Adjusting Entries and Accrual Accounting

These flashcards cover the lecture’s key points on revenue recognition, matching, adjusting entries, accruals, prepayments, bad debts, and the differences between accrual and cash-basis accounting.

What is the main purpose of end-of-period adjusting entries?

To ensure that revenues and expenses are recorded in the period in which they are earned or incurred, producing accurate financial statements.

According to the revenue recognition principle, when is revenue recorded?

When it is earned—i.e., when the product or service has been delivered to the customer, regardless of when cash is received.

According to the matching (expense recognition) principle, when are expenses recorded?

In the same period as the revenues they help generate, even if the cash is paid in a different period.

Why do companies usually wait until the end of the accounting period to make adjusting entries?

Because making daily or weekly adjustments would be costly and time-consuming; period-end adjustments achieve the same accuracy more efficiently.

Give three common examples of accrued expenses that often require adjustments.

Wages Expense, Utilities Expense, and Interest Expense.

In an accrued wages adjustment for £500, which accounts are affected and how?

Debit Wages Expense £500 (increase expense) and credit Wages Payable (or Accrued Wages) £500 (increase liability).

How does recording an accrued utilities expense of £1,500 affect the balance sheet?

Current Liabilities increase by £1,500 through Utilities Payable, while equity decreases via the related expense.

What journal entry records interest that has accrued but not yet been paid?

Debit Interest Expense; Credit Interest Payable for the amount accrued.

Define a prepaid expense.

A cost paid in advance that will provide future economic benefit and is recorded initially as an asset (e.g., Prepaid Insurance).

If €2,500 of insurance was paid and €500 relates to next year, how is the adjustment recorded?

Debit Prepaid Insurance (asset) €500 and credit Insurance Expense €500, decreasing current-period expense.

Where is a prepaid amount shown on the balance sheet?

Under Current Assets, typically labelled Prepayments or Prepaid Expenses.

When does a receivable become a bad debt?

When a customer is unable to pay the amount owed, making the receivable uncollectible.

How are bad debts reflected in the financial statements?

The uncollectible amount is removed (credited) from Trade Receivables and recorded (debited) as Bad Debt Expense in the income statement.

In the example, how is a €100 bad debt for a credit customer recorded?

Debit Bad Debt Expense €100; Credit Debtors (Accounts Receivable) €100.

Under accrual accounting, how is profit determined?

By subtracting expenses incurred from revenues earned during the period, regardless of cash movements.

Under cash-basis accounting, when are revenues and expenses recognised?

Only when cash is actually received or paid.

Name the two key principles that underpin accrual accounting.

The Revenue Recognition Principle and the Matching (Expense Recognition) Principle.

How is cost of sales calculated in an income statement?

Opening Stock + Purchases – Closing Stock.

What was the gross profit in the sample income statement with sales of €108,000 and cost of sales of €81,705?

€26,295.

In the same example, how did electricity accrual affect the expense total?

€300 was added to Electricity Expense, increasing total expenses and reducing net profit.

What is the effect of recognising an accrual on equity?

Equity decreases because the related expense reduces net profit.

What is the overall effect of a prepayment adjustment on equity?

Equity increases (or is preserved) because current-period expenses are reduced by the prepaid portion.