Adjusting journal entries are the fifth step in the accounting cycle and also an essential part of accrual accounting. However, adjusting journal entries allows you to adjust income and expense totals to reflect your financial position more accurately.
This article is a helpful and detailed guide about adjusting journal entries; what is the importance and purpose of adjusting entries with examples.
Table of content:
Adjusting journal entry is an entry in a company’s general ledger that occurs at the end of an accounting period to record any unrecognized income or expenses for the period. For example, when a transaction is started in one accounting period and ends later, an adjusting journal entry is required to account for the transaction properly.
Adjusting journal entries made at the end of an accounting period to update specific revenue and expenses accounts and ensure your contract the matching principle of accounting.
The matching principle states that expenses and revenue must be matched/recorded in the accounting period in which they occur, no matter whether the expense is paid or revenue is received in the concerned accounting period.
One of the critical components of accounting is making sure all of your accounts are accurate, which is why adjusting entries are necessary. While, adjusting statements allows you to add entries or notes to your ledger to denote corrections, such as writing the correct dates or amounts you received payments.
For example, suppose you documented the incorrect payment date for expenses. In that case, you may need to revise the entry to show the correct payment date to avoid faulty bookkeeping for that period.
The amount of adjusting journal entries in a business depends on the number of financial transactions. However, we divide adjusting entries into five types such as accruals, deferrals, and non-cash expenses.
Accrued revenue is revenue that has been earned from services and goods that have been delivered. While cash has not been received a common example is credit sales. But the revenue is through an accrued revenue account or receivable account. When the cash is accepted after the end of the accounting cycle, an adjusting journal entry is made to record the payment for the receivable account.
|3/4||Accrued revenue/ Account receivable||$600|
|Accrued Revenue/Account receivable||$500|
An accrued expense is the expenses that have been incurred and recorded in financial statements, but the payment against it is delayed for the future. For example, goods or services have been consumed before the cash payment has been made.
The example includes taxes, salaries, and utility bills, which are usually charged later after being incurred.
An adjusting entry is also made to remove the recorded account payable and the previously accrued expenses when the cash is paid.
Accrued Expenses and Adjusting Entries
|Accrued expenses/ payable||$10,000|
When accounting for deferred revenue, a company receives advance payment from customers and provides goods or services at a future date.
Moreover, this type of adjusted entry may change from cycle to cycle; it’s not typically documented as actual revenue but as a liability because of pending items.
If a customer pays you to paint their room, but inclement weather delays the service; you would have a deferment in revenue or payment until you complete the job and can cash out the payment on your books.
The estimates are adjusting entries that record non-cash items, such as depreciation expense, allowance for doubtful accounts, or the inventory elimination reserve.
When a fixed asset depreciates, it also turns into an expense you need to pay and record within accounting periods throughout your life.
While the adjusting entry for depreciation expenses exists on your business’s fixed assets, including plants, buildings, machinery, office equipment, and others.
The fixed assets build-up depreciation value is adjusted and recorded on the balance sheet when the accounting period ends. At the same time, depreciation expenses are recorded in your income statements.
This is similar to the concept of unearned revenue, and the only difference is that you also make the payment in advance to the supplier or others. However, the nature of prepaid expenses is assets, which is the opposite of the nature of unearned revenue.
Example of Adjusting Entry for prepaid expenses.
In January, you’ll record the transaction as a prepaid expense that will increase the expenses and decrease the cash from your account.
|January 1||Prepaid rent||$24,000|
At the end of January, when you utilize the prepaid rent for the month. You’ll need to transfer the rent of January into expenses.
|January 31||Rent expense||$2,000|
The purpose of adjusting entries is to update the accounts and to conform with the accrual concept. But at the end of the accounting period, some expenses and income may not have been recorded, taken up, or updated; hence, the accounts need to be updated.
Another purpose of adjusting entries is to assign an appropriate portion of revenue and expenses to the relevant accounting period.
Payment is given for the accounting period in which it is incurred by adjusting entries. It ensures that only the relevant expenses and revenue are reported in the income statement of a particular accounting period, so the financial statements can be prepared correctly according to the accrual concept of accounting.