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Sales commissions earned by a COMPANY would be reported as revenue in the company's income statement. Sales commissions that a company must pay to others are reported as an expense.

Under the accrual basis of ACCOUNTING (as opposed to the cash basis) commission revenues should be reported when the company earns the commissions. The commission expense should be reported when the company has incurred the expense and liability. (This would ALSO be the time when the other party has earned the commissions and the right to receive them.)

The commission revenues would be reported as operating revenue (in the section where sales are reported), if the commissions are earned as a main activity of the company. If the commissions are INCIDENTAL or involve a peripheral activity, these commission revenues would be reported as other income.

Commission expense would be reported as a SELLING expense along with other operating expenses when they are related to the company's main activities. If a commission expense pertains to a peripheral activity, it would be reported as other expense.

Sales commissions earned by a company would be reported as revenue in the company's income statement. Sales commissions that a company must pay to others are reported as an expense.

Under the accrual basis of accounting (as opposed to the cash basis) commission revenues should be reported when the company earns the commissions. The commission expense should be reported when the company has incurred the expense and liability. (This would also be the time when the other party has earned the commissions and the right to receive them.)

The commission revenues would be reported as operating revenue (in the section where sales are reported), if the commissions are earned as a main activity of the company. If the commissions are incidental or involve a peripheral activity, these commission revenues would be reported as other income.

Commission expense would be reported as a selling expense along with other operating expenses when they are related to the company's main activities. If a commission expense pertains to a peripheral activity, it would be reported as other expense.

Often a loan payment consists of both an interest payment and a payment to REDUCE the loan's principal balance. The interest portion is an expense whereas the principal portion is a reduction of a liability such as Loans Payable or NOTES Payable.

If a company uses the accrual method of accounting, it is logical to record the interest expense and the interest liability at the end of each accounting period (instead of recording the interest expense when the payment is made). This is done with an adjusting ENTRY in ORDER to match the interest expense to the appropriate accounting period. It also results in the reporting of a liability for the amount of interest that the company owes as of the date of the balance sheet.

Often a loan payment consists of both an interest payment and a payment to reduce the loan's principal balance. The interest portion is an expense whereas the principal portion is a reduction of a liability such as Loans Payable or Notes Payable.

If a company uses the accrual method of accounting, it is logical to record the interest expense and the interest liability at the end of each accounting period (instead of recording the interest expense when the payment is made). This is done with an adjusting entry in order to match the interest expense to the appropriate accounting period. It also results in the reporting of a liability for the amount of interest that the company owes as of the date of the balance sheet.

Adjusting entries are MADE at the end of the accounting period (but prior to preparing the financial statements) in order for a company's accounting records and financial statements to be up-to-date on the accrual basis of accounting. For example, each DAY the company incurs wages expense but the payroll involving workers' wages for the last days of the month won't be entered in the accounting records until after the accounting period ends. Similarly, the company uses electricity each day but receives only one bill per month, perhaps on the 20th day of the month. The electricity expense for the last 10-15 days of the month MUST get into the accounting records if the financial statements are to show all of the expenses and the AMOUNTS owed for the current accounting period. Other adjusting entries involve amounts that the company paid prior to amounts becoming expenses. For EXAMPLES, the company probably paid its insurance premiums for a six month period prior to the start of the six month period. The company may have deferred the expense by recording the amount in the asset account Prepaid Insurance. During the accounting period some of those premiums expired (were used up) and need to appear as expense in the current accounting period and the asset balance reduced.

Closing entries are dated as of the last day of the accounting period, but they are entered into the accounts after the financial statements are prepared. For the most part, closing entries involve the income statement accounts. The closing entries set the balances of all of the revenue accounts and the expense accounts to zero. This means that the revenue and expense accounts will start the new year with nothing in the accounts—allowing the company to easily report the new year revenues and expenses. The net amount of all of the balances from the revenue and expense accounts at the end of the year will end up in retained earnings (for corporations) or owner's equity (for sole proprietorships). Thanks to accounting software, the closing entries are quite effortless.

Adjusting entries are made at the end of the accounting period (but prior to preparing the financial statements) in order for a company's accounting records and financial statements to be up-to-date on the accrual basis of accounting. For example, each day the company incurs wages expense but the payroll involving workers' wages for the last days of the month won't be entered in the accounting records until after the accounting period ends. Similarly, the company uses electricity each day but receives only one bill per month, perhaps on the 20th day of the month. The electricity expense for the last 10-15 days of the month must get into the accounting records if the financial statements are to show all of the expenses and the amounts owed for the current accounting period. Other adjusting entries involve amounts that the company paid prior to amounts becoming expenses. For examples, the company probably paid its insurance premiums for a six month period prior to the start of the six month period. The company may have deferred the expense by recording the amount in the asset account Prepaid Insurance. During the accounting period some of those premiums expired (were used up) and need to appear as expense in the current accounting period and the asset balance reduced.

Closing entries are dated as of the last day of the accounting period, but they are entered into the accounts after the financial statements are prepared. For the most part, closing entries involve the income statement accounts. The closing entries set the balances of all of the revenue accounts and the expense accounts to zero. This means that the revenue and expense accounts will start the new year with nothing in the accounts—allowing the company to easily report the new year revenues and expenses. The net amount of all of the balances from the revenue and expense accounts at the end of the year will end up in retained earnings (for corporations) or owner's equity (for sole proprietorships). Thanks to accounting software, the closing entries are quite effortless.

The aging method USUALLY refers to the technique used for determining the credit balance needed in the account Allowance for Doubtful (or Uncollectible) Accounts. This Allowance account is a CONTRA asset account connected with Accounts Receivable. Usually when a credit adjustment is entered into the Allowance account, a corresponding debit amount is entered into Bad Debts Expense (or Uncollectible Accounts Expense).

The aging method takes place by sorting a company's accounts receivable according to the dates of these UNPAID invoices. The invoice amounts that are not yet DUE are entered into the first of PERHAPS five columns. The invoice amounts that are 1-30 days past due are entered into the second column. Amounts that are 31-60 days past due are entered into the third column, and so on. (Accounting software will likely have a feature for generating an aging of accounts receivable.) The aging will be reviewed in order to determine the approximate amount of the receivables that may not be collected.

The goal of the aging method is to have the company's balance sheet report the true amount of the receivables that will be turning to cash. For example, if the company's Accounts Receivable has a debit balance of $89,400 but the company estimates (based on its aging) that only $82,000 will be collected, the Allowance account must report a credit balance of $7,400.

If a company fails to report a needed credit balance in its Allowance account, it will be overstating its assets, working capital, current ratio, retained earnings, and stockholders' equity. Its current period's earnings may also be overstated.

The aging method usually refers to the technique used for determining the credit balance needed in the account Allowance for Doubtful (or Uncollectible) Accounts. This Allowance account is a contra asset account connected with Accounts Receivable. Usually when a credit adjustment is entered into the Allowance account, a corresponding debit amount is entered into Bad Debts Expense (or Uncollectible Accounts Expense).

The aging method takes place by sorting a company's accounts receivable according to the dates of these unpaid invoices. The invoice amounts that are not yet due are entered into the first of perhaps five columns. The invoice amounts that are 1-30 days past due are entered into the second column. Amounts that are 31-60 days past due are entered into the third column, and so on. (Accounting software will likely have a feature for generating an aging of accounts receivable.) The aging will be reviewed in order to determine the approximate amount of the receivables that may not be collected.

The goal of the aging method is to have the company's balance sheet report the true amount of the receivables that will be turning to cash. For example, if the company's Accounts Receivable has a debit balance of $89,400 but the company estimates (based on its aging) that only $82,000 will be collected, the Allowance account must report a credit balance of $7,400.

If a company fails to report a needed credit balance in its Allowance account, it will be overstating its assets, working capital, current ratio, retained earnings, and stockholders' equity. Its current period's earnings may also be overstated.

The amount reported in Bad Debts Expense is the loss that occurred from extending credit during the PERIOD of time indicated in the heading of the income statement. Bad Debts Expense is usually an estimated amount based on a company's credit sales during the period or the change in the collectibility of its accounts receivable.

The amount reported in the Allowance for Doubtful Accounts is the estimated amount of the accounts receivable that will not be collected. The Allowance for Doubtful Accounts is a contra asset account or valuation account associated with the balance in Accounts Receivable. Since these two accounts are balance sheet accounts, their account balances must report the amounts that are RELEVANT at a SPECIFIC moment in time, namely the date of the balance sheet.

To illustrate, let's assume that on December 31 a company had $100,000 in Accounts Receivable and its balance in Allowance for Doubtful Accounts was a credit balance of $3,000. For the first 30 days of January the company does not have any other information on bad accounts. Then on January 31 the company learns that an additional $1,000 of its accounts receivable will not be collectible. On January 31 the company will MAKE an adjusting entry to debit Bad Debts Expense for $1,000 and to credit Allowance for Doubtful Accounts for $1,000. After this entry is recorded, the company's income statement for the month of January will report Bad Debts Expense of $1,000 and its January 31 balance sheet will report a credit balance in Allowance for Doubtful Accounts in the amount of $4,000.

The amount reported in Bad Debts Expense is the loss that occurred from extending credit during the period of time indicated in the heading of the income statement. Bad Debts Expense is usually an estimated amount based on a company's credit sales during the period or the change in the collectibility of its accounts receivable.

The amount reported in the Allowance for Doubtful Accounts is the estimated amount of the accounts receivable that will not be collected. The Allowance for Doubtful Accounts is a contra asset account or valuation account associated with the balance in Accounts Receivable. Since these two accounts are balance sheet accounts, their account balances must report the amounts that are relevant at a specific moment in time, namely the date of the balance sheet.

To illustrate, let's assume that on December 31 a company had $100,000 in Accounts Receivable and its balance in Allowance for Doubtful Accounts was a credit balance of $3,000. For the first 30 days of January the company does not have any other information on bad accounts. Then on January 31 the company learns that an additional $1,000 of its accounts receivable will not be collectible. On January 31 the company will make an adjusting entry to debit Bad Debts Expense for $1,000 and to credit Allowance for Doubtful Accounts for $1,000. After this entry is recorded, the company's income statement for the month of January will report Bad Debts Expense of $1,000 and its January 31 balance sheet will report a credit balance in Allowance for Doubtful Accounts in the amount of $4,000.

A contingent asset is a potential asset associated with a contingent gain. Unlike contingent liabilities and contingent losses, contingent assets and contingent gains are not recorded in accounts, even when they are probable and the amount can be ESTIMATED.

An example of a contingent gain and contingent asset MIGHT be a lawsuit filed by Company A against Company B for infringement of Company A's patent. If it is probable that Company A will win the lawsuit and receive an estimated amount of money, it has a contingent asset and a contingent gain.

HOWEVER, it will not report the asset and gain until the lawsuit is settled. (At most Company A will PREPARE a very carefully worded disclosure stating that it possibly could win the case.) On the other hand, Company B will need to make an entry in its accounts if the loss contingency is probable and the amount can be estimated. If ONE of those are missing, Company B will have to disclose the loss contingency in the notes to its financial statements.

A contingent asset is a potential asset associated with a contingent gain. Unlike contingent liabilities and contingent losses, contingent assets and contingent gains are not recorded in accounts, even when they are probable and the amount can be estimated.

An example of a contingent gain and contingent asset might be a lawsuit filed by Company A against Company B for infringement of Company A's patent. If it is probable that Company A will win the lawsuit and receive an estimated amount of money, it has a contingent asset and a contingent gain.

However, it will not report the asset and gain until the lawsuit is settled. (At most Company A will prepare a very carefully worded disclosure stating that it possibly could win the case.) On the other hand, Company B will need to make an entry in its accounts if the loss contingency is probable and the amount can be estimated. If one of those are missing, Company B will have to disclose the loss contingency in the notes to its financial statements.

Because of double-entry accounting and the accrual-basis of accounting, the cost of utilities (electricity, natural gas, SEWER, water, etc.) will INVOLVE both an expense and a liability. For example, a retailer who is responsible for her store's heat and light will incur an expense for the amount of utilities used during the accounting period. The retailer will also have a liability for the utilities that were used but have not yet been PAID. Since the utility company provides the electric and gas service before it bills the user, the retailer will be INCURRING an expense every DAY and will be incurring a liability every day. The amount of the liability increases each day and is reduced by the amount paid by the retailer. (When the retailer pays the amount billed by the utility for the previous month's usage, the retailer will still have a liability for the utilities used since last month.)

For a manufacturer, the cost of the utilities used in the factory will be assigned or allocated to the products as manufacturing overhead. If all of the products manufactured remain in inventory, the cost of the utilities used in the factory are embedded in the inventory's cost. When products are sold, the cost of utilities allocated to those products will automatically be expensed as part of the cost of goods sold. Under accrual accounting, the cost of the utilities that were used are included in the products' cost—whether or not the utilities have been paid. Because of double-entry accounting, the amount owed for the utilities that were used is also reported on the balance sheet as a liability.

Since natural gas, electricity, and other utilities are used before the meters are read and billed by the utility company, the company using the utilities will have to estimate (1) the amounts used during an accounting period, and (2) the amounts owed at the end of each accounting period. The amounts are entered into the accounting records through an accrual-type adjusting entry.

Because of double-entry accounting and the accrual-basis of accounting, the cost of utilities (electricity, natural gas, sewer, water, etc.) will involve both an expense and a liability. For example, a retailer who is responsible for her store's heat and light will incur an expense for the amount of utilities used during the accounting period. The retailer will also have a liability for the utilities that were used but have not yet been paid. Since the utility company provides the electric and gas service before it bills the user, the retailer will be incurring an expense every day and will be incurring a liability every day. The amount of the liability increases each day and is reduced by the amount paid by the retailer. (When the retailer pays the amount billed by the utility for the previous month's usage, the retailer will still have a liability for the utilities used since last month.)

For a manufacturer, the cost of the utilities used in the factory will be assigned or allocated to the products as manufacturing overhead. If all of the products manufactured remain in inventory, the cost of the utilities used in the factory are embedded in the inventory's cost. When products are sold, the cost of utilities allocated to those products will automatically be expensed as part of the cost of goods sold. Under accrual accounting, the cost of the utilities that were used are included in the products' cost—whether or not the utilities have been paid. Because of double-entry accounting, the amount owed for the utilities that were used is also reported on the balance sheet as a liability.

Since natural gas, electricity, and other utilities are used before the meters are read and billed by the utility company, the company using the utilities will have to estimate (1) the amounts used during an accounting period, and (2) the amounts owed at the end of each accounting period. The amounts are entered into the accounting records through an accrual-type adjusting entry.

A cost might be an expense or it might be an asset. An expense is a cost that has expired or was necessary in order to earn revenues. We hope the following three examples will ILLUSTRATE the difference between a cost and an expense.

A company has a cost of $6,000 for property insurance covering the next six months. INITIALLY the cost of $6,000 is reported as the current asset Prepaid Insurance. HOWEVER, in each of the following six months, the company will report Insurance Expense of $1,000—the amount that is expiring each month. The unexpired portion of the cost will continue to be reported as the asset Prepaid Insurance.

The cost of equipment used in manufacturing is initially reported as the long lived asset Equipment. However, in each accounting period the company will report part of the asset's cost as Depreciation Expense.

A RETAILER's purchase of merchandise is initially reported as the current asset Inventory. When the merchandise is sold, the cost of the merchandise sold is removed from Inventory and is reported on the income statement as the expense entitled Cost of Goods Sold.

The matching principle guides ACCOUNTANTS as to when a cost will be reported as an expense.

A cost might be an expense or it might be an asset. An expense is a cost that has expired or was necessary in order to earn revenues. We hope the following three examples will illustrate the difference between a cost and an expense.

A company has a cost of $6,000 for property insurance covering the next six months. Initially the cost of $6,000 is reported as the current asset Prepaid Insurance. However, in each of the following six months, the company will report Insurance Expense of $1,000—the amount that is expiring each month. The unexpired portion of the cost will continue to be reported as the asset Prepaid Insurance.

The cost of equipment used in manufacturing is initially reported as the long lived asset Equipment. However, in each accounting period the company will report part of the asset's cost as Depreciation Expense.

A retailer's purchase of merchandise is initially reported as the current asset Inventory. When the merchandise is sold, the cost of the merchandise sold is removed from Inventory and is reported on the income statement as the expense entitled Cost of Goods Sold.

The matching principle guides accountants as to when a cost will be reported as an expense.

Under the ACCRUAL basis of accounting, unpaid wages that have been earned by EMPLOYEES should be entered as 1) Wages Expense and 2) Wages Payable or Accrued Wages Payable. Wages Expense is an income statement account. Wages Payable is a current liability account that is reported on the balance sheet.

The recording of wages that have been earned but not yet paid or processed through the routine PAYROLL ENTRIES is referred to as accruing wages. This is done through an accrual-type adjusting entry.

Under the accrual basis of accounting, unpaid wages that have been earned by employees should be entered as 1) Wages Expense and 2) Wages Payable or Accrued Wages Payable. Wages Expense is an income statement account. Wages Payable is a current liability account that is reported on the balance sheet.

The recording of wages that have been earned but not yet paid or processed through the routine payroll entries is referred to as accruing wages. This is done through an accrual-type adjusting entry.

When an accountant states that a reported amount is overstated, it MEANS two things:

1. The reported amount is incorrect, and
2. The reported amount is more than the TRUE or correct amount.

For example, a company reports that its prepaid insurance is $8,000. However, the true or correct amount of prepaid insurance is only $7,000. The accountant will say that the reported amount for prepaid insurance is overstated by $1,000.

Because of double-entry accounting or BOOKKEEPING, another general ledger account will also have a reporting error. In our example, if Prepaid Insurance is overstated (too MUCH being reported) it is likely that Insurance Expense will be understated (too little is being reported).

When an accountant states that a reported amount is overstated, it means two things:

For example, a company reports that its prepaid insurance is $8,000. However, the true or correct amount of prepaid insurance is only $7,000. The accountant will say that the reported amount for prepaid insurance is overstated by $1,000.

Because of double-entry accounting or bookkeeping, another general ledger account will also have a reporting error. In our example, if Prepaid Insurance is overstated (too much being reported) it is likely that Insurance Expense will be understated (too little is being reported).

Accrued revenues are fees and interest that have been earned and sales that occurred, but they have not yet been recorded through the normal invoicing paperwork. Since these are not yet in the accountant's general ledger, they will not appear on the financial statements unless an ADJUSTING ENTRY is entered prior to preparing the financial statements.

Here's an EXAMPLE. Your company lent a supplier $100,000 on December 1. The agreement is for the $100,000 to be repaid on February 28 along with $3,000 of interest for the three months of December through February. As of December 31 your company will not have a transaction/invoice/receipt for the interest it is earning since all of the interest is due on February 28. Without an adjusting entry to accrue the revenue it earned in December, your company's financial statements as of December 31 will not be reporting the $1,000 (one-third of the $3,000 of interest) that it has earned in December. In order for the financial statements to be correct on the accrual basis of accounting, the accountant needs to record an adjusting entry dated as of December 31. The adjusting entry will consist of a debit of $1,000 to Interest Receivable (a BALANCE sheet account) and a credit of $1,000 to Interest Income or Interest Revenue (income statement ACCOUNTS).

Accrued revenues are fees and interest that have been earned and sales that occurred, but they have not yet been recorded through the normal invoicing paperwork. Since these are not yet in the accountant's general ledger, they will not appear on the financial statements unless an adjusting entry is entered prior to preparing the financial statements.

Here's an example. Your company lent a supplier $100,000 on December 1. The agreement is for the $100,000 to be repaid on February 28 along with $3,000 of interest for the three months of December through February. As of December 31 your company will not have a transaction/invoice/receipt for the interest it is earning since all of the interest is due on February 28. Without an adjusting entry to accrue the revenue it earned in December, your company's financial statements as of December 31 will not be reporting the $1,000 (one-third of the $3,000 of interest) that it has earned in December. In order for the financial statements to be correct on the accrual basis of accounting, the accountant needs to record an adjusting entry dated as of December 31. The adjusting entry will consist of a debit of $1,000 to Interest Receivable (a balance sheet account) and a credit of $1,000 to Interest Income or Interest Revenue (income statement accounts).

An expense will decrease the amount of assets or increase the amount of liabilities, and will reduce the amount of owner's or stockholders' equity.

For EXAMPLE an expense might 1) reduce a company's assets such as Cash, PREPAID Expenses, or Inventory, 2) increase the credit balance in a contra-asset account such as Allowance for Doubtful Accounts or Accumulated DEPRECIATION, 3) increase the balance in the LIABILITY account Accounts Payable, or increase the amount of ACCRUED expenses payable such as Wages Payable, Interest Payable, and so on.

In addition to the change in the assets or liabilities, an expense will reduce the credit balance in the Owner Capital account of a sole proprietorship, or will reduce the credit balance in the Retained Earnings account of a corporation.

An expense will decrease the amount of assets or increase the amount of liabilities, and will reduce the amount of owner's or stockholders' equity.

For example an expense might 1) reduce a company's assets such as Cash, Prepaid Expenses, or Inventory, 2) increase the credit balance in a contra-asset account such as Allowance for Doubtful Accounts or Accumulated Depreciation, 3) increase the balance in the liability account Accounts Payable, or increase the amount of accrued expenses payable such as Wages Payable, Interest Payable, and so on.

In addition to the change in the assets or liabilities, an expense will reduce the credit balance in the Owner Capital account of a sole proprietorship, or will reduce the credit balance in the Retained Earnings account of a corporation.

Inventory change is the difference between last PERIOD's ENDING inventory and the current period's ending inventory. If last period's ending inventory was $100,000 and the current period's ending inventory is $115,000, the inventory change is an increase of $15,000.

The inventory change is often presented as an adjustment to purchases in the calculation of the cost of goods sold. If purchases were $300,000 during the current period and the inventory amounts are those listed above, the cost of goods sold is $285,000. (Purchases of $300,000 minus the $15,000 increase in inventory. The logic is that not all $300,000 of purchases should be MATCHED against sales, because $15,000 of the purchases went into inventory.) This is an alternative to the method used in introductory ACCOUNTING: beginning inventory of $100,000 + purchases of $300,000 = $400,000 of cost of goods available – ending inventory of $115,000 = cost of goods sold of $285,000.

If last period's ending inventory was $100,000 and the current period's ending inventory is $93,000, the inventory change is a decrease of $7,000. Assuming purchases of $300,000 in the current period, the cost of goods sold is $307,000 ($300,000 of purchases PLUS the $7,000 decrease in inventory).

Inventory change is the difference between last period's ending inventory and the current period's ending inventory. If last period's ending inventory was $100,000 and the current period's ending inventory is $115,000, the inventory change is an increase of $15,000.

The inventory change is often presented as an adjustment to purchases in the calculation of the cost of goods sold. If purchases were $300,000 during the current period and the inventory amounts are those listed above, the cost of goods sold is $285,000. (Purchases of $300,000 minus the $15,000 increase in inventory. The logic is that not all $300,000 of purchases should be matched against sales, because $15,000 of the purchases went into inventory.) This is an alternative to the method used in introductory accounting: beginning inventory of $100,000 + purchases of $300,000 = $400,000 of cost of goods available – ending inventory of $115,000 = cost of goods sold of $285,000.

If last period's ending inventory was $100,000 and the current period's ending inventory is $93,000, the inventory change is a decrease of $7,000. Assuming purchases of $300,000 in the current period, the cost of goods sold is $307,000 ($300,000 of purchases plus the $7,000 decrease in inventory).

Unearned income or unearned revenue occurs when a company receives money before the money is earned. This is also referred to as deferred revenues or customer deposits. The unearned amount is recorded in a liability account such as Unearned Revenues, Deferred Revenues, or Customer Deposits. After the amount has been earned, the liability account is reduced and a revenue account is increased.

Example 1. A lawn service company offers customers a special package of five applications of FERTILIZERS and weed treatments for $200 if the customer prepays in March. The service will be PROVIDED in April, May, June, July, and September. When the company receives $200 in March, it will debit the asset Cash for $200 and will credit the liability account Unearned Revenues. Since these are balance sheet accounts (and since no work has yet been performed), no revenue is REPORTED in March. In April when the FIRST service is provided, the company will debit the liability account Unearned Revenues for $40 and will credit the income statement account Service Revenues for $40. At the end of April, the balance sheet will report the company's remaining liability of $160. The income statement for April will report that $40 was earned. The $40 entry is referred to as an adjusting entry and the same entry will be recorded in May, June, July, and September.

Example 2. A company informs a customer that a $5,000 deposit is required before it will begin work on the customer's special order. The customer gives the company $5,000 on December 28 and the company will begin work on the special order on January 3. On December 28 the company will debit Cash for $5,000 and will credit a liability account, such as Customer Deposits (or Unearned Revenues or Deferred Revenues) for $5,000. No revenue is reported in December for this special order since the company did not perform any work. When the special order is completed in January the company will debit the liability account for $5,000 and will credit a revenue account.

Unearned income or unearned revenue occurs when a company receives money before the money is earned. This is also referred to as deferred revenues or customer deposits. The unearned amount is recorded in a liability account such as Unearned Revenues, Deferred Revenues, or Customer Deposits. After the amount has been earned, the liability account is reduced and a revenue account is increased.

Example 1. A lawn service company offers customers a special package of five applications of fertilizers and weed treatments for $200 if the customer prepays in March. The service will be provided in April, May, June, July, and September. When the company receives $200 in March, it will debit the asset Cash for $200 and will credit the liability account Unearned Revenues. Since these are balance sheet accounts (and since no work has yet been performed), no revenue is reported in March. In April when the first service is provided, the company will debit the liability account Unearned Revenues for $40 and will credit the income statement account Service Revenues for $40. At the end of April, the balance sheet will report the company's remaining liability of $160. The income statement for April will report that $40 was earned. The $40 entry is referred to as an adjusting entry and the same entry will be recorded in May, June, July, and September.

Example 2. A company informs a customer that a $5,000 deposit is required before it will begin work on the customer's special order. The customer gives the company $5,000 on December 28 and the company will begin work on the special order on January 3. On December 28 the company will debit Cash for $5,000 and will credit a liability account, such as Customer Deposits (or Unearned Revenues or Deferred Revenues) for $5,000. No revenue is reported in December for this special order since the company did not perform any work. When the special order is completed in January the company will debit the liability account for $5,000 and will credit a revenue account.

Without the balance SHEET account, ALLOWANCE for Uncollectible Accounts, all of the accounts receivable are assumed to be collectible and there is no bad debt expense REPORTED on the income statement until an account receivable is written off. This approach is KNOWN as the direct write-off method. (When an account is written off, the entry will be a debit to Bad Debt Expense and a CREDIT to Accounts Receivable.)

When the account Allowance for Uncollectible Accounts is reported on the balance sheet, the company anticipates that some of its accounts receivable will not be collected. In other words, without knowing specifically which account will not be collected, the company debits Bad Debt Expense and credits Allowance for Uncollectible Accounts. This results in an expense on the income statement (sooner than would occur under the direct write-off method) and a reduction of the current assets on the balance sheet. (When an account is written off under the "allowance" method, the entry will be a debit to Allowance for Uncollectible Accounts and a credit to Accounts Receivable.)

Without the balance sheet account, Allowance for Uncollectible Accounts, all of the accounts receivable are assumed to be collectible and there is no bad debt expense reported on the income statement until an account receivable is written off. This approach is known as the direct write-off method. (When an account is written off, the entry will be a debit to Bad Debt Expense and a credit to Accounts Receivable.)

When the account Allowance for Uncollectible Accounts is reported on the balance sheet, the company anticipates that some of its accounts receivable will not be collected. In other words, without knowing specifically which account will not be collected, the company debits Bad Debt Expense and credits Allowance for Uncollectible Accounts. This results in an expense on the income statement (sooner than would occur under the direct write-off method) and a reduction of the current assets on the balance sheet. (When an account is written off under the "allowance" method, the entry will be a debit to Allowance for Uncollectible Accounts and a credit to Accounts Receivable.)

A noncash expense is an expense that is reported on the INCOME statement of the current accounting period, but there was no related CASH payment during the period.

A common EXAMPLE of a noncash expense is depreciation. For instance, if a company PURCHASED equipment on December 31, 2012 for $200,000 cash, it could have Depreciation Expense of $20,000 in each of the next 10 years. As a result its income statement will report Depreciation Expense of $20,000 in each of the years 2013 through 2022. Since there is no cash payment in any of those years, each year's $20,000 of depreciation expense is referred to as a noncash expense.

A noncash expense is an expense that is reported on the income statement of the current accounting period, but there was no related cash payment during the period.

A common example of a noncash expense is depreciation. For instance, if a company purchased equipment on December 31, 2012 for $200,000 cash, it could have Depreciation Expense of $20,000 in each of the next 10 years. As a result its income statement will report Depreciation Expense of $20,000 in each of the years 2013 through 2022. Since there is no cash payment in any of those years, each year's $20,000 of depreciation expense is referred to as a noncash expense.

A prepaid expense might be recorded initially as 1) an expense, or 2) as an asset.

1. If a prepaid expense is recorded initially as an expense, then at the end of an accounting period, only the true expense amount for the period should remain in the expense account. The future expense (the portion that has not yet expired; the unexpired part) must be credited to the expense account and debited to the prepaid asset account.
2. If a prepaid expense is recorded initially in a prepaid asset account, the true expense of the period (the expired portion) needs to be removed and debited to the related expense account. The remaining amount in the prepaid asset account should be the unexpired portion.

Let's illustrate these two POSSIBILITIES by ASSUMING that an insurance premium of $6,000 is paid on December 1. This cost covers the six month period of December 1 through May 31. As a result the monthly expense will be $1,000. Let's also assume that the company did not have any insurance prior to December 1.

1. On December 1, the account Insurance Expense was initially debited for $6,000 and Cash was credited for $6,000. On December 31, an adjusting entry will be needed to debit Prepaid Insurance for $5,000 and to credit Insurance Expense for $5,000. After this adjusting entry is recorded, the balance in Insurance Expense will be December's true expense of $1,000 (original debit of $6,000 minus the adjusting entry credit of $5,000) and the balance in Prepaid Insurance will be the debit of $5,000. This REPRESENTS five months of cost that has not yet expired (5 months x $1,000 PER month).
2. On December 1, the account Prepaid Insurance was initially debited for $6,000 and Cash was credited for $6,000. On December 31, an adjusting entry will be needed to debit Insurance Expense for $1,000 (the amount that expired during December) and to credit Prepaid Insurance for $1,000. After this adjusting entry is recorded, the balance in the asset Prepaid Insurance will be $5,000 (the initial debit of $6,000 minus the credit of $1,000; and the unexpired amount consisting of 5 months x $1,000 per month). The account Insurance Expense will report the debit of $1,000.

Usually there would be insurance coverage prior to December 1. In that case the year-to-date balance in the expense account should be equal to the expired insurance cost during the year-to-date period. If there is a conflict between getting the prepaid asset balance to be correct and the expense balance to be correct, make CERTAIN that the prepaid asset balance is correct.

A prepaid expense might be recorded initially as 1) an expense, or 2) as an asset.

Let's illustrate these two possibilities by assuming that an insurance premium of $6,000 is paid on December 1. This cost covers the six month period of December 1 through May 31. As a result the monthly expense will be $1,000. Let's also assume that the company did not have any insurance prior to December 1.

Usually there would be insurance coverage prior to December 1. In that case the year-to-date balance in the expense account should be equal to the expired insurance cost during the year-to-date period. If there is a conflict between getting the prepaid asset balance to be correct and the expense balance to be correct, make certain that the prepaid asset balance is correct.

Income statement accounts are one of two types of general ledger accounts. (Balance SHEET accounts make up the other type.) Income statement accounts are used to sort and store transactions involving REVENUES, expenses, gains, and losses. The income summary account is also an income statement account. The number of income statement accounts used at a large company could be in the thousands. A few examples of income statement accounts INCLUDE Sales, Service Revenues, Salaries Expense, Rent Expense, Advertising Expense, Interest Expense, Gain on Disposal of Truck, etc.

Income statement accounts are described as temporary accounts because at the end of each accounting year the balances in the income statement accounts will be closed. This means that the balances will be combined and the net AMOUNT will be transferred to a balance sheet equity account. In the case of a corporation, the equity account is Retained Earnings. In the case of a sole proprietorship it is the owner's capital account.

The closing of the income statement accounts at the end of an accounting year means that the income statement accounts will begin the subsequent year with zero balances. As a result, the balances in the income statement accounts will be the year-to-date amounts.

It will be helpful to remember that every ADJUSTING entry will require at least one income statement account and at lease one balance sheet account.

Income statement accounts are one of two types of general ledger accounts. (Balance sheet accounts make up the other type.) Income statement accounts are used to sort and store transactions involving revenues, expenses, gains, and losses. The income summary account is also an income statement account. The number of income statement accounts used at a large company could be in the thousands. A few examples of income statement accounts include Sales, Service Revenues, Salaries Expense, Rent Expense, Advertising Expense, Interest Expense, Gain on Disposal of Truck, etc.

Income statement accounts are described as temporary accounts because at the end of each accounting year the balances in the income statement accounts will be closed. This means that the balances will be combined and the net amount will be transferred to a balance sheet equity account. In the case of a corporation, the equity account is Retained Earnings. In the case of a sole proprietorship it is the owner's capital account.

The closing of the income statement accounts at the end of an accounting year means that the income statement accounts will begin the subsequent year with zero balances. As a result, the balances in the income statement accounts will be the year-to-date amounts.

It will be helpful to remember that every adjusting entry will require at least one income statement account and at lease one balance sheet account.

Some PEOPLE USE Provision for Doubtful DEBTS to mean the contra-asset account reported on the balance sheet. Others use Provision for Doubtful Debts to mean the expense reported on the income statement.

If Provision for Doubtful Debts is the current PERIOD expense associated with the losses from normal credit sales, it will appear as an operating expense—usually as part of Selling, General and Administrative Expenses (SG&A). If the expense is associated with extending credit outside of a company's main selling activities, the credit loss will be reported as a nonoperating expense.

To AVOID the confusion with the use of the word "provision", the accounting textbooks often refer to the contra-asset account associated with accounts receivable as Allowance for Doubtful Accounts. The current period expense pertaining to accounts receivable is referred to as Bad Debt Expense, an operating expense.

Some people use Provision for Doubtful Debts to mean the contra-asset account reported on the balance sheet. Others use Provision for Doubtful Debts to mean the expense reported on the income statement.

If Provision for Doubtful Debts is the current period expense associated with the losses from normal credit sales, it will appear as an operating expense—usually as part of Selling, General and Administrative Expenses (SG&A). If the expense is associated with extending credit outside of a company's main selling activities, the credit loss will be reported as a nonoperating expense.

To avoid the confusion with the use of the word "provision", the accounting textbooks often refer to the contra-asset account associated with accounts receivable as Allowance for Doubtful Accounts. The current period expense pertaining to accounts receivable is referred to as Bad Debt Expense, an operating expense.

If the dollar amount of supplies is significant, the amount of unused supplies as of the balance sheet date should be reported in the asset account Supplies or Supplies on HAND. The supplies that have been USED during the ACCOUNTING period should be reported in the income statement account Supplies Expense. BASICALLY, supplies are assets until they are used. When they are used, they become an expense.

When the dollar amount of supplies is not significant, many companies will simply debit Supplies Expense when the supplies are purchased. They will report no supplies on hand or a small constant amount. This less-than-perfect accounting treatment of an insignificant amount is allowed because of an accounting concept known as materiality.

If the dollar amount of supplies is significant, the amount of unused supplies as of the balance sheet date should be reported in the asset account Supplies or Supplies on Hand. The supplies that have been used during the accounting period should be reported in the income statement account Supplies Expense. Basically, supplies are assets until they are used. When they are used, they become an expense.

When the dollar amount of supplies is not significant, many companies will simply debit Supplies Expense when the supplies are purchased. They will report no supplies on hand or a small constant amount. This less-than-perfect accounting treatment of an insignificant amount is allowed because of an accounting concept known as materiality.

Accrued interest is the AMOUNT of loan interest that has already occurred, but has not YET been paid to the LENDER by the borrower.

The accrued interest will be reported by the borrower as both

1. an EXPENSE on its income statement, and
2. a current liability on its balance sheet.

The accrued interest will be reported by the lender as both

1. revenue on its income statement, and
2. a current asset on its balance sheet.

Accrued interest is likely to require adjusting entries by both the borrower and the lender prior to issuing their financial STATEMENTS.

Accrued interest is the amount of loan interest that has already occurred, but has not yet been paid to the lender by the borrower.

The accrued interest will be reported by the borrower as both

The accrued interest will be reported by the lender as both

Accrued interest is likely to require adjusting entries by both the borrower and the lender prior to issuing their financial statements.

You need to adjust the balance in the contra asset account Allowance for Doubtful Accounts to be your best estimate of the amount in Accounts Receivable which are not collectible. In other words, adjust the credit balance in the allowance account to become the amount of the RECEIVABLES that is not EXPECTED to turn to cash.

If the Allowance for Doubtful Accounts presently has a credit balance of $2,000 and you believe there is a total of $2,900 of accounts receivable that will not be collected, you need to enter an additional credit of $900 into the Allowance for Doubtful Accounts, and you need to enter a debit of $900 into Bad Debts Expense.

The allowance account appearing on the balance sheet might be TITLED Allowance for Uncollectible Accounts, PROVISION for Bad Debts, or some combination of these. The income STATEMENT account might have a title such as Uncollectible Accounts Expense, Doubtful Accounts Expense, etc.

You need to adjust the balance in the contra asset account Allowance for Doubtful Accounts to be your best estimate of the amount in Accounts Receivable which are not collectible. In other words, adjust the credit balance in the allowance account to become the amount of the receivables that is not expected to turn to cash.

If the Allowance for Doubtful Accounts presently has a credit balance of $2,000 and you believe there is a total of $2,900 of accounts receivable that will not be collected, you need to enter an additional credit of $900 into the Allowance for Doubtful Accounts, and you need to enter a debit of $900 into Bad Debts Expense.

The allowance account appearing on the balance sheet might be titled Allowance for Uncollectible Accounts, Provision for Bad Debts, or some combination of these. The income statement account might have a title such as Uncollectible Accounts Expense, Doubtful Accounts Expense, etc.

Balance sheet accounts are one of two types of general ledger accounts. (Income statement accounts make up the other type.) Balance sheet accounts are used to sort and store transactions involving assets, liabilities, and owner's or stockholders' equity. Examples of a corporation's balance sheet accounts include Cash, Accounts RECEIVABLE, Investments, Buildings, Equipment, Accumulated Depreciation, Notes Payable, Accounts Payable, Payroll Taxes Payable, Paid-in Capital, Retained Earnings, etc.

Balance sheet accounts are described as permanent or real accounts because at the end of the accounting YEAR the balances in these accounts are not closed. Instead, the end-of-the-accounting-year balances will be carried forward to become the BEGINNING balances in the next accounting year. (This is different from the income statement accounts, which begin each accounting year with zero balances.)

The balances in the balance sheet accounts are PRESENTED in a company's balance sheet, which is one of the main FINANCIAL statements.

It will be helpful to keep in mind that every adjusting entry will require at least one balance sheet account and one income statement account.

Balance sheet accounts are one of two types of general ledger accounts. (Income statement accounts make up the other type.) Balance sheet accounts are used to sort and store transactions involving assets, liabilities, and owner's or stockholders' equity. Examples of a corporation's balance sheet accounts include Cash, Accounts Receivable, Investments, Buildings, Equipment, Accumulated Depreciation, Notes Payable, Accounts Payable, Payroll Taxes Payable, Paid-in Capital, Retained Earnings, etc.

Balance sheet accounts are described as permanent or real accounts because at the end of the accounting year the balances in these accounts are not closed. Instead, the end-of-the-accounting-year balances will be carried forward to become the beginning balances in the next accounting year. (This is different from the income statement accounts, which begin each accounting year with zero balances.)

The balances in the balance sheet accounts are presented in a company's balance sheet, which is one of the main financial statements.

It will be helpful to keep in mind that every adjusting entry will require at least one balance sheet account and one income statement account.

The term "deferred expense" is used to describe a payment that has been made, but it won't be reported as an expense until a future accounting period.

For example, a corporation might SPEND $500,000 in accounting, legal, and other fees in order to issue $40,000,000 of bonds payable. Rather than charging the $500,000 to expense in the year that the bonds are ISSUED, the corporation will "defer" the $500,000 to a balance sheet account such as Bond Issue Costs. If the bonds mature in 25 years, the corporation will charge $20,000 of the bond issue costs ($500,000 divided by 25 years) to expense each year. This accounting treatment does a better job of matching the $500,000 to the periods when the company will be earning revenues from the use of the $40,000,000.

Another example of a deferred expense is the $12,000 INSURANCE premium paid by a company on December 27 for insurance protection for the upcoming January 1 through June 30. On December 27 the $12,000 is deferred to the balance sheet account Prepaid Insurance. Beginning in January it will be expensed at the rate of $2,000 per month. Again, the deferral was necessary to achieve the matching principle.

As you can see from our examples, the word "deferred" overpowers the word "expense." A deferred expense is reported on the balance sheet as an asset until it expires. As it is expiring, it will be moving from the balance sheet to the INCOME STATEMENT where it will be reported as an expense. The entries involving deferred expenses are called adjusting entries.

The term "deferred expense" is used to describe a payment that has been made, but it won't be reported as an expense until a future accounting period.

For example, a corporation might spend $500,000 in accounting, legal, and other fees in order to issue $40,000,000 of bonds payable. Rather than charging the $500,000 to expense in the year that the bonds are issued, the corporation will "defer" the $500,000 to a balance sheet account such as Bond Issue Costs. If the bonds mature in 25 years, the corporation will charge $20,000 of the bond issue costs ($500,000 divided by 25 years) to expense each year. This accounting treatment does a better job of matching the $500,000 to the periods when the company will be earning revenues from the use of the $40,000,000.

Another example of a deferred expense is the $12,000 insurance premium paid by a company on December 27 for insurance protection for the upcoming January 1 through June 30. On December 27 the $12,000 is deferred to the balance sheet account Prepaid Insurance. Beginning in January it will be expensed at the rate of $2,000 per month. Again, the deferral was necessary to achieve the matching principle.

As you can see from our examples, the word "deferred" overpowers the word "expense." A deferred expense is reported on the balance sheet as an asset until it expires. As it is expiring, it will be moving from the balance sheet to the income statement where it will be reported as an expense. The entries involving deferred expenses are called adjusting entries.

In ACCOUNTING the monthly close is the processing of transactions, journal entries and financial statements at the end of each month. Under the accrual method of accounting, it is IMPERATIVE that the financial statements reflect only the transactions and journal entries having relevance to the current month's revenues and expenses, and end-of-the-month assets and liabilities. Expressed another way, the monthly close must achieve a proper cutoff of each month's financial ACTIVITIES.

To ensure that the monthly financial statements are accurate and timely, companies will use standard journal entries, recurring journal entries, and checklists for the TASKS that must be completed.

If a company has inventories, its monthly close will be more challenging as it will have to be certain that the costs are recorded in the same month as the goods are added to the inventories. In short, the accrual of expenses becomes immensely important when goods are received and are sold.

Another important step in the monthly close is to compare the amounts and percentages on the current financial statements to those of earlier months. For example, if the current income statement shows the cost of goods sold as 88% instead of the typical 81%, the current month's amounts need to be reviewed before releasing the financial statements. Often the comparison of the balance sheet amounts to those of earlier months will PROVIDE insight as to unusual amounts shown on the income statement.

In accounting the monthly close is the processing of transactions, journal entries and financial statements at the end of each month. Under the accrual method of accounting, it is imperative that the financial statements reflect only the transactions and journal entries having relevance to the current month's revenues and expenses, and end-of-the-month assets and liabilities. Expressed another way, the monthly close must achieve a proper cutoff of each month's financial activities.

To ensure that the monthly financial statements are accurate and timely, companies will use standard journal entries, recurring journal entries, and checklists for the tasks that must be completed.

If a company has inventories, its monthly close will be more challenging as it will have to be certain that the costs are recorded in the same month as the goods are added to the inventories. In short, the accrual of expenses becomes immensely important when goods are received and are sold.

Another important step in the monthly close is to compare the amounts and percentages on the current financial statements to those of earlier months. For example, if the current income statement shows the cost of goods sold as 88% instead of the typical 81%, the current month's amounts need to be reviewed before releasing the financial statements. Often the comparison of the balance sheet amounts to those of earlier months will provide insight as to unusual amounts shown on the income statement.

The term bad DEBTS usually refers to accounts receivable (or trade accounts receivable) that will not be collected. However, bad debts can also refer to notes receivable that will not be collected.

The bad debts associated with accounts receivable is REPORTED on the income STATEMENT as Bad Debts Expense or Uncollectible Accounts Expense.

When the allowance method is used, the journal entry to Bad Debts Expense will include a credit to Allowance for Doubtful Accounts, a contra account and valuation account to the asset Accounts Receivable. The allowance method anticipates the losses and THEREFORE requires the use of estimates.

Under the direct write-off method, the Allowance for Doubtful Accounts is not used. RATHER, Bad Debts Expense will be debited when an account receivable is actually written off. The credit in this entry will be to the asset Accounts Receivable.

The term bad debts usually refers to accounts receivable (or trade accounts receivable) that will not be collected. However, bad debts can also refer to notes receivable that will not be collected.

The bad debts associated with accounts receivable is reported on the income statement as Bad Debts Expense or Uncollectible Accounts Expense.

When the allowance method is used, the journal entry to Bad Debts Expense will include a credit to Allowance for Doubtful Accounts, a contra account and valuation account to the asset Accounts Receivable. The allowance method anticipates the losses and therefore requires the use of estimates.

Under the direct write-off method, the Allowance for Doubtful Accounts is not used. Rather, Bad Debts Expense will be debited when an account receivable is actually written off. The credit in this entry will be to the asset Accounts Receivable.

At the end of an accounting period (month, year, etc.) the INVENTORY account is adjusted so that the balance sheet will report the cost (or lower) of the goods actually owned by the company.

When an adjusting entry is USED, the related income statement account will be a cost of goods sold account. An example of such an account is Inventory Change or Inventory (Increase) Decrease.

To illustrate the inventory adjustment, let's assume that the cost of a company's actual inventory at the end of the year is $40,000. However, its general ledger asset account Inventory has a debit balance of $35,000. The company's inventory adjusting entry will 1) debit Inventory for $5,000 and 2) credit Inventory Change for $5,000. [You can think of the $5,000 credit balance in this income statement account as a reduction of the company's debit balance in its Purchases account. In other words, not all of the purchases should be matched with the period's sales since we know that the inventory has increased by $5,000.]

Next, let's assume that another company's cost of its actual ending inventory is $62,000. However, its inventory account has a debit balance of $70,000. This will require an adjusting entry to 1) credit Inventory for $8,000 and 2) debit Inventory Change for $8,000. The $8,000 debit in this income statement account will be an addition to the cost of the goods purchased. In other words, not only was it necessary to match the cost of purchases with sales, it was also necessary to match the additional $8,000 of cost that was removed from inventory.

TEXTBOOKS often change the balance in the account Inventory (under the periodic METHOD) through closing entries. (One closing entry removes the amount of beginning inventory and one closing entry records the cost of the ending inventory. ) We believe that an adjusting entry is more logical and EFFICIENT, especially when monthly and year-to-date financial statements are prepared using accounting software.

At the end of an accounting period (month, year, etc.) the inventory account is adjusted so that the balance sheet will report the cost (or lower) of the goods actually owned by the company.

When an adjusting entry is used, the related income statement account will be a cost of goods sold account. An example of such an account is Inventory Change or Inventory (Increase) Decrease.

To illustrate the inventory adjustment, let's assume that the cost of a company's actual inventory at the end of the year is $40,000. However, its general ledger asset account Inventory has a debit balance of $35,000. The company's inventory adjusting entry will 1) debit Inventory for $5,000 and 2) credit Inventory Change for $5,000. [You can think of the $5,000 credit balance in this income statement account as a reduction of the company's debit balance in its Purchases account. In other words, not all of the purchases should be matched with the period's sales since we know that the inventory has increased by $5,000.]

Next, let's assume that another company's cost of its actual ending inventory is $62,000. However, its inventory account has a debit balance of $70,000. This will require an adjusting entry to 1) credit Inventory for $8,000 and 2) debit Inventory Change for $8,000. The $8,000 debit in this income statement account will be an addition to the cost of the goods purchased. In other words, not only was it necessary to match the cost of purchases with sales, it was also necessary to match the additional $8,000 of cost that was removed from inventory.

Textbooks often change the balance in the account Inventory (under the periodic method) through closing entries. (One closing entry removes the amount of beginning inventory and one closing entry records the cost of the ending inventory. ) We believe that an adjusting entry is more logical and efficient, especially when monthly and year-to-date financial statements are prepared using accounting software.

The accounting cycle is often described as a process that includes the following steps: identifying, collecting and analyzing documents and transactions, recording the transactions in journals, posting the journalized amounts to accounts in the general and subsidiary ledgers, preparing an unadjusted trial balance, perhaps preparing a worksheet, DETERMINING and recording adjusting entries, preparing an adjusted trial balance, preparing the financial statements, recording and posting closing entries, preparing a post-closing trial balance, and perhaps recording reversing entries.

Cycle and steps seem to be a carryover from the days of manual bookkeeping and accounting when transactions were first written into journals. In a separate step the amounts in the JOURNAL were POSTED to accounts. At the end of each month, the remaining steps had to take place in order to get the monthly, manually-prepared financial statements.

Today, most companies USE accounting software that processes many of these steps simultaneously. The speed and accuracy of the software reduces the accountant's need for a worksheet containing the unadjusted trial balance, adjusting entries, and the adjusted trial balance. The accountant can enter the adjusting entries into the software and can obtain the complete financial statements by simply selecting the reports from a menu. After reviewing the financial statements, the accountant can make ADDITIONAL adjustments and almost immediately obtain the revised reports. The software will also prepare, record, and post the closing entries.

The accounting cycle is often described as a process that includes the following steps: identifying, collecting and analyzing documents and transactions, recording the transactions in journals, posting the journalized amounts to accounts in the general and subsidiary ledgers, preparing an unadjusted trial balance, perhaps preparing a worksheet, determining and recording adjusting entries, preparing an adjusted trial balance, preparing the financial statements, recording and posting closing entries, preparing a post-closing trial balance, and perhaps recording reversing entries.

Cycle and steps seem to be a carryover from the days of manual bookkeeping and accounting when transactions were first written into journals. In a separate step the amounts in the journal were posted to accounts. At the end of each month, the remaining steps had to take place in order to get the monthly, manually-prepared financial statements.

Today, most companies use accounting software that processes many of these steps simultaneously. The speed and accuracy of the software reduces the accountant's need for a worksheet containing the unadjusted trial balance, adjusting entries, and the adjusted trial balance. The accountant can enter the adjusting entries into the software and can obtain the complete financial statements by simply selecting the reports from a menu. After reviewing the financial statements, the accountant can make additional adjustments and almost immediately obtain the revised reports. The software will also prepare, record, and post the closing entries.

Reversing entries are made on the first day of an accounting period in order to remove certain adjusting entries made in the previous accounting period. Reversing entries are used in order to avoid the double counting of revenues or expenses and to allow for the efficient processing of documents. Reversing entries are most often used with accrual-type adjusting entries.

To illustrate reversing entries, let's assume that a retailer uses a temporary help service from December 15 - 31. The temp agency will BILL the retailer on January 10 and the retailer agrees to pay the invoice by January 15. If the retailer's accounting year ENDS on December 31, the retailer will MAKE an accrual-type adjusting entry for the estimated amount. If the estimated amount is $18,000 the retailer will debit Temp Service Expense for $18,000 and will credit Accrued Expenses PAYABLE for $18,000. This adjusting entry assures that the retailer's income statement and balance sheet as of December 31 will include the temp service expense and obligation.

On January 1, the retailer enters the following reversing entry: debit Accrued Expenses Payable for $18,000 and credit Temp Service Expense for $18,000. When the actual invoice ARRIVES from the temp agency on January 11, the retailer can simply debit the invoice amount to Temp Service Expense. If the invoice is $18,000 the Temp Service Expense will show $0. (The credit from the reversing entry and the debit from the invoice entry.) Thanks to the reversing entry, the retailer did not have to stop and consider whether the invoice amount pertains to December or January.

If the invoice amount is $18,180 the entire amount is debited to Temp Service Expense and $180 will appear as a January expense. This insignificant amount is acceptable since the adjusting entry amount was an estimate.

Reversing entries are made on the first day of an accounting period in order to remove certain adjusting entries made in the previous accounting period. Reversing entries are used in order to avoid the double counting of revenues or expenses and to allow for the efficient processing of documents. Reversing entries are most often used with accrual-type adjusting entries.

To illustrate reversing entries, let's assume that a retailer uses a temporary help service from December 15 - 31. The temp agency will bill the retailer on January 10 and the retailer agrees to pay the invoice by January 15. If the retailer's accounting year ends on December 31, the retailer will make an accrual-type adjusting entry for the estimated amount. If the estimated amount is $18,000 the retailer will debit Temp Service Expense for $18,000 and will credit Accrued Expenses Payable for $18,000. This adjusting entry assures that the retailer's income statement and balance sheet as of December 31 will include the temp service expense and obligation.

On January 1, the retailer enters the following reversing entry: debit Accrued Expenses Payable for $18,000 and credit Temp Service Expense for $18,000. When the actual invoice arrives from the temp agency on January 11, the retailer can simply debit the invoice amount to Temp Service Expense. If the invoice is $18,000 the Temp Service Expense will show $0. (The credit from the reversing entry and the debit from the invoice entry.) Thanks to the reversing entry, the retailer did not have to stop and consider whether the invoice amount pertains to December or January.

If the invoice amount is $18,180 the entire amount is debited to Temp Service Expense and $180 will appear as a January expense. This insignificant amount is acceptable since the adjusting entry amount was an estimate.

A trial balance is a bookkeeping or accounting report that LISTS the balances in each of an organization's general ledger accounts. (Accounts with zero balances will likely be omitted.) The debit balance amounts are listed in a column with the HEADING "Debit balances" and the credit balance amounts are listed in another column with the heading "Credit balances." The total of each of these TWO columns should be identical.

In a manual SYSTEM a trial balance was commonly prepared by the bookkeeper in order to discover whether math errors and/or some posting errors were made. Today, bookkeeping and accounting software has eliminated those clerical errors. This means that the trial balance is less important for bookkeeping purposes since it is almost certain that the total of the debit and credit columns will be equal.

However, the trial balance continues to be useful for auditors and accountants who wish to show 1) the general ledger account balances prior to their proposed adjustments, 2) their proposed adjustments, and 3) all of the account balances after the proposed adjustments. These final balances are known as the adjusted trial balance, and these amounts will be used in the organization's financial statements.

Neither the unadjusted trial balance nor the adjusted trial balance is a financial statement and neither trial balance is DISTRIBUTED to anyone outside of the accounting and auditing staff. In other words, the trial balance is an internal document.

A trial balance is a bookkeeping or accounting report that lists the balances in each of an organization's general ledger accounts. (Accounts with zero balances will likely be omitted.) The debit balance amounts are listed in a column with the heading "Debit balances" and the credit balance amounts are listed in another column with the heading "Credit balances." The total of each of these two columns should be identical.

In a manual system a trial balance was commonly prepared by the bookkeeper in order to discover whether math errors and/or some posting errors were made. Today, bookkeeping and accounting software has eliminated those clerical errors. This means that the trial balance is less important for bookkeeping purposes since it is almost certain that the total of the debit and credit columns will be equal.

However, the trial balance continues to be useful for auditors and accountants who wish to show 1) the general ledger account balances prior to their proposed adjustments, 2) their proposed adjustments, and 3) all of the account balances after the proposed adjustments. These final balances are known as the adjusted trial balance, and these amounts will be used in the organization's financial statements.

Neither the unadjusted trial balance nor the adjusted trial balance is a financial statement and neither trial balance is distributed to anyone outside of the accounting and auditing staff. In other words, the trial balance is an internal document.

The sum of the years' digits, often referred to as SYD, is a form of accelerated depreciation. (A more common form of accelerated depreciation is the declining balance method used in tax depreciation.) The sum of the years' digits method will result in greater depreciation in the earlier years of an asset's useful life and less in the later years. However, the total amount of depreciation over an asset's useful life should be the same regardless of the depreciation method used. The DIFFERENCE is in the TIMING of the total depreciation.

To ILLUSTRATE the sum of the years' digits method of depreciation, let's assume that a plant asset is purchased at a cost of $160,000. The asset is expected to have a useful life of 5 years and then be sold for $10,000. This means that the asset's depreciable amount will be $150,000 to be expensed over its useful life of 5 years.

Next the digits in the years of the asset's useful life are summed: 1 + 2 + 3 + 4 + 5 = 15. In the first year of the asset's life, 5/15 of the depreciable amount (5/15 of $150,000) or $50,000 will be debited to Depreciation Expense and $50,000 will be credited to Accumulated Depreciation. In the second year of the asset's life, $40,000 (4/15 of $150,000) will be the depreciation amount. In the third year, $30,000 (3/15 of $150,000) will be the depreciation. The fourth year will be $20,000 (2/15 of $150,000) and the fifth year will be $10,000 (1/15 of $150,000). As indicated earlier, the total depreciation during the asset's useful life needs to sum to the depreciable cost (in this case $150,000) regardless of the depreciation method used.

Instead of adding the individual digits in the years of the asset's useful life, the FOLLOWING formula can be used: n(n+1) divided by 2. In this formula, n = the useful life in years. Let's use the formula to check our CALCULATION above. When the useful life is 5 years, the formula will be 5(5+1)/2 = 5(6)/2 = 30/2 = 15. If the useful life is 10 years, the formula will show 10(10+1)/2 = 10(11)/2 = 110/2 = 55. In the first year of the asset having a 10 year useful life, the depreciation will be 10/55 of the asset's depreciable cost. The second year will be 9/55 of the asset's depreciable cost. In the tenth year, the depreciation will be 1/55 of the asset's depreciable cost.

The sum of the years' digits, often referred to as SYD, is a form of accelerated depreciation. (A more common form of accelerated depreciation is the declining balance method used in tax depreciation.) The sum of the years' digits method will result in greater depreciation in the earlier years of an asset's useful life and less in the later years. However, the total amount of depreciation over an asset's useful life should be the same regardless of the depreciation method used. The difference is in the timing of the total depreciation.

To illustrate the sum of the years' digits method of depreciation, let's assume that a plant asset is purchased at a cost of $160,000. The asset is expected to have a useful life of 5 years and then be sold for $10,000. This means that the asset's depreciable amount will be $150,000 to be expensed over its useful life of 5 years.

Next the digits in the years of the asset's useful life are summed: 1 + 2 + 3 + 4 + 5 = 15. In the first year of the asset's life, 5/15 of the depreciable amount (5/15 of $150,000) or $50,000 will be debited to Depreciation Expense and $50,000 will be credited to Accumulated Depreciation. In the second year of the asset's life, $40,000 (4/15 of $150,000) will be the depreciation amount. In the third year, $30,000 (3/15 of $150,000) will be the depreciation. The fourth year will be $20,000 (2/15 of $150,000) and the fifth year will be $10,000 (1/15 of $150,000). As indicated earlier, the total depreciation during the asset's useful life needs to sum to the depreciable cost (in this case $150,000) regardless of the depreciation method used.

Instead of adding the individual digits in the years of the asset's useful life, the following formula can be used: n(n+1) divided by 2. In this formula, n = the useful life in years. Let's use the formula to check our calculation above. When the useful life is 5 years, the formula will be 5(5+1)/2 = 5(6)/2 = 30/2 = 15. If the useful life is 10 years, the formula will show 10(10+1)/2 = 10(11)/2 = 110/2 = 55. In the first year of the asset having a 10 year useful life, the depreciation will be 10/55 of the asset's depreciable cost. The second year will be 9/55 of the asset's depreciable cost. In the tenth year, the depreciation will be 1/55 of the asset's depreciable cost.

An ACCRUAL occurs before a payment or receipt. A deferral occurs after a payment or receipt. There are accruals for expenses and for revenues. There are deferrals for expenses and for revenues.

An accrual of an expense refers to the reporting of an expense and the related liability in the period in which they occur, and that period is prior to the period in which the payment is made. An example of an accrual for an expense is the electricity that is used in December, but the payment will not be made until January.

An accrual of revenues refers to the reporting of revenues and the related receivables in the period in which they are EARNED, and that period is prior to the period of the cash receipt. An example of the accrual of revenues is the interest earned in December on an investment in a government bond, but the interest will not be received until January.

A deferral of an expense refers to a payment that was made in ONE period, but will be reported as an expense in a later period. An example is the payment in December for the six-month insurance premium that will be reported as an expense in the months of January through June.

A deferral of revenues refers to receipts in one accounting period, but they will be earned in FUTURE accounting periods. For example, the insurance company has a cash receipt in December for a six-month insurance premium. However, the insurance company will report this as part of its revenues in January through June.

An accrual occurs before a payment or receipt. A deferral occurs after a payment or receipt. There are accruals for expenses and for revenues. There are deferrals for expenses and for revenues.

An accrual of an expense refers to the reporting of an expense and the related liability in the period in which they occur, and that period is prior to the period in which the payment is made. An example of an accrual for an expense is the electricity that is used in December, but the payment will not be made until January.

An accrual of revenues refers to the reporting of revenues and the related receivables in the period in which they are earned, and that period is prior to the period of the cash receipt. An example of the accrual of revenues is the interest earned in December on an investment in a government bond, but the interest will not be received until January.

A deferral of an expense refers to a payment that was made in one period, but will be reported as an expense in a later period. An example is the payment in December for the six-month insurance premium that will be reported as an expense in the months of January through June.

A deferral of revenues refers to receipts in one accounting period, but they will be earned in future accounting periods. For example, the insurance company has a cash receipt in December for a six-month insurance premium. However, the insurance company will report this as part of its revenues in January through June.

The PROVISION for bad debts might refer to the balance sheet account also known as the Allowance for Bad Debts, Allowance for DOUBTFUL Accounts, or Allowance for Uncollectible Accounts. In this case Provision for Bad Debts is a contra asset account (an asset account with a CREDIT balance). It is used along with the account Accounts Receivable in order to report the net realizable VALUE of the accounts receivable.

Provision for Bad Debts might also be an the income statement account also known as Bad Debt Expense or Uncollectible Account Expense. In this situation, the Provision for Bad Debts reports the credit losses that PERTAIN to the period shown on the income statement.

The provision for bad debts might refer to the balance sheet account also known as the Allowance for Bad Debts, Allowance for Doubtful Accounts, or Allowance for Uncollectible Accounts. In this case Provision for Bad Debts is a contra asset account (an asset account with a credit balance). It is used along with the account Accounts Receivable in order to report the net realizable value of the accounts receivable.

Provision for Bad Debts might also be an the income statement account also known as Bad Debt Expense or Uncollectible Account Expense. In this situation, the Provision for Bad Debts reports the credit losses that pertain to the period shown on the income statement.

Accounts receivable is the MONEY that a company has a right to receive because it had provided customers with goods and/or services. For example, a manufacturer will have an account receivable when it delivers a truckload of goods to a customer on June 1 and the customer is allowed to pay in 30 days. From June 1 until the company receives the money, the company will have an account receivable (and the customer will have an account payable). Accounts receivables are also known as trade receivables.

Companies who sell on credit are unlikely to have liens on their customers' property. Hence, there is a risk that the full amount of their accounts receivable might not be collected. This means that companies need to cautious when granting credit and establishing an account receivable. If there is uncertainty of a potential (or existing) customer's credit WORTHINESS, it is wise for the company to require the customer to pay with a credit card before delivering goods or services.

It is also important for a company to monitor its accounts receivable and to immediately follow up with any customer who has not paid as agreed. An aging of accounts receivable is a tool that will help and it is READILY available with most accounting software. A general rule is that the older a receivable gets, the less likely it will be collected in full.

Accounts receivable are reported as a current asset on a company's balance sheet. Good accounting requires that an estimate be made for the amount that is unlikely to be collected. That estimate is reported as a credit balance in a related receivable account such as ALLOWANCE for Doubtful Accounts. Any adjustments to the Allowance balance will also be recorded in the income statement account Uncollectible Accounts Expense.

Accounts receivable is the money that a company has a right to receive because it had provided customers with goods and/or services. For example, a manufacturer will have an account receivable when it delivers a truckload of goods to a customer on June 1 and the customer is allowed to pay in 30 days. From June 1 until the company receives the money, the company will have an account receivable (and the customer will have an account payable). Accounts receivables are also known as trade receivables.

Companies who sell on credit are unlikely to have liens on their customers' property. Hence, there is a risk that the full amount of their accounts receivable might not be collected. This means that companies need to cautious when granting credit and establishing an account receivable. If there is uncertainty of a potential (or existing) customer's credit worthiness, it is wise for the company to require the customer to pay with a credit card before delivering goods or services.

It is also important for a company to monitor its accounts receivable and to immediately follow up with any customer who has not paid as agreed. An aging of accounts receivable is a tool that will help and it is readily available with most accounting software. A general rule is that the older a receivable gets, the less likely it will be collected in full.

Accounts receivable are reported as a current asset on a company's balance sheet. Good accounting requires that an estimate be made for the amount that is unlikely to be collected. That estimate is reported as a credit balance in a related receivable account such as Allowance for Doubtful Accounts. Any adjustments to the Allowance balance will also be recorded in the income statement account Uncollectible Accounts Expense.

Reconciling an account often means PROVING or documenting that an account balance is correct. For example, we reconcile the balance in the general ledger account Cash in Checking to the balance shown on the bank statement. The objective is to report the correct amount in the general ledger account Cash in Checking. You will often need to adjust the general ledger account balance for items appearing on the bank statement that were not entered in the general ledger account.

I recall being ASKED to reconcile the general ledger account Freight Payable. What I needed to do was PROVIDE documentation that the balance in Freight Payable was proper. I proceeded to look at the shipments of recent SALES and then determined how much we would be obligated to pay for the freight on those sales. We then adjusted the balance in Freight Payable to my documented amount. This reconciliation was done to have the correct account balance and to provide the outside auditors with documentation which could easily be reviewed.

I ALSO reconciled the balance in Utilities Payable by computing the daily cost of each utility that the company used. The cost per day was then multiplied by the number of days since the last meter reading date shown on the utility bills already entered in our accounting system. We then adjusted the Utilities Payable account balance to be equal to the documented amount.

Reconciling an account often means proving or documenting that an account balance is correct. For example, we reconcile the balance in the general ledger account Cash in Checking to the balance shown on the bank statement. The objective is to report the correct amount in the general ledger account Cash in Checking. You will often need to adjust the general ledger account balance for items appearing on the bank statement that were not entered in the general ledger account.

I recall being asked to reconcile the general ledger account Freight Payable. What I needed to do was provide documentation that the balance in Freight Payable was proper. I proceeded to look at the shipments of recent sales and then determined how much we would be obligated to pay for the freight on those sales. We then adjusted the balance in Freight Payable to my documented amount. This reconciliation was done to have the correct account balance and to provide the outside auditors with documentation which could easily be reviewed.

I also reconciled the balance in Utilities Payable by computing the daily cost of each utility that the company used. The cost per day was then multiplied by the number of days since the last meter reading date shown on the utility bills already entered in our accounting system. We then adjusted the Utilities Payable account balance to be equal to the documented amount.

In manual accounting or bookkeeping systems, business transactions are first recorded in a journal...hence the term journal entry.

A manual journal entry that is recorded in a company's GENERAL journal will consist of the following:

• the appropriate date
• the amount(s) and account(s) that will be debited
• the amount(s) and account(s) that will be credited
• a short description/memo
• a reference such as a check number

These journalized amounts (which will appear in the journal in order by date) are then posted to the accounts in the general ledger.

Today, computerized accounting systems will automatically record most of the business transactions into the general ledger accounts immediately after the software prepares the sales invoices, issues checks to creditors, processes receipts from customers, etc. The result is we will not SEE journal entries for most of the business transactions.

However, we will need to PROCESS some journal entries in order to record transfers between bank accounts and to record adjusting entries. For example, it is likely that at the end of each month there will be a journal entry to record depreciation. (This will INCLUDE a debit to Depreciation Expense and a credit to Accumulated Depreciation.) In addition, there will likely be a need for journal entry to accrue interest on a bank LOAN. (This will include a debit to Interest Expense and a credit to Interest Payable.)

In manual accounting or bookkeeping systems, business transactions are first recorded in a journal...hence the term journal entry.

A manual journal entry that is recorded in a company's general journal will consist of the following:

These journalized amounts (which will appear in the journal in order by date) are then posted to the accounts in the general ledger.

Today, computerized accounting systems will automatically record most of the business transactions into the general ledger accounts immediately after the software prepares the sales invoices, issues checks to creditors, processes receipts from customers, etc. The result is we will not see journal entries for most of the business transactions.

However, we will need to process some journal entries in order to record transfers between bank accounts and to record adjusting entries. For example, it is likely that at the end of each month there will be a journal entry to record depreciation. (This will include a debit to Depreciation Expense and a credit to Accumulated Depreciation.) In addition, there will likely be a need for journal entry to accrue interest on a bank loan. (This will include a debit to Interest Expense and a credit to Interest Payable.)