Journalizing adjusting entries are a necessary part of every company’s accounting or bookkeeping process because, without these adjusting entries, a company’s financial records which include the statement of financial position, statement of cash flows, and income statement will be riddled with errors and inconsistencies. When transactions occur in a business, journal entries are made to record such transactions. These journal entries are made based on the accounting debit and credit rules which stipulates that for every debit made, there is usually an equal but opposite credit entry made to ensure the accounts are balanced.
Journalizing adjusting entries are usually made at the end of each accounting period based on accrual accounting and the matching principle whereby transactions that begin in one accounting period spillover into a different accounting period or expenses incurred in one period have revenue being realized in a different period, hence making adjustments to the initial journal entries are required to properly record transactions and correct any errors made within the accounting cycle. In this article, we shall discuss some examples of adjusting entries that are made by companies at the end of each accounting cycle but before we begin, let us have a closer look at what adjusting entries mean.
See also: Adjusting entry for uncollectible accounts
What are adjusting entries?
Adjusting entries are journal entries made at the end of an accounting period to update accounts for transactions or events that have not been recorded during the regular accounting cycle. These entries are necessary to ensure that the financial statements accurately reflect the company’s financial position and performance for the period. Adjusting entries typically involves two accounts, although there are cases where more accounts may be involved. One account is usually from the company’s income statement and the other will be from the balance sheet. These adjusting entries are usually recorded in the general ledger of the company.
The adjusting entries typically fall into one of two categories: accruals or deferrals. Accruals involve recording revenue or expenses that have been earned or incurred but not yet recorded. Deferrals involve recording revenue or expenses that have been received or paid in advance but should be recognized in a future period. Examples of adjusting entries include adjusting the balance in prepaid expenses or accrued liabilities accounts, recognizing unearned revenue or deferred revenue, recording depreciation expense for fixed assets, and adjusting the balance in the allowance for doubtful accounts or inventory valuation accounts. By making adjusting entries, companies can ensure that their financial statements accurately reflect their financial position and performance and provide useful information to stakeholders.
See also: Adjusting entry for accrued salaries
When are adjusting entries made?
Adjusting entries are made at the end of an accounting period, usually at the end of a month, quarter, or year depending on the company’s accounting cycle. The purpose of these entries is to update the accounts for any transactions or events that have occurred but have not yet been recorded in the accounting system. For example, if a company has earned revenue but has not yet received payment for it, an adjusting entry would be made to record the revenue as accounts receivable. Similarly, if a company has incurred an expense but has not yet paid for it, an adjusting entry would be made to record the expense as accounts payable.
Adjusting entries are essential because they ensure that the financial statements of a company accurately reflect its financial position at the end of the accounting period. Without adjusting entries, the financial statements would not be complete or accurate, and users of the financial statements would not have a clear picture of the company’s financial health.
See also: Adjusting entry for bad debt expense
Types of Journalizing Adjusting Entries
- Depreciation and amortization
Before journalizing adjusting entries, the accounts that will be affected has to be first identified, this will determine whether the transaction is an accrual, deferral, revaluation, deprecation, or amortization. Let us discuss each of these adjusting journal entries below:
An adjusting entry for accruals is made to record revenue or expenses that have been earned or incurred but have not yet been recorded in the accounting system. Examples of accruals include accrued salaries, interest payable, and accrued rent. When journalizing adjusting entries for accruals, the amount of revenue earned or expenses incurred but not yet recorded has to be determined. This involves reviewing invoices, receipts, and other documents to identify any transactions that have not been recorded in the accounting system. The appropriate amount of revenue or expense is then recorded in the relevant account. Adjusting entries for accruals is important because they ensure that revenue and expenses are recognized in the appropriate period.
For revenues, if a company has earned revenue by selling a good or providing a service that has not yet been recorded, the entry would be to debit the revenue account and a credit to accrued revenue which is an accrual account. The journal entry will be as shown in the table below:
When the company sends the invoice and the actual cash is received, another entry which is the adjusting entry is made to reduce the accrual account and increase the cash account. This is done by debiting the accrued revenue account of the amount paid and crediting the cash account with the same amount as follows:
For expenses, if a company has accrued expenses for a particular expense, they will make a journal entry involving a debit to the utility expense account and a credit to accrued expenses account. The journal entry will be as follows:
The utility expense account records all utility expenses consisting of water supply, internet, electricity, natural gas, telephone services, waste management, etc. Once the company clears this debt by paying the expense, an adjusting entry will be made to journalize the payment by debiting the accrued expenses account and crediting the cash account as follows:
Deferrals are adjustments made for revenues or expenses that have been received or paid in advance but have not yet been earned or incurred. Examples of deferrals include prepaid insurance, unearned revenue, and prepaid rent.
When journalizing deferrals, the amount of revenue received or expenses paid in advance, that has not yet been earned or incurred has to be determined by reviewing invoices, receipts, and other documents; this is done to identify any deferred transactions that have been recorded in the accounting system but need to be adjusted. The appropriate amount of revenue or expense is then recorded in the relevant account.
Adjusting entries for deferrals is important because they ensure that deferred revenue or expenses are recognized appropriately and accurately.
When recording deferred revenue, the entry would be to debit to the cash account and a credit to an unearned revenue account such as unearned service revenue if the payment is for services or unearned sales revenue if the payment is for a product. Deferred revenue journal entries are common in companies that receive payments in advance for products or services that have not yet been provided. This includes subscriptions to legal services, books, channels, magazines, financial consultations, etc, or preorders for clothes, shoes, furniture, etc. Such journal entries will be recorded as shown in the following table:
|Unearned service revenue or unearned sales revenue||$$|
When the revenue is actually earned by providing the good or service to the customer, journalizing an adjusting entry becomes necessary to reduce the unearned revenue account and increase the revenue account. This is done by recording a debit to unearned revenue and a credit to the revenue account as follows:
In the case of deferred expenses, when prepayments have been made for expenses such as rent, the journal entry for such a transaction will be a debit to the particular expense account and a credit to the cash account as shown below:
As the prepayment gets used up, adjusting entries are made to make sure the amount used up tallies the company financials. To journalize this adjusting entry, there will be a debit to the particular expense account and a credit to the prepaid expense account as shown below:
Depreciation and amortization
Depreciation and amortization adjustments are systematic allocations of the cost of long-term assets and intangible assets over their useful lives. These adjustments reduce the value of the asset on the balance sheet and recognize a portion of the cost as an expense on the income statement. An adjusting entry is made at the end of each accounting period to record the depreciation or amortization expense for the period. To make an adjusting entry for depreciation and amortization, first, determine the amount of depreciation or amortization expense to be recognized for the period. This involves calculating the total cost of the asset, the useful life of the asset, and the method of depreciation or amortization.
Then debit the depreciation or amortization expense account and credit the accumulated depreciation or amortization account. Adjusting entries for depreciation and amortization is important because they ensure that the cost of assets is allocated over their useful lives, providing a more accurate picture of a company’s financial position and performance.
For depreciation on fixed assets, the adjusting journal entry to recognize the asset’s depreciation is as shown below:
For amortization on intangible assets such as trademarks, patents, and copyrights, the adjusting journal entry will be a debit to amortization expense and a credit to amortization as follows:
Revaluations typically involve adjusting the carrying value of an asset or liability to its fair value. Adjusting entries for revaluations are made to reflect the change in the value of the asset or liability due to market fluctuations or other factors. Once a revaluation is done, the company’s financial statements are updated accordingly. Hence, adjusting entries for revaluations is important because they ensure that the carrying value of assets and liabilities reflects their fair value, thereby providing a more accurate picture of a company’s assets and liabilities. Examples of revaluations include the revaluation of investment securities and the adjustment of the value of property, plant, and equipment.
To make an adjusting entry for revaluations, determine the amount of the revaluation gain or loss. This involves comparing the current fair value of the asset or liability to its original carrying value. Then debit or credit the appropriate account to record the revaluation gain or loss. When recording a revaluation, the particular account that records the asset or liability that is being revalued is debited and the revaluation reserve account is credited with the same amount. The adjusting journal entry will be as seen in the table below:
|DD/MM/YYYY||Asset or liability account||$$|
|Revaluaton reserve account||$$|
See also: Adjusting Entry for Prepaid Insurance
Adjusting journal entries examples
Example 1: Accrued revenue
Assuming a plumbing company got a contract to install pipes in a building. If the cost of the pipes, as well as the charges for the installation, accumulate to $10,000 and the work was completed on April 25, 2023, the plumbing company will make the following journal entry to record the transaction.
Suppose the company sends the invoice to the owner of the building and they make payment for the work by May 1, 2023, another entry which is the adjusting entry will be made to reduce the accrual account and increase the cash account with a debit to the accrued revenue account of the amount paid and a credit to the cash account of the same amount as shown below:
Example 2: Accrued expenses
Suppose Meta incurred an expense worth $8,000 of the water bill for the month of March for which they received the water bill on April 1, 2023. Since the bill was for the month of March, it will be recorded as an accrued expense for the previous month with a debit to the utility expense account and a credit to the accrued expense account as follows:
If Meta pays for the water bill by April 3, 2023, they will reduce the accrued expenses account by $8,000 and decrease the cash account by the same amount. To journalize this adjusting entry for the water bill payment, a debit will be made to the accrued expenses account and a credit will be made to the cash account as recorded in the table below:
Example 3: Deferred revenue
Suppose Northern Hairs, a wig production company, receives a prepayment of $500,000 from a retailer for the preorder of braided wigs on January 5, 2023. Since this payment is made in advance before the wigs are sent, Northern Hairs will record the transaction as deferred revenue. Journalizing the transaction will involve a debit to the cash account and a credit to the unearned revenue account as follows:
If Northern Hairs supplies the wigs to the retailer by February 5, 2023, a corresponding adjusting entry would be made to reduce the unearned revenue account and increase the revenue account. The adjusting journal entry will be a debit to unearned revenue and a credit to the revenue account as seen below:
Example 4: Deferred expense
Assuming Amazon has a warehouse in Colorado whose yearly rent costs $1,200,000 and made an upfront payment for the year 2023 on December 30, 2022. Amazon will record this rent prepayment as a debit to the prepaid rent account and a credit to the cash account to indicate an increase in the prepaid rent account and a decrease in the cash account as follows:
By the end of January, Amazon will journalize an adjusting entry to the prepaid rent account to reflect the portion of the rent that has been used up. To determine the monthly amount for adjustments, the rental amount will be divided by the number of months in a year. This means $1,200,000/12 which will be $100,000. Hence the monthly adjusting entry will be a debit of $100,000 to the rent expense account and a corresponding debit to the prepaid rent account. If Amazon uses a monthly accounting cycle, then the adjusting entry for the month of January will be as shown below:
The above adjusting entry will be made at the end of every month to indicate a reduction in the prepaid rent account. However, if Amazon uses a yearly accounting cycle, then at the end of the year, they will journalize a year-end adjusting entry by debiting the rent expense account of the yearly rent payment and debiting the prepaid rent account of the same amount. This adjusting entry empties the prepaid rent account to indicate that all the rent has been used up. The yearly adjusting journal entry will be as follows:
Example 5: Depreciation
Assuming a company bought a computer for official use on June 13, 2023, and its total cost is $2,000. The company will record the computer purchase as a debit to the computer account and a credit to the cash account as follows:
Suppose the useful life of the computer is 4 years, using the straight-line method of depreciation, the computer purchase price will be divided by 4 to determine the amount of yearly depreciation that will be recorded. Hence, the amount of yearly depreciation will be $2,000/4 = $500. The adjusting entry to record the yearly depreciation will be a debit depreciation expense for $500 and an equivalent credit to accumulated depreciation as shown in the following table.
Example 6: Revaluation
Suppose MacDonald’s bought land in San Fransisco in 2013 for $1,000,000, if the land is revalued to a fair value of $1,500,000 by April 2023. It means there has been a revaluation gain worth $500,000 on the land. Hence, for MacDonald’s to ensure that their financial statements accurately reflect the current value if this land, they will journalize an adjusting entry to record the land s current fair market value. The adjusting entry would be to debit Land for the $500,000 increase and a credit to the revaluation reserve account for the same amount as recorded in the following table.
|Revaluation reserve account||$500,000|
See also: Adjusting entry for bad debt expense
Journalizing adjusting entries are used by companies to ensure accurate recording and reporting of all transactions such as accruals, deferrals, estimates, and revaluations that require adjusting entries made. These adjustments to various accounts are done either monthly, quarterly, or yearly to effectively capture expenses and revenue within the same period that they occur. Without journalizing adjusting entries, the financial statements of companies will be inaccurate as assets and liabilities may be overestimated or understated. When either of these happens, investors and business owners will not have a true picture of the company’s financial position.
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