When a business uses the accrual accounting method, several year-end adjusting entries must be made to the profit & loss statement and balance sheet. A year-end adjusting entry is an adjustment made to a journal entry so that the year-end reports reflect the business’ accounts and financial position accurately. The basic types of year-end adjustments usually done to the books include accruals, deferrals, and non-cash expenses. In this article, we will be discussing year-end adjusting entries with examples.
Year-end adjusting entry explained
A year-end adjusting entry is a journal entry made to a general ledger account at the end of the fiscal year, to ensure revenue and expenses are matched and recognized at the time that they occur. Businesses need to make year-end adjusting entries to update previously recorded journal entries so that their financial records are in compliance with the matching principle and GAAP for revenue recognition.
At the end of a fiscal year, the number of year-end adjustments required is dependent on how meticulously the company’s financial record has been maintained on a monthly basis. When the financial statements are to be audited by the company’s auditors, it is very necessary to make the required year-end adjusting entries. If these year-end adjustments are not made, the company’s financial statements will be overstating its net income and owner’s equity and understating its expenses and liabilities.
The basic types of year-end adjustments usually done to the books include accruals, deferrals, and non-cash expenses. However, there are other uncommon types of year-end adjusting entries, such as the reclassification of transactions from one account to another and year-end adjustments based on issues found by outside auditors.
For instance, a year-end adjusting entry can be made to reclassify a portion of an amount due under a long-term debt arrangement as a short-term debt, since it is due and payable within one year. Also, year-end adjusting entries may be required if outside auditors discover any error. For instance, assume auditors discover that the ending inventory is overstated by $20,000, they would request that a year-end adjusting entry is made to correct this error.
See also: Adjusting entry for accrued salaries
Types of year-end adjustments
- Accrual adjustments
- Deferred adjustments
- Noncash expenses
Adjusting entries are recorded for certain kinds of business transactions. The various kinds of year-end adjusting entries fall under three main categories which are accruals, deferrals, and noncash expenses.
Accrual adjustments include the adjusting entry for accrued revenues and the adjusting entry for accrued expenses. Revenue is accrued when a business recognizes revenue but has not yet invoiced the customer. This is an unbilled revenue that is recognized but has not yet been realized. Such transactions involve interest revenue and delivered goods or completed services that have not yet been billed to customers.
Accrued expenses, on the other hand, are expenses that the company has incurred, but have not yet been invoiced by the vendor. Typical examples of expenses that can be accrued include interest payments on loans, taxes, and warranties on products or services received, that have been incurred, but no invoices have been received nor payments made. Also, expenses such as wages or salaries, employee commissions, and bonuses are usually accrued in an accounting period while the actual payment is made in the next accounting period.
Year-end adjusting entry for Accrued revenue
A company’s accountant recognizes unbilled revenues as accrued revenues by posting journal entries that debit accounts receivable (or an accrued revenues asset account) on the balance sheet, and credits the revenue account on the income statement. Then, when the customer has been billed (or makes payment), in the next fiscal year or accounting period, year-end adjustments are made for accrued revenues which will be a debit to the cash account on the balance sheet, and a credit to the accounts receivable (or accrued revenue account) to reduce the account.
|Accounts receivable (or Accrued revenue) A/c||00|
Year-end adjusting entry for accrued expenses
A company’s accountant recognizes unbilled expenses as accrued expenses, which are recorded as a liability on the balance sheet. In order to report these accrued expenses, journal entries that debit the Expense account (to increase expenses) on the income statement, and credit the Accrued expenses account (to increase liabilities) on the balance sheet would be made.
Then, when the company has been billed (or makes payment), in the next fiscal year or accounting period, year-end adjusting entries for accrued expenses are made which will be a debit to the Accrued expenses account (to decrease liabilities) and a credit to the Bank (or Cash) account (to decrease the amount of cash) in order to reflect that a debt has been cleared.
|Accrued expenses A/C||00|
|Bank (or Cash) A/c||00|
Deferral adjustments include the adjusting entry for deferred revenues and prepaid expenses adjusting entry. Deferred revenues (also known as unearned revenue) are reported in the books when a customer has paid for a product or service that is yet to be delivered to the customer. This payment is treated in the financial record of the company (who receives this payment) as a liability. Typical examples of deferred revenue include yearly memberships or subscriptions, a rent payment received in advance, services contracts paid in advance, airline tickets, and annual magazine subscriptions.
Prepaid expenses (also known as deferred expenses), on the other hand, are reported in the books when a company pays for a product or service in advance. This payment is treated in the financial record of the company (who makes this payment) as an asset. Typical examples of deferred revenue include prepaid rent, prepaid utilities, prepaid insurance, and the purchase of office supplies.
Year-end adjusting entry for deferred revenue
When an advance payment is received from a customer, such revenues will be recorded as a liability in an unearned revenues (or deferred revenue) account on the balance sheet because the company is yet to earn them and owes the customer. This is recorded as a debit to the cash (or bank) account and a credit to the deferred revenue account.
Over time, as the company delivers the paid goods or services to the customer, adjusting entries are made so that the deferred revenue is then recognized as revenue and reported on the income statement. In order to reflect that the company has earned the revenue at the end of the fiscal year, a year-end adjusting entry is made by debiting unearned revenues on the balance sheet and crediting the revenue account on the income statement.
|Unearned Revenue A/c||00|
Year-end adjusting entry for prepaid expenses
When an advance payment has been made for an expense, it will be recorded as a current asset in the appropriate prepaid expense account on the balance sheet because these prepayments benefit the company and usually cover a period of one year or less. This advance payment is recorded as a debit to the appropriate prepaid expense account and a credit to the cash account.
Then, a year-end adjusting entry is made to recognize the used-up prepayments in order to ensure that the company’s expenses get recognized within the same accounting period as when they are incurred. That is, in order to reflect that the company has used up the prepaid expense at the end of the fiscal year, a year-end adjusting entry is made by debiting the appropriate expense account on the income statement (rent expense, insurance expense, utility expense, etc), and crediting the prepaid expense account on the balance sheet.
|Prepaid Expense A/c||00|
One of the types of year-end adjustments involves non-cash expenses such as the allowance for doubtful accounts or bad debt expense, depreciation expense, or the inventory obsolescence reserve. Some smaller businesses do not bother to recognize amortization and depreciation on a monthly basis, rather they choose to recognize it at the end of the year and therefore, make year-end adjusting entries for depreciation and amortization.
Year-end adjusting entry for depreciation
Depreciation expenses journal entry is usually made to account for the loss in value of a fixed asset such as vehicles, equipment, or buildings. Each time you pay depreciation, it is reflected on your income statement as an expense. The moment an asset is purchased, depreciation should begin and theoretically should be computed monthly, starting with the first month after acquiring it. However, in reality, many companies only report depreciation on a quarterly, semi-annual, or annual basis, depending on how frequently they produce their financial statements.
When it comes to depreciation, the year-end adjusting entry is different compared to other year-end adjustments because you have to consider the long-term accumulated depreciation which is a contra-asset account that is used to track depreciation expenses. When accounting for depreciable assets, you make a year end adjusting entry for depreciation which will be a debit to the depreciation expense account and a credit to the accumulated depreciation account. This means that, at the end of a fiscal year wherein an asset is depreciated, the total amount of accumulated depreciation on the balance sheet changes.
|Depreciation Expense A/C||00|
|Accumulated depreciation A/c||00|
Year-end adjusting entry for amortization
Amortization is reported just as with depreciation but applies to intangible assets. This is the write-down of intangible assets’ value over the useful life of the assets. Like with depreciation, amortization expense is reported on the income statement, while the accumulated amortization, the contra-asset account is reported on the balance sheet for the corresponding intangible asset.
|Amortization Expense A/C||00|
|Accumulated Amortization A/c||00|
Year-end adjusting entry for allowance for doubtful accounts
In business, there are chances that a business may not recover some debts from customers, so in the books, the bookkeeper can make use of allowance for doubtful accounts to offset the account. This is common when a business offers credit to customers and anticipates that the customer may miss payments.
When a business decides that an account is uncollectable, it writes it off by decreasing the allowances for doubtful accounts account by a debit and decreasing the accounts receivable account by a credit entry. However, if peradventure the customer later pays the debt the business can make a year-end adjusting entry which is a debit to the accounts receivable account and a credit to the allowance for doubtful accounts.
|Allowance for doubtful accounts||00|
Then, the adjusting entry to record the payment of debt will be a debit to the cash account and credit to the accounts receivable account.
Year end adjusting entries examples
Let’s look at some year-end adjusting entries examples:
Year-end adjustment example 1
Let’s look at prepaid insurance as one of the year-end adjusting entries examples. For insurance policies, it is customary to purchase it in advance and pay cash upfront to cover a future period of protection. Let’s say a 3-year insurance policy was purchased on January 1, 2022, for $6,000. This means that by December 31, 2022, at the end of the year, about $2,000 of insurance coverage would have been used up (expired). That is one year out of three years (i.e 1/3 of $6,000). The following entry would be needed to record the prepaid insurance transaction on January 1:
Then, on December 31, the year-end adjusting entry for prepaid insurance to record the portion of the insurance that has been used up would be:
As a result of the first journal entry and the year-end adjusting entry, the company’s income statement for 2022 would report an insurance expense of $2,000, and the balance sheet at the end of 2022 would report prepaid insurance of $4,000 ($6,000 debit less $2,000 credit). Then, over the next two years, the remaining $4,000 amount would be transferred to insurance expenses by preparing similar year-end adjustments at the end of 2023 and 2024.
Year end adjusting entries example 2
For our next example, let’s look at depreciation as an example of year-end adjusting entries. Long-term assets such as equipment and buildings will render productive benefits over a period of time. Hence, a portion of their cost has to be allocated to each period by reporting depreciation expense. One simple method that is used for depreciation expense calculation is the straight-line method, where an equal amount of the cost of an asset is assigned to each year of the asset’s useful life.
For our example, let’s assume a $150,000 truck with a 3-year life was acquired on January 1 of 2021. This means the truck’s depreciation expense would be $50,000 per year (ie $150,000/3 = $50,000). This expense amount would be reported on the company’s income statement each year. Hence, the year-end adjusting entry for the depreciation of the truck would be a debit to the Depreciation Expense account and a credit to the Accumulated Depreciation (instead of crediting the asset account directly). That is:
On the company’s balance sheet, the asset will continue to be reported at its $150,000 cost every year. However, it is also going to be reduced each year by the ever-growing accumulated depreciation as a result of the year-end adjusting entry for the depreciation that will be done at the end of every fiscal year (2021-2023). By the end of the truck’s useful life, its cost would have been fully depreciated and its net book value would have been reduced to zero.
Year-end adjusting entry example 3
Let’s look at unearned revenue as one of the year-end adjusting entries examples. Unearned revenue is recorded when a business collects money in advance of providing goods or services. Take a magazine publisher for instance, that sells a multi-year subscription and collects the full payment at the beginning of the subscription period. Say a customer pays $1,800 for one year and six months. The magazine publisher would record such advance payments received as a debit to Cash and a credit to Unearned Revenue:
The magazine publisher records this money as a liability because it reflects the company’s obligation to deliver products in the future. However, as the publisher delivers the magazines, the Unearned Revenue account is debited (reduced), and the Revenue account is credited (increased). That is the year end adjusting entry would look like this:
At the end of the fiscal year, the balance sheet would include the remaining unearned revenue ($600) for the magazine not yet delivered. This amount shows the publisher’s obligation for future performance, while the reported revenue ($1,200) on the income statement reflects the magazine that has been delivered.
Year end adjusting entries example 4
Accrued interest is a typical example of year-end adjusting entries. An interest billing may arrive late from the bank and so a company may accrue this expense. The majority of loans include interest charges that depend on the amount borrowed, the interest rate, and the length of the borrowing period. The total amount of interest on a loan is calculated as Principal amount x Rate x Time.
Now, let’s assume you borrowed $100,000 at 6% per year for 18 months; this means the total interest on the loan will amount to $9,000 (i.e $100,000 x 6% x 1.5 years). It is logical and appropriate for you to accrue the interest in your books as time passes so that you can assign the correct interest cost to each accounting period. So, let’s say you took the 18-month loan on July 1, 2020, and the loan was due on December 31, 2021. This is how the accounting for the loan on the various dates with the appropriate year-end adjusting entry for the accrued interest would look like:
Year-end adjustment example 5
Recording the supplies expense for office or store supplies is another example of year-end adjusting entries. The accounting process for supplies is similar to prepaid expenses because supplies are initially recorded as an asset and then later recorded as an expense when used or consumed. For example, assume Jotscroll company purchased office supplies worth $2500 on 1st January 2022. The journal entry to record this would be:
Assuming, out of these office supplies, about $1000 worth of supplies remained unused on 31st December 2022. This means the Supplies expense at the end of the fiscal year would be $1500 ( i.e $2500 – $1000). This means the year-end adjustment entry would be:
|Office supplies||Office Supplies|