One of the steps in an accounting cycle is the process called adjusting entries. Accountants record these journal entries in the general ledger accounts and usually prepare them at the end of the financial year after the preparation of a trial balance. Every adjusting entry involves a change in revenue or expense accounts, as well as an asset or a liability account.
According to the accrual method of accounting, certain adjustments have to be made to match the current period usage.
Adjusting entries affect one real account and at least one nominal account. We should note that not all entries, recorded by the business at the end of an accounting year, are adjusting journal entries. For instance, an entry for a purchase or a sale made on the last day of the fiscal period is not an adjusting entry.
Classification of Adjusting Entries
Adjusting journal entries can be classified into three main types:
- Prepaid expenses – money paid in advance for unused yet assets;
- Unearned revenues – income business received in advance that is not yet earned.
- Accrued expenses – expenses took place, but there was no payment or no record of it yet;
- Accrued revenues – income earned but not yet recorded nor money received.
- Non-cash expenses (estimates)
These expenses are for non-cash items such as depreciation, doubtful debts, etc.
Adjusting Journal Entries Examples
Here are the examples for each category of the journal entries:
1.Prepaid expenses (insurance is one of them)
Company’s insurance for a year is $1800 (paid on Jan, 1st)
The monthly insurance cost is 1800/12 months= $150 per month;
The adjustment journal entry, required on January, 31st, is shown below:
A company has not provided a service yet to earn any sum of the $3000.
A debit of the $3000 cancels the effect of the original entry. Unearned revenue is a liability account. A client has a claim on those funds until the business provides the promised services.
The company’s electricity bill of $250 for January is due on February 15th.
The adjusting entry will be recorded on January, 31st as follows:
A company delivered services on the last day of the month and sent an invoice of $3500 to its customer.
For instance, a company estimates depreciation on its office equipment to be $350 per month. The following adjustment journal entry, say, for September, is going to be:
It should be brought to your attention that adjustments for expenses and income are not recorded during the accounting year. The journal entries take place on the last day of that year to update ledger accounts. Summarized general ledger information is needed to release annual financial statements of the company under Generally Accepted Accounting Principles (GAAP). Thus, these entries are very important to be taken into account to show an accurate financial position of the business.