Joan Miller is the President of an advertising agency. One of the adjustments a staff accountant made at the end of July was $360 for unpaid wages of the secretary. Joan Miller might ask, "Why go to the trouble of making this adjustment? Why worry about
it? Doesn't everything come out in the end, when the secretary is paid in August? Because wages expense in total is the same for the two months, isn't the net income in total unchanged?" Give three reasons why adjusting entries can help Joan Miller assess the performance of the business. (Net income was $1,600.)
Adjusting entries are important because they help accountants compile information that is useful to shareholders and managers. First, adjusting entries are necessary to measure income and financial position in a relevant and useful way. Joan Miller should know how much the agency has earned each month and what its liabilities and assets are on the last day of the month. For instance, if the accrued wages for the secretary are not recorded, the agency's income will be overstated by $360, or 22.5 percent ($360 / $1,600). Second, adjusting entries allow financial statements to be compared from one accounting period to the next. Joan Miller can see whether the company is making progress toward earning a profit or if the company has improved its financial position. If the adjustment for accrued wages is not recorded, not only will the net income for July be overstated by $360, but the net income for August (the month when payment will be made) will be understated by $360. This error will make August's earnings, whatever they may be, appear lower than they actually are. Third, even though one adjusting entry may seem insignificant, the cumulative effect of all adjusting entries can be great.
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