Before any financial statements are prepared, journal entries, called adjusting entries, are made to ensure that the company's financial records adhere to the revenue recognition and matching principles. Adjusting entries are necessary because a single transaction may affect revenues or expenses in more than one accounting period and also because all transactions have not necessarily been documented during the period. Each adjusting entry usually affects one income statement account such as a revenue or expense account and one balance sheet account. For example if a company has a $1,000 debit balance in its supplies account at the end of a month, but a count of supplies on hand finds only $300 of them remaining. Since supplies worth $700 have been used up, the supplies account requires a $700 adjustment so assets are not overstated, and the supplies expense account requires a $700 adjustment so expenses are not understated.
The four types of adjusting entries are accrued revenues, unearned revenues, accrued expenses, and finally prepaid expenses. The first is accrued revenues it is also called accrued assets are revenues already earned but not yet paid by the customer or posted to the general ledger. An example of accrued revenue would be if a custom ordered machine that has been shipped Freight On Board shipping point on the day the accounts receivable module is closed and the approval to bill the customer has not been received by the billing clerk. An adjusting entry would be recorded to recognize the revenue in the correct period. This entry will reverse when the customer is appropriately invoiced. The next would be unearned revenues or deferred revenues are revenues received in cash and recorded as liabilities prior to being earned. Unearned revenue is a liability to the entity until the revenue is earned. An example of unearned revenue would be if the customer