acty2100 ADJUSTING ENTRIES - ADJUSTING ENTRIES Adjusting...

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ADJUSTING ENTRIES Adjusting entries are needed to make sure that all revenue earned during a period and all expenses incurred during that period are recorded in that period regardless of when the cash is received or paid out . They are also made to make sure that all the assets and liabilities are properly valued. If revenue earned is not recorded, net income will be too low. If expenses incurred are not recorded, net income will be too high. Each adjusting entry has one account from the balance sheet (an asset or a liability) and one account from the income statement (a revenue or an expense). Cash is never one of the accounts. Let’s look at an example of a loan. The company borrowing money from the bank will be recording a liability, Notes Payable, when it receives the loan. This liability will be repaid when the loan matures. The bank will be recording an asset, Notes Receivable, when it lends the money. The cost of borrowing money is called interest. It’s an expense for the borrower and a revenue for the lender. Let’s take a look at the accounts involved with a five year loan of $10,000. The note was issued by the borrower on October 1 and carries an interest rate of 8%. Note that that is an annual interest rate. The borrower must pay 8% of the principal each year. Borrower Lender October 1--The note is issued: Cash 10,000 Notes Payable 10,000 October 1--The note is accepted: Notes Receivable 10,000 Cash 10,000 As of December 31 st , the borrower has used the money for 3 months and has an interest expense of $10,000 x 8% x 3/12 = $200. The lender has earned 3 months interest. First we’ll look at what happens if the borrower pays the interest on December 31. This probably wouldn’t happen, but we’ll presume it does.
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