Adjusting Entries: 5 Scenarios
Practice recording adjusting entries for five common scenarios: prepaid expense, unearned revenue, accrued expense, accrued revenue, and depreciation.
Problem Scenario
At December 31 (year-end), Echo Company needs to prepare adjusting entries for the following: (1) Prepaid insurance of $12,000 was paid July 1 for 12 months of coverage. (2) $9,000 was received October 1 for 6 months of rent from a tenant. (3) Employees earned $4,500 in wages for Dec 29-31, payable January 5. (4) The company performed $2,000 of consulting services in December not yet billed. (5) Equipment costing $60,000 with a $6,000 salvage value has a 9-year useful life (straight-line).
Given Data
Requirements
- Record the adjusting entry for prepaid insurance (6 months expired)
- Record the adjusting entry for unearned rent (3 months earned)
- Record the adjusting entry for accrued wages
- Record the adjusting entry for accrued consulting revenue
- Record the adjusting entry for depreciation
Solution
Step 1:
Prepaid Insurance: 6 months have passed (July-December). Monthly amount = $12,000/12 = $1,000. Expense for 6 months = $6,000.
| Account | Debit | Credit |
|---|---|---|
| Insurance Expense | $6,000 | |
| Prepaid Insurance | $6,000 |
Step 2:
Unearned Rent: 3 months have passed (October-December). Monthly rent = $9,000/6 = $1,500. Earned revenue = $4,500.
| Account | Debit | Credit |
|---|---|---|
| Unearned Rent Revenue | $4,500 | |
| Rent Revenue | $4,500 |
Step 3:
Accrued Wages: Employees worked Dec 29-31 but won't be paid until January 5. The expense belongs in December.
| Account | Debit | Credit |
|---|---|---|
| Salaries and Wages Expense | $4,500 | |
| Salaries and Wages Payable | $4,500 |
Step 4:
Accrued Revenue: Services were performed in December but not yet billed. Revenue must be recognized when earned.
| Account | Debit | Credit |
|---|---|---|
| Accounts Receivable | $2,000 | |
| Consulting Revenue | $2,000 |
Step 5:
Depreciation: Annual depreciation = (Cost - Salvage) / Life = ($60,000 - $6,000) / 9 = $6,000 per year.
| Account | Debit | Credit |
|---|---|---|
| Depreciation Expense | $6,000 | |
| Accumulated Depreciation | $6,000 |
Final Answer
Total adjusting entries: Insurance Expense $6,000, Rent Revenue $4,500, Wages Expense $4,500, Consulting Revenue $2,000, Depreciation Expense $6,000. These entries ensure the financial statements accurately reflect the period's activity under accrual accounting.
Key Takeaways
- ✓Prepaid expenses convert assets to expenses as benefits are consumed
- ✓Unearned revenue converts liabilities to revenue as services are performed
- ✓Accrued expenses recognize costs incurred but not yet paid
- ✓Accrued revenue recognizes income earned but not yet billed
- ✓Depreciation allocates asset cost over its useful life
Common Errors to Avoid
- ✗Calculating the wrong number of months for prepaid or unearned adjustments
- ✗Debiting the wrong type of account (e.g., debiting a liability when you should debit an expense)
- ✗Forgetting that Accumulated Depreciation is credited, not the asset account directly
- ✗Not making adjusting entries at all, which misstates both the balance sheet and income statement
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Common questions about this problem type
Under accrual accounting, revenues and expenses must be recognized in the period they are earned or incurred, regardless of when cash changes hands. Adjusting entries ensure financial statements reflect economic reality, not just cash transactions.
Adjusting entries are made at the end of each accounting period, before preparing financial statements. They are part of the accounting cycle, occurring after the unadjusted trial balance and before the adjusted trial balance.