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:

Let's begin with the asset accounts:

Cash $1,800
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. See the major topic Bank Reconciliation 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:

1. Draw two T-accounts. (Every journal entry involves at least two accounts. One account to be
debited and one account to be credited.)
2. 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.)
3. Enter the preliminary balance in each of the T-accounts.
4. Determine what the ending balance ought to be for the balance sheet account.
5. Make an adjustment so that the ending amount in the balance sheet account is correct.
6. Enter the same adjustment amount into the related income statement account.
7. 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.

Allowance for Doubtful Accounts $0

(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.

Supplies $1,100

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 $25,000

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 $7,500

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 adjusting entry for Accumulated Depreciation in general journal format is:

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.