Common Accounting Adjustments: Prepaid Expenses, Accrued Revenues, and Depreciation

Adjusting entries are essential for accurate financial reporting. Among the most common adjustments are prepaid expenses, accrued revenues, and depreciation. These ensure that financial statements reflect the true financial position of a business in line with accrual accounting principles.

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Accounting Terms

What Are Adjusting Entries?

Adjusting entries are journal entries made at the end of an accounting period to update accounts before financial statements are prepared. They record income earned and expenses incurred that haven’t yet been entered into the books.

Why Adjusting Entries Are Important in Financial Reporting

Ensure revenues and expenses match the correct period.
Provide accurate profit and loss figures.
Keep financial statements compliant with accrual accounting standards.

Types of Common Adjusting Entries

Prepaid expenses
Accrued revenues
Accrued expenses
Depreciation and amortization
Unearned revenue adjustments

What Are Prepaid Expenses? (Definition + Examples)

Prepaid expenses are payments made for goods or services to be received in the future. Instead of expensing them immediately, they are recorded as current assets and expensed gradually.

Common Examples

Insurance premiums paid for a year in advance.
Rent payments covering several months.
Software subscriptions paid annually.

Journal Entries for Prepaid Expenses

1. Initial Payment:
Debit: Prepaid Expense (Asset)
Credit: Cash/Bank

2. Periodic Adjustment:
Debit: Expense Account (e.g., Rent Expense)
Credit: Prepaid Expense

Prepaid Expenses vs. Accrued Expenses

Prepaid Expenses: Paid in advance for future benefits.
Accrued Expenses: Expenses incurred but not yet paid.

What Are Accrued Revenues? (Definition + Examples)

Accrued revenues are income earned but not yet received or recorded by the end of the accounting period.

When Are Revenues Considered Accrued?

Services performed, but payment not yet invoiced.
Interest earned but not received.

Journal Entries for Accrued Revenues

1. At Period End:
Debit: Accounts Receivable
Credit: Revenue

2. When Cash is Received:
Debit: Cash
Credit: Accounts Receivable

Difference Between Accrued Revenues and Accounts Receivable

Accrued Revenues: Recognized before an invoice is issued.
Accounts Receivable: Amounts billed and awaiting payment.

What Is Depreciation Adjustments?

Depreciation records the gradual reduction in value of tangible assets over their useful life. It spreads the cost of assets like machinery or buildings across the periods benefiting from their use.

Types of Depreciation Methods

Straight-Line: Equal expense each year.
Declining Balance: Higher expense in early years.
Units of Production: Based on usage or output.

Journal Entries for Depreciation

Each period:
Debit: Depreciation Expense
Credit: Accumulated Depreciation

Depreciation vs. Amortization

Depreciation: For tangible assets like equipment or buildings.
Amortization: For intangible assets such as patents or trademarks.

How These Adjustments Impact Financial Statements

Effect on Income Statement

Prepaid Expenses: Convert to expenses as benefits are used, reducing net income.
Accrued Revenues: Increase revenue and profit for the period.
Depreciation: Non-cash expense that lowers reported profit.

Effect on Balance Sheet

Prepaid Expenses: Decrease in assets as amounts are expensed.
Accrued Revenues: Increase assets through accounts receivable .
Depreciation: Reduces book value of fixed assets via accumulated depreciation.

Compliance with Accrual Accounting Principles

These adjustments align financial statements with accrual accounting by matching revenues with expenses in the correct periods.

Conclusion

Adjusting entries for prepaid expenses, accrued revenues, and depreciation ensure that financial statements present an accurate and fair view of a company’s finances. They align income and expenses to the periods in which they occur, support GAAP compliance, and provide meaningful data for decision-makers and investors.

Vineet Goyal

Chartered Accountant

MRN No.: 411502

City: Delhi

I am a chartered accountant with over 14 years of experience. I understand income tax, GST, and balancing financial records. I analyze financial statements and tax codes effectively. However, I also have a passion for writing, which is different from working with numbers. Recently, I started writing articles and blog posts. My goal is to make finance easier for everyday people to understand.

Frequently Asked Questions

What is the difference between accrued revenue and deferred revenue?

Accrued revenue is earned but not yet received, while deferred revenue is cash received before the service or product is delivered.
Where do prepaid expenses appear on the balance sheet?

They appear as current assets until the related expense is recognized.
Is depreciation a cash or non-cash expense?

Depreciation is a non-cash expense because it doesn’t involve actual cash outflow.
Are accrued expenses the same as accounts payable?

Not exactly. Accrued expenses are incurred but not yet billed, while accounts payable are amounts already invoiced and due.
How often are adjusting entries recorded?

Typically, at the end of each accounting period—monthly, quarterly, or annually—depending on the company’s reporting schedule.

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