MAB1033 Adjusting Entries

Which of the following statements about the need for adjustments is not correct?

• Without adjustments, the financial statements present an incomplete and misleading picture of the company.

• Adjusting entries are intended to change the operating results to reflect management's objectives for operating performance.

• Adjustments help the financial statements present the best picture of whether the company's activities were profitable for the period.

• Adjustments help the financial statements present the economic resources that the company owns and owes at the end of the period.

Answer explanation

Adjustments need to be made at the end of an accounting period to (1) update amounts already recorded in the accounting records and (2) include events that occurred but had not yet been recorded. Without these adjustments, the financial statements present an incomplete and misleading picture of the company's financial performance.

One of the major advantages of making adjustments in order to improve the quality of financial statements is that they:

• ensure that revenues and expenses are recognized during the period they are earned and incurred.

• ensure that all estimates of future activities are eliminated from consideration.

• ensure that revenues and expenses are recognized conservatively during the period in which they are paid.

• provide an opportunity to manipulate the numbers to the best advantage of the reporting company.

Answer explanation

Adjustments need to be made at the end of an accounting period to (1) update amounts already recorded in the accounting records and (2) include events that occurred but had not yet been recorded. Without these adjustments, the financial statements present an incomplete and misleading picture of the company's financial performance. Proper counting is critical to income measurement, but estimation also plays a role.

Adjusting entries are typically prepared:

• at the beginning of the accounting period.

• at the end of the accounting period.

• on a daily basis.

• on a weekly basis.

Answer explanation

Companies wait until the end of the accounting period to adjust their accounts because daily adjustments would be costly and time-consuming.

If certain assets are partially used up during the accounting period, then:

• nothing is recorded on the financial statements until they are completely used up.

• a liability account is decreased and an expense is recorded.

• an asset account is decreased and an expense is recorded.

• nothing is recorded on the financial statements until they are replaced or replenished.

Answer explanation

When the company pays cash before incurring the expense, the prepayment is recorded in an asset account on the balance sheet. When an asset is partially used up during the accounting period, the expense is incurred and recorded with a debit and the asset account is decreased with a credit.

The company uses up $5,000 of an existing asset and the company adjusts its accounts accordingly. This is an example of a(n):

• accrual adjustment.

• closing adjustment.

• deferral adjustment.

• unethical adjustment.

Answer explanation

When the company pays cash before incurring the expense, the prepayment is recorded in an asset account on the balance sheet. A deferral adjustment occurs when the asset is partially used up during the accounting period. The expense is incurred and recorded and the asset account is decreased.

The term deferral best describes a situation in which:

• cash is paid in advance of recognizing an expense.

• an expense is recognized before it is paid for with cash.

• an expense is recognized after cash has been received.

• a liability is established at the time an expense is recognized.

Answer explanation

The term defer means to postpone until later. In accounting, we say an expense or revenue has been deferred if we have postponed reporting it on the income statement until a later period. A deferral exists when cash is paid in advance of recognizing an expense or when cash is received in advance of recognizing revenue.

At the end of the year, accrual adjustments could include a:

• debit to an expense and a credit to an asset.

• credit to revenue and a debit to an expense.

• debit to cash and a credit to Common Stock.

• debit to an asset and a credit to a revenue.

Answer explanation

Accrual adjustments are needed when a company has earned revenue or incurred an expense in the current period but has not yet recorded it because the related cash will not be received or paid until a later period. As a result, accrual adjustments would include a debit to an expense account and a credit to a liability account or a debit to an asset account and a credit to a revenue account.

Accrual adjustments involve increasing:

• assets and revenues or increasing liabilities and expenses.

• assets and expenses or increasing liabilities and revenues.

• assets and decreasing revenues or increasing liabilities and decreasing expenses.

• assets and decreasing expenses or increasing liabilities and decreasing revenues.

Answer explanation

Accrual adjustments are needed when a company has earned revenue or incurred an expense in the current period but has not yet recorded it because the related cash will not be received or paid until a later period. As a result, accrual adjustments would include a debit to increase an expense account and a credit to increase a liability account or a debit to increase an asset account and a credit to increase a revenue account.

Accrued revenues recorded at the end of the current year:

• often result in cash receipts from customers in the next period.

• often result in cash payments in the next period.

• are also called Deferred Revenues.

• are recorded in the current year when cash is received.

Answer explanation

An accrual adjustment is needed when a company has earned revenue in the current period but has not yet received the related cash. Cash will not be received until a later period.

What is the main difference between accrual and deferral adjustments?

• Deferral adjustments are required to update previously recorded items whereas accrual adjustments are required to include items not previously recorded.

• Deferral adjustments are required under the cash basis of accounting whereas accrual adjustments are required under the accrual basis of accounting.

• Deferral adjustments are required to include items not previously recorded whereas accrual adjustments are required to update previously recorded items.

• Deferral adjustments are used for expenses whereas accrual adjustments are used for revenues.

Answer explanation

Deferral adjustments are needed when an asset (or liability) has already been recorded and it needs to be updated to show that some of its benefits have been used up (or its obligations have been fulfilled). Accrual adjustments are needed when revenue has been earned (but not yet recorded) or expenses have been incurred (but not yet recorded).