What are the effects on the accounting equation from the adjustment for salaries incurred but not yet paid during the accounting period?

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Adjusting entries assure that both the balance sheet and the income statement are up-to-date on the accrual basis of accounting. A reasonable way to begin the process is by reviewing the amount or balance shown in each of the balance sheet accounts. We will use the following preliminary balance sheet, which reports the account balances prior to any adjusting entries:

Let's begin with the asset accounts:

Cash $1,800

The Cash account has a preliminary balance of $1,800—the amount in the general ledger. Before issuing the balance sheet, one must ask, "Is $1,800 the true amount of cash? Does it agree to the amount computed on the bank reconciliation?" The accountant found that $1,800 was indeed the true balance. (If the preliminary balance in Cash does not agree to the bank reconciliation, entries are usually needed. For example, if the bank statement included a service charge and a check printing charge—and they were not yet entered into the company's accounting records—those amounts must be entered into the Cash account. See the major topic Bank Reconciliation for a thorough discussion and illustration of the likely journal entries.)

Accounts Receivable $4,600

To determine if the balance in this account is accurate the accountant might review the detailed listing of customers who have not paid their invoices for goods or services. (This is often referred to as the amount of open or unpaid sales invoices and is often found in the accounts receivable subsidiary ledger.) When those open invoices are sorted according to the date of the sale, the company can tell how old the receivables are. Such a report is referred to as an aging of accounts receivable. Let's assume the review indicates that the preliminary balance in Accounts Receivable of $4,600 is accurate as far as the amounts that have been billed and not yet paid.

However, under the accrual basis of accounting, the balance sheet must report all the amounts the company has an absolute right to receive—not just the amounts that have been billed on a sales invoice. Similarly, the income statement should report all revenues that have been earned—not just the revenues that have been billed. After further review, it is learned that $3,000 of work has been performed (and therefore has been earned) as of December 31 but won't be billed until January 10. Because this $3,000 was earned in December, it must be entered and reported on the financial statements for December. An adjusting entry dated December 31 is prepared in order to get this information onto the December financial statements.

To assist you in understanding adjusting journal entries, double entry, and debits and credits, each example of an adjusting entry will be illustrated with a T-account.

Here is the process we will follow:

1. Draw two T-accounts. (Every journal entry involves at least two accounts. One account to be debited and one account to be credited.)
2. Indicate the account titles on each of the T-accounts. (Remember that almost always one of the accounts is a balance sheet account and one will be an income statement account. In a smaller font size we will indicate the type of account next to the account title and we will also indicate some tips about debits and credits within the T-accounts.)
3. Enter the preliminary balance in each of the T-accounts.
4. Determine what the ending balance ought to be for the balance sheet account.
5. Make an adjustment so that the ending amount in the balance sheet account is correct.
6. Enter the same adjustment amount into the related income statement account.
7. Write the adjusting journal entry.

Let's follow that process here:

The adjusting entry for Accounts Receivable in general journal format is:

Notice that the ending balance in the asset Accounts Receivable is now $7,600—the correct amount that the company has a right to receive. The income statement account balance has been increased by the $3,000 adjustment amount, because this $3,000 was also earned in the accounting period but had not yet been entered into the Service Revenues account. The balance in Service Revenues will increase during the year as the account is credited whenever a sales invoice is prepared. The balance in Accounts Receivable also increases if the sale was on credit (as opposed to a cash sale). However, Accounts Receivable will decrease whenever a customer pays some of the amount owed to the company. Therefore the balance in Accounts Receivable might be approximately the amount of one month's sales, if the company allows customers to pay their invoices in 30 days.

At the end of the accounting year, the ending balances in the balance sheet accounts (assets and liabilities) will carry forward to the next accounting year. The ending balances in the income statement accounts (revenues and expenses) are closed after the year's financial statements are prepared and these accounts will start the next accounting period with zero balances.

Allowance for Doubtful Accounts $0

(It's common not to list accounts with $0 balances on balance sheets.)

Although the Allowance for Doubtful Accounts does not appear on the preliminary balance sheet, experienced accountants realize that it is likely that some of the accounts receivable might not be collected. (This could occur because some customers will have unforeseen hardships, some customers might be dishonest, etc.) If some of the $4,600 owed to the company will not be collected, the company's balance sheet should report less than $4,600 of accounts receivable. However, rather than reducing the balance in Accounts Receivable by means of a credit amount, the credit amount will be reported in Allowance for Doubtful Accounts. (The combination of the debit balance in Accounts Receivable and the credit balance in Allowance for Doubtful Accounts is referred to as the net realizable value.)

Let's assume that a review of the accounts receivables indicates that approximately $600 of the receivables will not be collectible. This means that the balance in Allowance for Doubtful Accounts should be reported as a $600 credit balance instead of the preliminary balance of $0. The two accounts involved will be the balance sheet account Allowance for Doubtful Accounts and the income statement account Bad Debts Expense.

The adjusting journal entry for Allowance for Doubtful Accounts is:

It is possible for one or both of the accounts to have preliminary balances. However, the balances are likely to be different from one another. Because Allowance for Doubtful Accounts is a balance sheet account, its ending balance will carry forward to the next accounting year. Because Bad Debts Expense is an income statement account, its balance will not carry forward to the next year. Bad Debts Expense will start the next accounting year with a zero balance.

Supplies $1,100

The Supplies account has a preliminary balance of $1,100. However, a count of the supplies actually on hand indicates that the true amount of supplies is $725. This means that the preliminary balance is too high by $375 ($1,100 minus $725). A credit of $375 will need to be entered into the asset account in order to reduce the balance from $1,100 to $725. The related income statement account is Supplies Expense.

The adjusting entry for Supplies in general journal format is:

Notice that the ending balance in the asset Supplies is now $725—the correct amount of supplies that the company actually has on hand. The income statement account Supplies Expense has been increased by the $375 adjusting entry. It is assumed that the decrease in the supplies on hand means that the supplies have been used during the current accounting period. The balance in Supplies Expense will increase during the year as the account is debited. Supplies Expense will start the next accounting year with a zero balance. The balance in the asset Supplies at the end of the accounting year will carry over to the next accounting year.

Prepaid Insurance $1,500

The $1,500 balance in the asset account Prepaid Insurance is the preliminary balance. The correct balance needs to be determined. The correct amount is the amount that has been paid by the company for insurance coverage that will expire after the balance sheet date. If a review of the payments for insurance shows that $600 of the insurance payments is for insurance that will expire after the balance sheet date, then the balance in Prepaid Insurance should be $600. All other amounts should be charged to Insurance Expense.

The adjusting journal entry for Prepaid Insurance is:

Note that the ending balance in the asset Prepaid Insurance is now $600—the correct amount of insurance that has been paid in advance. The income statement account Insurance Expense has been increased by the $900 adjusting entry. It is assumed that the decrease in the amount prepaid was the amount being used or expiring during the current accounting period. The balance in Insurance Expense starts with a zero balance each year and increases during the year as the account is debited. The balance at the end of the accounting year in the asset Prepaid Insurance will carry over to the next accounting year.

Equipment $25,000

Equipment is a long-term asset that will not last indefinitely. The cost of equipment is recorded in the account Equipment. The $25,000 balance in Equipment is accurate, so no entry is needed in this account. As an asset account, the debit balance of $25,000 will carry over to the next accounting year.

Accumulated Depreciation - Equipment $7,500

Accumulated Depreciation - Equipment is a contra asset account and its preliminary balance of $7,500 is the amount of depreciation actually entered into the account since the Equipment was acquired. The correct balance should be the cumulative amount of depreciation from the time that the equipment was acquired through the date of the balance sheet. A review indicates that as of December 31 the accumulated amount of depreciation should be $9,000. Therefore the account Accumulated Depreciation - Equipment will need to have an ending balance of $9,000. This will require an additional $1,500 credit to this account. The income statement account that is pertinent to this adjusting entry and which will be debited for $1,500 is Depreciation Expense - Equipment.

The adjusting entry for Accumulated Depreciation in general journal format is:

The ending balance in the contra asset account Accumulated Depreciation - Equipment at the end of the accounting year will carry forward to the next accounting year. The ending balance in Depreciation Expense - Equipment will be closed at the end of the current accounting period and this account will begin the next accounting year with a balance of $0.

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Notes Payable $5,000

Notes Payable is a liability account that reports the amount of principal owed as of the balance sheet date. (Any interest incurred but not yet paid as of the balance sheet date is reported in a separate liability account Interest Payable.) The accountant has verified that the amount of principal actually owed is the same as the amount appearing on the preliminary balance sheet. Therefore, no entry is needed for this account.

Interest Payable $0

(It's common not to list accounts with $0 balances on balance sheets.)

Interest Payable is a liability account that reports the amount of interest the company owes as of the balance sheet date. Accountants realize that if a company has a balance in Notes Payable, the company should be reporting some amount in Interest Expense and in Interest Payable. The reason is that each day that the company owes money it is incurring interest expense and an obligation to pay the interest. Unless the interest is paid up to date, the company will always owe some interest to the lender.

Let's assume that the company borrowed the $5,000 on December 1 and agrees to make the first interest payment on March 1. If the loan specifies an annual interest rate of 6%, the loan will cost the company interest of $300 per year or $25 per month. On March 1 the company will be required to pay $75 of interest. On the December income statement the company must report one month of interest expense of $25. On the December 31 balance sheet the company must report that it owes $25 as of December 31 for interest.

The adjusting journal entry for Interest Payable is:

It is unusual that the amount shown for each of these accounts is the same. In the future months the amounts will be different. Interest Expense will be closed automatically at the end of each accounting year and will start the next accounting year with a $0 balance.

Accounts Payable $2,500

Accounts Payable is a liability account that reports the amounts owed to suppliers or vendors as of the balance sheet date. Amounts are routinely entered into this account after a company has received and verified all of the following: (1) an invoice from the supplier, (2) goods or services have been received, and (3) compared the amounts to the company's purchase order. A review of the details confirms that this account's balance of $2,500 is accurate as far as invoices received from vendors.

However, under the accrual basis of accounting the balance sheet must report all the amounts owed by the company—not just the amounts that have been entered into the accounting system from vendor invoices. Similarly, the income statement must report all expenses that have been incurred—not merely the expenses that have been entered from a vendor's invoice. To illustrate this, assume that a company had $1,000 of plumbing repairs done in late December, but the company has not yet received an invoice from the plumber. The company will have to make an adjusting entry to record the expense and the liability on the December financial statements. The adjusting entry will involve the following accounts:

The adjusting entry for Accounts Payable in general journal format is:

The balance in the liability account Accounts Payable at the end of the year will carry forward to the next accounting year. The balance in Repairs & Maintenance Expense at the end of the accounting year will be closed and the next accounting year will begin with $0.

Wages Payable $1,200

Wages Payable is a liability account that reports the amounts owed to employees as of the balance sheet date. Amounts are routinely entered into this account when the company's payroll records are processed. A review of the details confirms that this account's balance of $1,200 is accurate as far as the payrolls that have been processed.

However, under the accrual basis of accounting the balance sheet must report all of the payroll amounts owed by the company—not just the amounts that have been processed. Similarly, the income statement must report all of the payroll expenses that have been incurred—not merely the expenses from the routine payroll processing. For example, assume that December 30 is a Sunday and the first day of the payroll period. The wages earned by the employees on December 30-31 will be included in the payroll processing for the week of December 30 through January 5. However, the December income statement and the December 31 balance sheet need to include the wages for December 30-31, but not the wages for January 1-5. If the wages for December 30-31 amount to $300, the following adjusting entry is required as of December 31:

The adjusting journal entry for Wages Payable is:

The $1,500 balance in Wages Payable is the true amount not yet paid to employees for their work through December 31. The $13,420 of Wages Expense is the total of the wages used by the company through December 31. The Wages Payable amount will be carried forward to the next accounting year. The Wages Expense amount will be zeroed out so that the next accounting year begins with a $0 balance.

Unearned Revenues $1,300

Unearned Revenues is a liability account that reports the amounts received by a company but have not yet been earned by the company. For example, if a company required a customer with a poor credit rating to pay $1,300 before beginning any work, the company increases its asset Cash by $1,300 and it should increase its liability Unearned Revenues by $1,300.

As the company does the work, it will reduce the Unearned Revenues account balance and increase its Service Revenues account balance by the amount earned (work performed). A review of the balance in Unearned Revenues reveals that the company did indeed receive $1,300 from a customer earlier in December. However, during the month the company provided the customer with $800 of services. Therefore, at December 31 the amount of services due to the customer is $500.

Let's visualize this situation with the following T-accounts:

The adjusting entry for Unearned Revenues in general journal format is:

Since Unearned Revenues is a balance sheet account, its balance at the end of the accounting year will carry over to the next accounting year. On the other hand Service Revenues is an income statement account and its balance will be closed when the current year is over. Revenues and expenses always start the next accounting year with $0.

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As a high school accounting teacher I have used the resources on AccountingCoach PRO to enhance my understanding of accounting concepts and make my explanation of concepts clearer for my students. I recommend AccountingCoach PRO to students pursuing higher level accounting after high school and to anyone teaching accounting classes---the money spent on this resource will be one of the best investments in professional development you'll make in your career.
-Sharon M.

The PRO membership allows me to provide great explanations to my coworkers who are not versed in accounting without me spending a lot of time finding examples they may understand. I use my membership to review topics that I don't use very often and it has been one of the best investments I've made for my work and it costs less than my Accounting textbook!
-John B.

AccountingCoach has helped tremendously while I was studying for accounting and I strongly believe that my grade would not have been in the 90's had it not been for the AccountingCoach. I will always keep the AccountingCoach in my favourites list even though I have completed my courses as I will no doubt make reference to it when I second-guess myself. It has helped with all aspects of accounting from the very beginning to the very end. Whomever decided to create AccountingCoach was a genius because it is designed in a way that anyone from an amateur to a PRO can follow along. I recommend it to everyone. It has become my new limb. Cannot boast enough about it. Well worth it.
-Tammy

Becoming a member of AccountingCoach was hands down a great decision for me. I have been in bookkeeping for over 16 years and all the training I had was from the CPA that I worked for. While I felt I had a good foundation and years of experience, once I took the leap and branched out with my own bookkeeping practice I felt the need to brush up on my skills. AccountingCoach actually not only helped me brush up on my knowledge, but has helped me pinpoint my strengths and weaknesses which allowed me to focus on those areas that I was lacking knowledge. It was also a great boost to see how much knowledge I already had. I think it was a great investment and I love knowing that when I second-guess myself I can easily log in and review the information needed. Worth every penny!
-Judith G.

Thank you AccountingCoach! As an auditor, I frequently encounter government and private financial transactions that I vaguely remember from my college years. The information and ease of finding the right accounting procedures to those instances has been an enormous help to me in my job. This has definitely been a good decision to be a member.
-Enrique E.

I came across AccountingCoach some years ago and since then it has been my go-to solution for all and any problems or issues that arise in my day-to-day work. Whenever I come across a situation I have not faced before I sign in, read up on the related data, of which there is plenty, and solve another problem. I think of AccountingCoach as my personal library where I can look up information on any aspect of my business. My clients are always impressed with the results I provide. Thank you AccountingCoach.
-Joseph C.

I started using AccountingCoach when I found myself unemployed and looking to brush up on my cost accounting skills. It was a wonderful tool and I found it easy to use and contained all the information I would need to get familiar with the topic, all while not having to go back to my college books or my CPA review materials. It is affordably priced and well worth investing in. I am now employed and the materials I studied helped me to prepare for questions I received in the interview process regarding topics I needed to brush up on.
-Karen B.

In my roles as a business owner, member of senior management teams and as a business consultant, I frequently deal with accounting-related issues. While I have a solid grasp of a wide range of accounting practices and methods, I still find that there are times when I want to refresh or investigate aspects of accounting that I either seldom visit or have not had the opportunity to work with. When those circumstances arise, I turn to AccountingCoach which I find covers not only a wide range of topics but usually in enough depth and detail that you can use it almost like a condensed primer on any given topic. The information and examples are complete enough that I find I can apply what is shown to the task at hand and have the result be equal to what I would get from an accounting professional. It is not an exaggeration to state that it has saved both time and cost on numerous occasions. Highly recommended!
-James F.

Living in a small tourist rural town, there are limited choices in the job market. I knew if I bumped up my skills, I would become eligible for a bookkeeping position locally. AccountingCoach has helped me do that. Such a small investment for a HUGE return. Thank you so much for making this available!
-Pam P.

I would like to say thank you very much for your support. I am a student of Accounting at George Mason University in Virginia. I found your website some time ago, and I have been a PRO member ever since. From the moment I found AccountingCoach, I recognize the value, quality and effort of your work. Currently, I am taking Financial Accounting. I confess I was scared because it has been awhile since I took accounting classes. Thankfully, AccountingCoach helps me to not just refresh my mind on basic accounting terminology, but also helps me to understand new terminology in plain English.
-Desire S.

I found AccountingCoach online about 2 years ago. It has helped me tremendously to brush up on knowledge and information about accounting that I don't have time to go to school for. I have been an accountant for many years and don't plan on going back to college at this point; I have a Bachelor’s degree already. I use AccountingCoach to study for a job in accounting if I am not familiar with the work or to understand something like cash flow statements when prepping for a job interview. Recently, I used the online exams extensively to study for a city accounting job; with great success. Thank you Harold!
-Mary B.

I have been using AccountingCoach in my bookkeeping business for a few years now and love it! There are times when I need an answer to some accounting situation that baffles me and always have been able to find the answers I need on your website. I particularly like the clear and concise way the material is presented so I can quickly get results.
-Cheryl N..

I enrolled in an accounting course online. I was sent textbooks and a workbook in the mail and that was it. I was on my own to figure out the rest. It was difficult trying to match the course and workbook together to do the lessons and exercises and the explanations left too many gaps and questions. I knew I needed extra support. I stumbled upon AccountingCoach in an internet search and from the little I was able to read, I gained a far better understanding than the college-level textbook I had been studying for months. I signed up for PRO and it got even better. I'm able to do more exercises and gain extra studying tools and more detailed explanations to ensure my understanding of the accounting process. Truthfully, I've learned more through the AccountingCoach Pro than the college textbook and it cost sooo much less! It has been a life saver. I don't think I could have continued without it. Thank you for creating such an amazing experience and giving me the confidence I needed to keep working towards my goal.
-Crystal C.

AccountingCoach is a simply fantastic self-learning source. The way it explains various accounting concepts in such a simple and self explanatory manner is really commendable. Being an engineering student, with no past accounting background, AccountingCoach has been a great saviour in my MBA accounting module. The Balance Sheets, Statement of Cash Flows, and Income Statement all have been explained very beautifully. Thank you AccountingCoach. Keep up the good work.
-Amber A.