Video Transcript: The Need for Adjusting Entries

Hello and welcome back. Now we're going to discuss the need for adjusting  entries. The income statement of a business reports all revenues earned and all  expenses incurred to generate those revenues during a given period. An income statement that does not report all revenues and expenses is incomplete,  inaccurate and possibly misleading. Similarly, a balance sheet that does not  report all of them, the entity's assets, liabilities and stockholder equity at specific  time may be misleading as well. Each adjusting entry has a dual purpose. The  first is to make the income statement report the proper revenue and expenses,  and two, to make the balance sheet report the proper assets and liabilities.  Thus, every adjusting entry affects at least one income statement account and  one balance sheet account. Since those interested in the activities of a business need timely information, companies must prepare financial statements  periodically. To prepare such statements, the accountant divides an entity's life  into time periods. These time periods are usually equal in length and are called  accounting periods. An accounting period may be one month, one quarter or  one year. An accounting year or fiscal year is an accounting period of one year.  A fiscal year is any 12 consecutive months. The fiscal year may or may not  coincide with the calendar year, which ends on December 31 as we show in  Exhibit 15, 63% of the companies surveyed in 2024 had fiscal years that  coincided with the calendar year in 20. In 2008 the comparable figure for  publicly traded companies in the US was 65% companies in certain industries  often have a fiscal year that differs from the calendar year. For instance, many  retail stores end their fiscal year on January one to avoid closing their books  during the peak sales period, other companies select a fiscal year ending at a  time when inventories and business activities are at the lowest. Periodic  reporting and the matching principle necessitate the preparation of adjusting  entries. Adjusting entries are journal entries made at the end of the accounting  period or at any time financial statements are to be prepared to bring about a  proper matching of revenues and expenses. The matching principle requires  that expenses incurred in producing revenues be deducted from the revenues  they generate during the accounting period. Again, with the prepaid insurance.  Is anything prepaid? That is where the adjusting entry comes into play. What the adjusting entry does it it takes away from the prepaid asset account, the used up part and expense of that out. The matching principle is one of the underlying  principles of accounting. This matching of expenses and revenues is necessary  for the income statement to present an accurate picture of the profitability of the  business. Adjusting entries reflect unrecorded economic activity that has taken  place but has not yet been recorded. Why has the company not recorded this  activity by the end of the period? One reason is that it is more convenient and  economical to wait until the end of the period to record the activity. A second  reason is that no source document concerning that activity has yet come to the  accountant's attention. Adjusting entries bring the amounts in the general ledger 

accounts to the proper balances before the company prepares the financial  statements. That is, adjusting entries convert the amounts that are actually in  the general ledger accounts. Let's yes to the account to the amount that should  be in the general ledger accounts for proper financial reporting to make the  conversion, the accountants analyze the accounts to determine which need  adjustments. For example, assume a company purchased a three year  insurance policy costing $600 at the beginning of the year and debited 600 to  prepaid insurance at year end. The company should remove 200 of the costs  from the asset and record it as an expense. Failure to do so will misstate assets  and net income on the financial statements, and that's the main purpose of  making sure that you adjust so that nothing is misstated whether over or under.  So here's two classes and four types of adjusting entries. Okay, you have your  deferred items and you have your accrued items data previously court recorded  in an asset account are transferred to an expense account, or data previously  recorded in a liability account are transferred to a revenue account, and then on  the accrued items, data not previously recorded are entered into an account, an  asset account, and a revenue account or a liability account in an asset account,  so companies continuously receive benefits from many assets, such as a  prepaid expense. Thus, an entry could be made daily to record the expense  incurred. Typically, the firms do not make the entry until financial statements are  to be prepared. Therefore, if monthly financial statements are prepared, monthly adjusting entries are required by custom and in some instances by law,  businesses report to their owners at least annually. Accordingly, adjusting entries are required at least once a year. Remember, however, that the entries  transferring an amount from an asset account to an expense account should  transfer only the asset costs that have expired.