The adjusting process involves recording and reporting business income on financial statements and is done based on accounting periods, such as monthly, quarterly, semiannually, and annually. Revenue and expense transactions need to be recorded in the relevant accounting period to accurately report the business activities for a company. In a cash-basis world, accounting would be relatively straightforward: cash received would equal revenue earned in a period, and cash paid would equal expense incurred for that period. However, under accrual basis accounting, there are often differences between the timing of cash flows and when revenue and expenses need to be recognized under generally accepted accounting principles (GAAP). In accounting, such timing differences are addressed using the adjusting process and by preparing adjusting entries.
At A Glance
Accrual basis accounting is required by GAAP and uses the matching principle in the adjusting process. Cash basis accounting is a simpler method, as it recognizes revenue or expenses when cash is received or paid, and is not subject to GAAP.
Adjusting entries are important for accurately reporting the transactions and results of a business for a certain time period.
- In accrual basis accounting, adjusting entries are required to properly account for revenue and expenses recognition in accordance with GAAP.
Deferral entries may be needed when revenue is unearned, which impacts the accounting equation, the income statement, and the balance sheet.
- When expenses are prepaid, deferral entries may be needed, as they impact the accounting equation, the income statement, and the balance sheet.
- Adjusting entries are needed for various fixed assets, such as property and equipment, which may depreciate in value over time. Journal entries are used to record depreciation of fixed assets using expense accounts.
- Journal entries are used to record depreciation of fixed assets using contra asset accounts.
- There are five types of adjusting entries that may affect the trial balance. Throughout this adjusting process, there is a flow of information from journal entries to adjusting entries, to the general ledger, through to the adjusted trial balance.