Concept of Adjustments

Introduction

Adjusting entries are made at the end of the accounting period to make your financial statements more accurately reflect your income and expenses, usually — but not always — on an accrual basis. This can be at the end of the month or the end of the year.

Typically, you — or your bookkeeper — will enter income and expenses as they are recognized in your business. This can be done on either a cash basis or an accrual basis. Regardless of how meticulous your bookkeeping is, though, there will be a need to make adjusting entries from time to time. An adjusting entry is simply an adjustment to your books to make your financial statements more accurately reflect your income and expenses, usually — but not always — on an accrual basis.

Classification of adjustment

1. General adjustments
2. Capital expenditure and revenue expenditure
3. Depreciation
4. Disposal of fixed asset
5. Bad debts

i. General adjustment

The basic adjusting entries and the way to adjust them

i. Accrued expenses

An accrued expense is an expense that has occurred in one accounting period but won't be paid until another period. They may also be called arrears or outstanding expenses.

Example: Assume the rent of 600,000 per year is payable at the end of every three months. The rent was always paid on time but this is not always the case.

Amount	Rent due	Rent paid
Tshs 150,000	31st March 2021	31st March 2021
Tshs 150,000	30th June 2021	4th July 2021
Tshs 150,000	30th September 2021	5th October 2021
Tshs 150,000	31st December 2021	15th January 2022

Required: Prepare rent account as 31^st December 2021

DR	RENT ACCOUNT				CR
2021 31.03 04.07 05.10 31.12	Cash Cash Cash Accrued c/d	150,000 150,000 150,000 150,000	2021 31.12	Profit and loss	600,000
		600,000			600,000
			2022 1.1	Accrued b/d	150,000

Note: The balance c/d has been described as accrued c/d rather than as balance c/d. This is to explain what the balance is for. It is for an accrued expense.

ii. Prepaid expenses

A prepaid expense is a type of asset on the balance sheet that results from a business making advanced payments for goods or services to be received in the future. Prepaid expenses are initially recorded as assets, but their value is expensed over time onto the income statement.

Example: Insurance for a business is at the rate of Tshs 240,000 a year, starting from 1^st January 2020. The business has agreed to pay this at the rate of 60,000 every three months. However, payments were not made at the correct times. Details were:

Amount	Insurance due	Insurance paid
Tshs 60,000	31st March 2020	31st March 2020 (60,000)
Tshs 60,000	30th June 2020	-
Tshs 60,000	30th September 2020	25th August 2020 (120,000)
Tshs 60,000	31st December 2020	15th November 2020 (120,000)

Required: Prepare rent account as 31^st December 2021

DR	INSURANCE ACCOUNT				CR
2021 31.03 25.08 15.11	Cash Cash Cash	60,000 120,000 120,000	2021 31.12	Profit and loss Prepaid c/d	240,000 60,000
		300,000			300,000
2022 1.1	Prepaid b/d	60,000

iii. Accrued income/revenue owing

Accrued income is money that's been earned but has yet to be received. Mutual funds or other pooled assets that accumulate income over a period of time—but only pay shareholders once a year—are, by definition, accruing their income.

Example: Our warehouse is large than we need. We rent part of it to another business for Tshs 1,200,000 per annum. Details for the year ended 31^st December were as follows

Amount	Rent due	Rent paid
Tshs 300,000	31st March 2020	4th March 2020
Tshs 300,000	30th June 2020	6th July 2020
Tshs 300,000	30th September 2020	9th October 2020
Tshs 300,000	31st December 2020	7th January 2021

Required: Prepare rent account as 31^st December 2021

DR	RENT RECEIVABLE ACCOUNT				CR
2020 31.12	Profit and loss	1,200,000	2020 31.03 25.08 15.11 31.12	Bank Bank Bank Accrued c/d	300,000 300,000 300,000 300,000
		1,200,000			1,200,000
2021 1.1	Accrued b/d	1,200,000

Example

Electricity and advertising paid in the year amounted to sh. 300,000. The following information was also provided.

2010	Accrued electricity	Prepaid advertising for Jan.1
	Sh. 25,000	Sh. 19,000
Dec.31	Sh. 40,000	Sh. 24,000

You are required to compute the amount to be charged to the Profit and Loss account without opening accounts

Solution

DR ELECTRICITY AND ADVERTISING A/C CR

Date	Details	Amount	Date	Details	Amount
1.1.2010	Bal. b/d	19,000	1/1/10	Bal. b/d	25,000
	Cash/Bank	300,000		Profit and loss	310,000
31.12. 10	Bal. c/d	40,000	31.12.10	Bal. c/d	24,000
		359,000			359,000
	Bal. b/d	24,000		Bal. b/d	40,000