All adjusting entries (other than error corrections) will always involve at least one account on the balance sheet and at least one account on the income statement.
A deferral involves a past exchange of cash that has initially been recorded on the balance sheet rather than on the income statement. The name deferral comes about because the recording on the income statement is deferred (postponed) to a later time.
A deferred expense is initially recorded on the balance sheet as an asset than being immediately expensed. An adjusting entry becomes necessary as the asset is consumed and becomes an expense.
1. Illustration for a short-term asset > Past exchange of cash Asset XXX Cash XXX > Adjusting entry necessary as the asset is consumed Expense XXX (Income statement) Asset XXX (Balance sheet) Example: The supplies account currently shows a $300 balance. A count of the supplies determines that only $250 remains. Supplies Expense 50 Supplies 50 2. Illustration for a long-term asset The adjusting entry for long-term assets differs in that instead of reducing the asset directly, a contra account is used that is subtracted from the asset on the balance sheet. > Past exchange of cash Asset XXX Cash XXX > Adjusting entry necessary as the asset is consumed Depreciation Expense XXX (Income statement) Accumulated Depreciation XXX (Balance sheet) Example: Current year depreciation is $2,500. Depreciation Expense 2,500 Accumulated Depreciation 2,500 Note: Accumulated depreciation is a contra account that is subtracted from the asset on the balance sheet. It has a normal credit balance.
A revenue cannot be recorded until the income has been earned. Cash received in advance of income realization should be initially recorded in a liability account such as "Unearned Revenue". An adjusting entry later becomes necessary as the revenue is earned. The liability should be reduced and the revenue recorded.
> Past exchange of cash Cash XXX Unearned Revenue XXX > Adjusting entry necessary as revenue is earned Unearned Revenue XXX (Balance sheet) Revenue XXX (Income statement) Example: Adams CPA previously received $500 for bookkeeping services in advance of providing the services. Adams has now earned $300 of the money. Unearned Revenue 300 Revenue 300
An accrual involves a future exchange of cash that must be recorded on the income statement before cash is exchanged.
> Adjusting entry Expense XXX (Income statement) Liability XXX (Balance sheet) > Future exchange of cash Liability XXX Cash XXX Example: Interest accrued on a loan at the end of the month is $550. Interest Expense 550 Interest Payable 550
> Adjusting entry Receivable XXX (Balance sheet) Revenue XXX (Income statement) > Future exchange of cash Cash XXX Receivable XXX Example: Performed $400 of services for a customer on account. Accounts Receivable 400 Revenue 400