Adjusting Entries and Depreciation

Adjusting Journal Entries: Shipping Supplies Example

Asset Value Decrease: When shipping supplies are used up, the asset's value decreases. Specifically, it goes down by 4,000,000 due to usage.
Impact on T-Accounts:
- Shipping Supplies (Asset): The account is credited for 4,000,000, resulting in an ending balance of 1,000,000 as of December 31. This ensures the balance sheet correctly reflects the actual owned amount.
- Shipping Supplies Expense (Expense): An expense of 4,000,000 is added to this account, which then appears on the income statement. This is correct because using up resources creates an expense.
Core Principle: The act of using up resources converts them into an expense, necessitating an adjusting entry to accurately reflect financial performance and position.

Accuracy of Financial Statements: The primary reason for making adjusting entries is to ensure the accuracy of financial statements.
- Without them, the income statement will be incorrect.
- Assets will be reported at incorrect values on the balance sheet.
- Liabilities will also be misstated, not reflecting the true amount owed.
Investor Confidence & Legal Compliance: Incorrect financial statements can lead to investor dissatisfaction and severe legal trouble for a company, even if the errors are accidental.
Exam Relevance: Expect to perform five adjusting entries on Midterm Two, which will be a significant portion of the exam, worth approximately 27 points.
General Rule for Adjusting Entries:
- Cash is never involved in an adjusting entry.
- All adjusting entries involve one income statement account (either a revenue or an expense) and one balance sheet account (either an asset or a liability).

Unearned Revenues:
- Occur when cash is received from customers before the service is provided.
- As time passes and the service is rendered, revenue is officially earned.
- These are less common but may appear on the exam.
Prepaid Expenses:
- Occur when cash is paid first, and then the expense is recorded as time passes and the resource is used.
- These are super common and are guaranteed to appear (e.g., supplies are a classic example of a prepaid expense).
- Note: If cash is paid and an expense is incurred simultaneously, no adjusting entry is required.

Definition: Depreciation is the accounting mechanism used to match the expense (cost) of using a long-term asset (like equipment, property) with the revenue that asset helps generate over its useful life. It represents the allocation of the asset's cost over the period it is used.
Purpose: To record the expense associated with the consumption of a long-term resource over time, reflecting that using up a resource creates an expense.
Distinction from Market Value Decline: It is crucial to understand that accounting depreciation does not reflect the decline in the market value of an asset (e.g., a car's resale value decreasing over time). Instead, it is the systematic allocation of the asset's initial cost over its useful life for financial reporting purposes.
Accounts Involved:
- Depreciation Expense: This is an income statement account. It records the portion of the asset's cost that has been