Adjusting Journal Entry

What is an Adjusting Journal Entry?

Adjusting journal entries brings an entity’s accounting entries into accordance with accounting standards and rectifies discrepancies between the recorded entries and what actually occurred.

It holds a key role in the accounting process. Sometimes, a business’ recorded transactions and actual finances differ.

Adjusting entries ensures that the expense recognition principle is followed. We will cover this in detail later on in the article.

Adjusting entries is necessary because trial balances may not be up-to-date and complete. 

The journal entries rectify any discrepancies, thereby providing accurate information to stakeholders.

These entries are made at the end of the business’s accounting period. A company’s financial position must be accurately reflected in its financial statements.

They ensure revenues and expenses go into their respective accounting periods.

In accrual accounting, adjustments are relied upon. The differences between accrual and cash accounting will be discussed later.

Adjusting entries ensures stakeholders get the most accurate picture of the company’s financials. Companies must meet certain accounting standards, and these adjustments allow them to do that.

The entries provide transparency since they show the company did not distort any information. Adjustments bring a company’s entries into compliance with GAAP standards. The last purpose of adjusting entries is to improve a company’s internal controls and decision-making.

Now that you know the meaning of adjusting entries, let’s dive more into it!

Accrual Accounting vs. Cash Accounting

There are two ways to record transactions in business and accounting. Both accomplish the same goal but slightly differ in how transactions are recognized.

Revenue and Expense Recognition Principles

Both principles are important to review when discussing adjusting entries.

The revenue recognition principle recognizes revenue in the accounting period in which the performance is satisfied. Here, financial statements show income in the period they are earned. By this principle, revenue is recognized when the service is performed.

Adjusting entries ensures that accrued revenue is properly recognized at the end of the accounting period.

The expense recognition principle matches expenses with revenues in the period the company generates the expenses. Expenses follow the revenues. Keep that saying in mind. It is self-explanatory. Expenses need to always tag along with the related revenue.

Adjusting entries ensures that expenses are properly recognized at the end of the accounting period.

Adjusting entries works with these two principles to properly recognize revenue and expenses, accurately represent the company’s finances, be transparent, provide stakeholders with information, and comply with accounting standards.

What Adjusting Entries Deal With

Adjusting entries address accruals, deferrals, and expenses. What do those three things mean?

Accruals are transactions that have not been recorded. The service has been performed, but cash has not been received yet. Examples of accruals are interest, rent, and any services performed.

Deferrals are transactions that have been recorded, but the service has not been performed yet. 

These items are usually received or paid for in advance.

These are expenses or revenues that are recognized at a date later than the point when cash was originally exchanged. Examples of deferrals are unearned revenue and prepaid insurance.

The third concept is expenses. Expenses are transactions that are not immediately recognized in the correct accounting period. The main expense that has to be adjusted is depreciation. Depreciation is the process of allocating the cost of an asset to expense over its useful life.

Adjusting entries is necessary for some expenses to spread the cost of the assets over time. This will match the depreciation expense in the respective accounting periods.

Now, let’s go over the five main types of adjusting entries.

Types of Adjusting Journal Entries

As mentioned before, there are five commonly used types of adjusting entries. These are accrued expenses, accrued revenues, deferred expenses, deferred revenues, and depreciation expenses.

1. Accrued Expenses

An accrued expense is an expense incurred by a company but not yet recorded or paid for. Think of this as an obligation to pay. Accrued expenses include salaries and wages, rent, utilities, and interest.

Payroll is a common accrued expense. Think of employees who get paid monthly. They work throughout the whole month, 30 days. But get paid on the first of the following month. To the company, this is an accrued expense.

The journal entries would look like this:

2. Accrued Revenues

Accrued revenue is revenue that the business is entitled to. They have performed the services, but payment has not been received yet. Accrued expenses include interest income, goods delivered, and services provided.

Since businesses must recognize their revenues when it is earned, adjusted entries help accomplish this even if the cash is not received at that moment.

The journal entries for accrued revenues would look like this:

3. Deferred Expenses

So far, we have discussed two types of accruals. Now let’s discuss the deferrals. Remember, deferrals are when the service has not yet been performed, but the money has been received.

The first deferral to cover is a deferred expense. This is when a company pays for goods or services but has not received them.

Examples of deferred expenses are prepaid rent and prepaid insurance. Prepaid items are deferred expenses since they are paid for before the service.

The journal entries for deferred expenses would look like this:

4. Deferred Revenues

Deferred revenues are when a company gets paid for its goods or services but has not yet delivered them. To the company, this is unpaid revenue.

By adjusting their entries, the company can recognize the revenues when the work is done; the expenses match the revenues.

Examples of deferred revenues are prepaid subscriptions and gift cards.

The journal entries for deferred revenues would look like this:

5. Depreciation Expenses

This is the last type of adjusting entry we will cover in this article. Depreciation expenses are the reductions in a tangible asset’s value. Keep in mind that this value is over its entire useful life.

Adjusting entries are needed to account for the depreciation expense and update the asset’s carrying value.

The journal entries for depreciation expenses would look like this:

Conclusion

We hope this article cleared up adjusting journal entries.

To reiterate, these entries have a particular function. By applying the accrual-based accounting method, entities ensure transactions are accounted for in the correct accounting period.

Accounts and financial statements must be accurate to provide a clear snapshot of the company’s financial position. Remember, finances are important not only to the company’s executives but also to stakeholders.

People have put their money and trust in the company, so it is only fitting to be honest with the finances so that they can make reasonable decisions about their money.

Understand accruals, deferrals, and expenses. Look at the five types of adjusting entries above and understand the reasoning why the entries are set up as such.

If you know the logic of adjusting entries, you can work with them properly in accounting.

Thanks for reading this article. Make sure to check out Wall Street Oasis for other articles and courses that can help progress your career.

Researched and authored by Omkar Iyer | LinkedIn

Reviewed and edited by Mohammad Sharjeel Khan | Linkedin

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