You are a tutor for introductory financial accounting. You tell the students, “Recording adjusting entries is a critical step in the accounting cycle, and the two major classifications of adjusting entries are prepayments and accruals.” Chris, one of the students in the class, says, “I don’t understand.”
Respond to Chris.
1. When do prepayments occur? When do accruals occur?
2. Describe the appropriate adjusting entry for prepaid expenses and for unearned revenues. What is the effect on net income, assets, liabilities, and stockholders’ equity of not recording a required adjusting entry for prepayments?
3. Describe the required adjusting entry for accrued expenses and for accrued revenues. What is the effect on net income, assets, liabilities, and shareholders’ equity of not recording a required adjusting entry for accruals?