Adjustments like Outstanding Expenses, Depreciation, and Bad Debts in Accounting

1. Introduction

Adjustments in accounting are necessary to ensure that financial statements reflect the true and fair financial position of a business. Common adjustments include outstanding expenses, depreciation, and bad debts.

2. Outstanding Expenses

Outstanding expenses are expenses that are incurred during an accounting period but remain unpaid at the end of the period.

Example:

A company has a salary expense of $5,000 per month. By the end of December, the salary for December is unpaid.

Adjustment:

• Journal Entry: Debit Salaries Expense and Credit Outstanding Salaries (Liability).
• Impact: The Profit & Loss Account includes the expense, and the Balance Sheet reflects the liability.

Journal Entry:

          Salaries Expense       Dr   $5,000
          To Outstanding Salaries    $5,000
      

3. Depreciation

Depreciation is the allocation of the cost of a tangible asset over its useful life.

Example:

A business purchases machinery for $50,000 with an expected useful life of 10 years. Annual depreciation is calculated as $50,000 / 10 = $5,000.

Adjustment:

• Journal Entry: Debit Depreciation Expense and Credit Accumulated Depreciation (Contra Asset).
• Impact: Depreciation Expense reduces profit, and Accumulated Depreciation reduces the book value of the asset.

Journal Entry:

          Depreciation Expense       Dr   $5,000
          To Accumulated Depreciation    $5,000
      

4. Bad Debts

Bad debts are amounts owed by customers that are unlikely to be collected.

Example:

A company has accounts receivable of $10,000, but a customer owing $1,000 declares bankruptcy, making the amount uncollectible.

Adjustment:

• Journal Entry: Debit Bad Debts Expense and Credit Accounts Receivable.
• Impact: Bad Debts Expense reduces profit, and Accounts Receivable is reduced by the uncollectible amount.

Journal Entry:

          Bad Debts Expense       Dr   $1,000
          To Accounts Receivable       $1,000
      

5. Summary

Adjustments such as outstanding expenses, depreciation, and bad debts are crucial for accurate financial reporting. These adjustments ensure that expenses and revenues are matched in the correct accounting period, providing a true representation of the business's financial health.