What is the main purpose of adjusting entries?
Adjusting entries allow us to prepare accurate financial statements for a given accounting period. These entries are typically made on the last day of the accounting period to reflect any revenue earned or expense incurred during the accounting period. Adjusting entries are required in the following scenario:
- Accrued income: An earned revenue is not recorded.
- Accrued expense: An incurred expense is not reported.
- Prepaid expense: Some amount is prepaid. For example, lets say that the business paid for the annual insurance in one installment, however that means that it is prepaid for the next 11 months and that the accounting period is one month. And hence the entire amount will not be shown as an expense for the current accounting period.
- Deferred income: A customer pre-paid the bill but the goods have not been delivered. In such a scenario, the amount is shown as a liability until the order is complete.
- Bad accounts
The adjusting entry will ensure that both the income statement and balance sheet are accurate.