refers to checking accounts as
demand deposits.
For the past 52 years, Harold Averkamp (CPA, MBA) has
worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.
