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Term Definition
An Adjustment Entry is a financial journal entry which is typically made at the end of the accounting period to allocate income and expenditure to the period in which they actually occurred. The revenue recognition principle is the basis of making adjusting entries that pertain to unearned and accrued revenues under the accrual accounting system. They are sometimes called Balance Day adjustments because they are made on balance day.
Based on the matching principle of accrual accounting, revenues and associated costs are recognized in the same accounting period. However, the actual cash may be received or paid at a different time. Adjustment entries can be classified as prepaid expenses, prepaid revenues, accrued expenses or accrued revenues.
Prepayments are payments that are made before the consumption of goods or services. Accrual is cash paid after the consumption of goods or services. Prepaid expenses are expenses that expire with the passage of time, such as insurance, or through use and consumption, such as supplies. Prepaid expenses are included in assets but are gradually expensed. Without an adjustment entry, assets and expenses may be overstated. Prepaid revenue is unearned revenue and is classified as a liability. An example of unearned revenue is when a customer pays in advance for a consultation with a trainer. The revenue has been received but the service has not yet been delivered. Once the consultation occurs, the trainer is no longer liable for the service and the revenue can now be recognized. Once the good or service is delivered an adjustment entry will record the liability as earned revenue.
Accrued revenues are earned but not yet recorded or received. When the revenue is recognized, it is recorded as Accounts Receivable. Accrued expenses could be interest, taxes, rent, and salaries. One company's accrued expenses are accrued revenues for another. Allowance for doubtful accounts is also accrued expenses.
Area of Application
GAAP
Revenue Recognition
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