Journal entries are the foundation for any accounting and financial operations. They provide clear records of all business transactions; however, there are multiple types of journal entries that bookkeepers use to keep track of a business’s finances. One type is the adjusting journal entry, which is used when there’s a correction needed or a missing entry.
In this guide, we’ll discuss what adjusting journal entries are, when they’re used, and the role they play in accurate financial reporting. We’ll also take a look at the common types of adjusting entries with examples.
What Are Adjusting Journal Entries?
Adjusting journal entries are used in the accrual-based accounting system to modify accounting records at the end of the period to reflect the actual timing of transactions.
Rather than going back and directly changing or deleting a past entry to reflect the proper timing of transactions, a separate adjusting entry is made instead.
They help provide a clear audit trail of how money flows in and out of the business during a given period. In this way, they support more accurate records of the business's income and expenses in a certain month, quarter, or year.
Why Are Adjusting Journal Entries Important?
What is the purpose of adjusting entries in accounting? Adjusting journal entries are necessary so businesses can adhere to the matching principle, which means that expenses are recorded in the same period as the revenues they help generate.
Otherwise, there could be timing inconsistencies or incorrect reporting of the revenue and expenses. In other words, adjusting entries help provide a more accurate representation of a company’s financial position and performance in a given period.
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Types of Adjusting Journal Entries
A business may need to record an adjusting journal entry for a number of reasons. The following are common types of adjusting entries.
Accrual Adjustments
One type of transaction that requires an adjustment is accruals. This may include accrued expenses, which have been incurred but not paid for. Or, this may include accrued revenues, which have been earned but not yet paid for by clients.
For instance, a company may have delivered services for a client in April. However, if they don’t bill the client and receive payment until the next month, there will need to be an adjusting entry at the end of April to reflect that it still needs to be paid.
Deferral Adjustments
Adjusting entries may also be necessary when the company has recorded deferred expenses or revenues. This means they’ve paid for or received payments in advance.
For example, a business may pay for a year of office rent upfront. However, there needs to be an adjustment made at the end of the quarter to reflect the rent expense that was actually used over that period, supporting the matching principle.
Depreciation and Amortization
Teams need to make an adjusting journal entry to record the depreciation expense on long-term assets, like a piece of equipment, a vehicle, or machinery. This is used to represent how the asset declines in value over time. It also represents the portion of the asset’s “value” that was used to produce revenue in the given period.
Inventory Adjustments
Companies that sell physical products and carry inventory may need to make an adjusting entry for inventory on hand at the end of the period to reflect any spoilage, theft, damage, or errors.
An accounting entry for inventory adjustment is needed when taking a physical inventory count that differs from the recorded value on the balance sheet. Any difference between these two values needs to be accounted for through an adjusting journal entry.
When Should Adjusting Journal Entries Be Made?
Adjusting journal entries are made at the end of the accounting cycle, whether that’s the month, quarter, or year-end. Again, they’re mostly used for companies that follow accrual-based accounting. Those who use a cash basis system typically don’t need to record adjusting entries.
These entries are completed before preparing the trial balance or official financial statements, ensuring that all transaction data for the period is accurately reflected in financial reporting.
Typically, the company’s accountant or bookkeeper will handle adjusting entries as part of their period-close duties.
Steps for How to Make an Adjusting Entry
Once you understand why adjusting entries are needed and the appropriate circumstances to use them, making these entries is not too complicated. We’ll now take a closer look at how to do adjusting entries in accounting.
- Determine affected accounts.
First, identify which accounts require an adjustment based on recorded transactions throughout the period. This may require bookkeepers to review account balances, transaction records, and supporting documentation that show that an adjustment is needed.
In any case, the adjusting entries will affect at least two accounts, following double-entry accounting rules. Importantly, adjusting entries will always affect an income statement account and a balance sheet account.
For instance, an adjustment made for deferred revenue would impact the deferred revenue account (current asset on the balance sheet) and revenue (on the income statement).
- Apply debits and credits to balance the entries.
For the two (or more) general ledger accounts that will be affected, apply the appropriate credits and debits to either increase or decrease the balance of each account as necessary.
Thus, if you need to make an adjustment to decrease the value of accrued expenses, you would need to debit the accrued expense account and credit the appropriate expense account.
Remember, total debits and credits must be equal to one another. If they don’t, it may indicate that there’s an error somewhere.
- Post adjustments to the general ledger.
The adjusting journal entry is posted to the general ledger, as with any other standard journal entry. It will include important information like the names of each account involved, the appropriate debits and credits, the date, and a description of the adjustment, where relevant.
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Common Examples of Adjusting Journal Entries
Let’s take a look at some adjusting entry examples to illustrate how they are used in practice. Remember, all of these sample adjusting entries are made at the end of the period.
Accrued salaries
If employees at the company earned $8,500 in wages during the final week of April, but payroll isn’t run until the first week of May, the business must record accrued salaries at the month-end close to account for this liability.
This way, the expense is recorded in the proper period when it’s incurred, even if the payment has yet to go through.
The adjusting journal entry here would include a debit (increase) to the salary expense account and a credit (increase) to the salaries payable account.
Prepaid insurance
Another example of an adjusting entry would be if a company pays $15,000 for a one-year insurance policy on June 1. At the end of the year, the company would need to make an adjusting entry to only record the seven months' worth of the insurance premium expense that applied to the year.
Here, the adjusting entry would show a debit (increase) to the insurance expense account and a credit (decrease) to the prepaid insurance account for the amount that is used up.
Depreciation expense for equipment
A company has a piece of equipment that costs $40,000. It has an estimated useful life of ten years and no resale value.
Following the straight-line depreciation method, the company would need to record $4,000 of depreciation expense each year over the equipment’s useful life.
After the first year of owning the equipment, the company would record a debit (increase) of this amount to depreciation expense and an equivalent credit (decrease) to the accumulated depreciation account.
Unearned revenue
On December 1, a client pays the company $6,000 upfront for three months of services. At the end of the year, the business needs to make an adjusting entry to reflect only the portion of this payment that it actually earned as revenue by this point.
The adjusting entry would have a debit (decrease) to unearned revenue and a credit (increase) to revenue of the same amount.
How Adjusting Entries Affect Financial Statements
Adjusting journal entries have a direct impact on the accuracy of financial statements. As mentioned throughout, they help companies adhere to the matching principle, only recording the revenues and expenses they’ve actually earned or incurred in a given period, regardless of when cash is exchanged.
Conclusion
Making adjusting journal entries is a crucial part of period-close bookkeeping tasks. While not overly complicated, they can be difficult for teams to manage correctly without the proper knowledge and experience.
Outsourcing bookkeeping tasks to an experienced team like Bob’s Bookkeepers helps keep a business’s books and records in order, while giving the team more time to focus on what they do best.
Contact us today to learn more about our outsourced bookkeeping services.
