Adjusting and correcting entries

Learning goals

• Separate deferrals, accruals, estimates, and corrections.
• Calculate and record period-end adjustments with debit/credit reasoning.
• Explain each adjustment's effect on profit and the statement of financial position.
• Use a reasonableness check to catch omitted or duplicated adjustments.

Prerequisite check

What two questions does accrual accounting ask at period-end? Ask: “What has been earned?” and “What has been incurred?” Cash timing is evidence, but not necessarily the recognition date.

Vocabulary

• Deferral: cash was recorded before the related revenue or expense is recognized.
• Accrual: revenue is earned or an expense incurred before cash is recorded.
• Estimate: a supported approximation, such as depreciation or doubtful accounts.
• Correction: an entry that fixes an error; it is not a normal period-end adjustment.
• Carrying amount: asset cost less accumulated depreciation or another valuation allowance.

Core idea

Adjustments bring account balances to the amounts that belong at the reporting date. They normally affect one statement-of-financial-position account and one income-statement account. Corrections instead compare what was recorded with what should have been recorded and enter the difference.

Why this treatment makes sense

A December utility bill belongs in December profit even if it is paid in January. Likewise, a prepaid insurance payment is not all an expense on payment day because future coverage remains an asset. Matching costs with the periods they help serve prevents cash timing from distorting performance.

A repeatable method

1. Write the unadjusted balance.
2. Compute the required ending balance or amount earned/incurred.
3. Calculate required − recorded = adjustment.
4. Identify the statement account and income account.
5. Journalize only the difference; never overwrite the ledger without an entry.
6. Recalculate the ending balance and ask whether profit moved in the logical direction.

For a correction, use three lines: recorded / should be / correcting difference.

Worked example

At December 31, Cedar Cycle Repair has these facts:

• Supplies shows $5,900; a count finds $1,700 remaining.
• A $9,600 one-year insurance policy began October 1 and was recorded as Prepaid Insurance.
• Employees earned $2,350 that will be paid January 4.
• A $1,200 cash equipment repair was wrongly debited to Equipment.

Calculations: supplies used = $5,900 − $1,700 = $4,200. Insurance expired = $9,600 × 3/12 = $2,400.

Table: Cedar Cycle Repair period-end adjustments

All four entries lower current profit by $10,150. The first two reduce assets, the third creates a liability, and the correction reduces an overstated asset.

Journal, ledger, and statement connection

After posting, Supplies ends at $1,700 and Prepaid Insurance at $7,200. Wages Payable reports the unpaid obligation. On a worksheet, adjustment debits and credits update the adjusted trial balance before amounts flow into statements. Closing happens later; these balances must first produce correct profit.

Common mistakes

• Using cash paid as the expense without checking the coverage period.
• Crediting Cash in an adjusting entry when no cash moves at period-end.
• Recording the required ending balance instead of the difference needed.
• Treating every correction as an adjustment and hiding the error trail.
• Calculating months incorrectly; mark both the start date and reporting date.

Guided practice

On November 1, Northline Studio received $7,500 for five monthly reports and credited Unearned Revenue. Two reports are complete by December 31. The required liability is $4,500, so the adjustment is debit Unearned Revenue $3,000 and credit Service Revenue $3,000. Profit and equity rise $3,000; liabilities fall $3,000.

Independent practice

1. Equipment costing $36,000 has a six-year life, no residual value, and uses straight-line depreciation. Record one full year's adjustment.
2. Services of $2,800 were completed but not yet billed or recorded. Prepare the entry.
3. A $640 advertising payment was correctly credited to Cash but incorrectly debited to Accounts Receivable. Prepare the correction.
4. State whether omitting each entry in questions 1–2 overstates or understates profit.

Self-check and solutions

1. Annual depreciation is $36,000 ÷ 6 = $6,000: debit Depreciation Expense—Equipment $6,000; credit Accumulated Depreciation—Equipment $6,000.
2. Debit Accounts Receivable $2,800; credit Service Revenue $2,800.
3. Debit Advertising Expense $640; credit Accounts Receivable $640.
4. Omitting depreciation overstates profit $6,000. Omitting accrued revenue understates profit $2,800.

Retrieval practice

Classify each as accrual, deferral, estimate, or correction: unpaid interest; expired prepaid rent; expected credit losses; supplies posted to Equipment. Answers: accrual, deferral, estimate, correction.

Exam-style application

Before adjustments, Maple Device Repair reports profit of $48,000. Unearned Revenue must decrease $3,600, accrued wages are $2,100, and $900 of supplies were used. What is adjusted profit and why?

Solution: Earning deferred revenue raises profit $3,600; wages and supplies lower it $3,000. Adjusted profit is $48,600. The sign check matters: decreasing a revenue liability because work is complete produces revenue, not an expense.

Lesson summary

An adjustment makes the ending balance correct; a correction makes the recorded entry agree with the event. Compute the required amount, post only the difference, and check the direction of the statement effects.