Which Of The Following Is Not Considered An Adjustment

Which of the Following is NOT Considered an Adjustment? A Comprehensive Guide to Accounting Adjustments

Understanding accounting adjustments is crucial for accurate financial reporting. These adjustments are necessary to ensure that the financial statements reflect the true economic reality of a business. However, knowing what isn't an adjustment is equally important. This comprehensive guide will delve into the intricacies of accounting adjustments, clarifying what constitutes an adjustment and, equally importantly, what does not. We'll explore various scenarios and provide practical examples to solidify your understanding.

What are Accounting Adjustments?

Accounting adjustments are modifications made to the trial balance accounts at the end of an accounting period. These modifications are necessary because of the limitations of the accrual accounting system. Accrual accounting records transactions when they occur, regardless of when cash changes hands. This means that some transactions might not be fully reflected in the initial recordings. Adjustments bridge this gap, ensuring that all revenues earned and expenses incurred during a period are accurately reported. They are crucial for preparing accurate financial statements like the income statement and balance sheet.

Key Characteristics of Accounting Adjustments:

• Impact Multiple Accounts: Adjustments always affect at least two accounts to maintain the accounting equation (Assets = Liabilities + Equity).
• End-of-Period Process: They are performed at the end of an accounting period, before the preparation of financial statements.
• Accruals and Deferrals: The majority of adjustments fall under accruals (recording revenue earned or expense incurred but not yet recorded) and deferrals (recording prepayments or unearned revenue).
• Improve Accuracy: Their primary purpose is to improve the accuracy and reliability of the financial statements.

Types of Accounting Adjustments

Before we explore what isn't an adjustment, let's briefly review the common types:

1. Accrued Revenue:

This adjustment accounts for revenue earned but not yet received in cash. For instance, if a company provides services in December but receives payment in January, the revenue should be recorded in December as an accrued revenue.

2. Accrued Expenses:

These are expenses incurred but not yet paid. A common example is accrued salaries. If employees work during December but receive their salary in January, the salary expense needs to be recorded in December as an accrued expense.

3. Deferred Revenue:

This is revenue received in advance for goods or services that will be provided in the future. For example, if a company receives payment for a subscription service for the entire year in January, the revenue should be recognized evenly over the twelve months.

4. Deferred Expenses:

These are expenses paid in advance for goods or services that will be used in the future. Prepaid insurance is a prime example. The portion of the prepaid insurance that expires during the accounting period is recognized as an expense.

What is NOT Considered an Accounting Adjustment?

Now, let's address the core question: which of the following is not considered an adjustment? The answer depends on the context, but generally, actions that don't directly correct discrepancies between the initial recording of transactions and the actual economic reality are not adjustments.

Here are some examples of activities that are not considered accounting adjustments:

1. Recording Initial Transactions:

The initial recording of transactions in the general ledger is not an adjustment. This is the foundational step of accounting, and adjustments are made after these initial entries. Recording a sale, paying a supplier, or receiving cash are all part of the initial recording process, not adjustments.

2. Correcting Errors:

While correcting errors is vital for accurate financial reporting, it's distinct from adjustments. Adjustments address timing differences, whereas correcting errors addresses mistakes made in the initial recording. For example, if a transaction was recorded in the wrong account, correcting it is not an adjustment, but rather an error correction. This involves using a journal entry to reverse the incorrect entry and make a new, correct entry.

3. Posting Transactions to the General Ledger:

Posting transactions to the general ledger from the journal is a necessary step in the accounting cycle, but it's not an adjustment. Posting is simply transferring the information from the journal to the ledger accounts, organizing and summarizing the transactions.

4. Preparing Financial Statements:

Preparing the financial statements—the income statement, balance sheet, and statement of cash flows—is the final step in the accounting cycle. It uses the adjusted trial balance, but the preparation itself is not an adjustment. The financial statements summarize the information gathered and adjusted throughout the accounting process.

5. Reconciling Bank Statements:

Bank reconciliations are a crucial control measure to ensure the accuracy of cash balances. They compare the bank statement with the company's internal records, identifying discrepancies such as outstanding checks and bank charges. Although important, it is not an accounting adjustment. Any discrepancies discovered during reconciliation might lead to the need for adjustments, but the reconciliation itself isn't an adjustment.

6. Analyzing Financial Statements:

Analyzing financial statements involves interpreting the information presented in the statements to make informed business decisions. It's a valuable tool for management, but it's a separate process from making accounting adjustments.

7. Closing Entries:

Closing entries transfer the balances of temporary accounts (revenue, expense, and dividends) to retained earnings at the end of the accounting period. While these entries are essential to prepare for the next accounting period, they are not considered adjustments. They summarize the results of operations for the period.

Distinguishing between Adjustments and Corrections:

It's crucial to differentiate between adjustments and error corrections. Adjustments deal with timing differences inherent in accrual accounting; they don't imply that a previous entry was wrong. Corrections, on the other hand, are made to fix errors in the initial recording of transactions.

Example:

• Adjustment: Recording accrued salaries (expense incurred but not yet paid) is an adjustment because it accounts for the expense related to the period, even though the cash payment is in a future period.

• Correction: Recording a sales transaction in the wrong account (e.g., debiting accounts receivable instead of sales revenue) requires a correction to fix the error in the initial recording.

Practical Examples to Illustrate the Difference

Let's look at some practical examples to further clarify the distinction between adjustments and non-adjustments:

Scenario 1: A company receives a payment of $10,000 for a year's worth of consulting services on January 1st.

• Non-adjustment: Initially recording the $10,000 as cash and deferred revenue. This is an initial transaction recording.
• Adjustment: At the end of the month, adjusting the entry to recognize $833.33 of revenue earned ($10,000 / 12 months). This is a necessary adjustment to accurately reflect the revenue earned during January.

Scenario 2: An employee worked for 10 days in December but will be paid on January 5th. Their daily rate is $100.

• Non-adjustment: Recording the payment in January when it's made. This would be an inaccurate reflection of expenses for December.
• Adjustment: Adjusting the entries at the end of December to record a salary expense of $1000 ($100/day * 10 days) and the related payable. This is an accrual adjustment.

Scenario 3: A company mistakenly recorded a $500 purchase of office supplies as an expense instead of an asset.

• Non-adjustment: The initial incorrect entry of the $500. This is an accounting error.
• Correction: Correcting the entry by debiting office supplies (asset) and crediting the expense account. This is an error correction.

Conclusion

Understanding what constitutes an accounting adjustment and what doesn't is crucial for accurate financial reporting. Adjustments are modifications made at the end of an accounting period to ensure that revenues and expenses are accurately reflected. This guide has explored various scenarios and highlighted activities that are not considered adjustments, emphasizing the importance of distinguishing between adjustments, corrections, and routine accounting processes. By mastering this distinction, you can build a strong foundation in accounting principles and prepare accurate and reliable financial statements.