Adjusting entries are accounting journal entries that are to be made at the end of an accounting period. Adjusting entries are made to ensure that income and expenditure is allocated to the correct accounting period, this means that the accounting records are completed on an accruals basis and are in compliance with the revenue recognition and matching principles, and the time period assumption. Adjusting entries are sometimes referred to as balance day adjustments.
Classification of Adjusting Entries
Adjusting entries can be classified into one of six categories.
- Prepaid expenses (sometimes called deferred expenses) representing expenses which have been paid and recorded in advance before they are incurred (used or consumed) and need to be allocated to a later accounting period. Before they are used, the prepaid expenses are recorded as assets in the current accounting period. An example would be adjusting entries for prepaid insurance.
- Deferred revenue (sometimes referred to as unearned revenue) representing revenues which have been received and recorded before they are earned and need to be allocated to a later accounting period. Before they are earned, deferred revenues are recorded as liabilities in the current accounting period. A typical example would be the unearned rent revenue adjusting entry.
- Accrued expenses representing expenses which have been incurred (used and consumed) but not yet paid or recorded and need to be allocated and accrued to the current accounting period. As they have not been paid, accrued expenses are recorded as liabilities in the current accounting period.
- Accrued revenue representing revenues which have been earned but have not yet been received or recorded and need to be allocated to the current accounting period in which they were earned. As they have been earned but not received, they are recorded as assets (accounts receivable) during the current accounting period.
The first four types of adjusting entry are summarized in the table below.
- Estimated expenses adjusting entries are used when the exact value of an expense cannot be determined. For example depreciation and the bad debt expense adjusting entry are both examples of expenses which need to be estimated at the end of an accounting period, but the exact value is unknown.
- Periodic inventory adjusting entries for inventory are used in a periodic inventory system to determine the cost of goods sold expense.
Adjusting Journal Entries Examples
There are various types of accounting adjusting entries examples in accounting a few of which are given below. The important point to remember is that the adjusting entries represent the change in the amount that occurred during the accounting period, and affect at least one balance sheet account and one income statement account, but never the cash account.
An expense paid in advance is carried as an asset (prepayments) in the balance sheet to the next accounting period.
An adjusting entry for unearned revenue. Revenue which has been received but not yet earned is transferred to the balance sheet as a liability (deferred revenue).
An accrual for an expense incurred but not yet paid which is carried as a liability (accruals) in the current accounting period.
An accrual for revenue earned but not yet received which is carried as an asset (accounts receivable) in the current accounting period.
An adjusting entry for depreciation on fixed assets used to match use of a long term asset to revenue.
|Cost of sales||XXX|
To charge cost of sales with the inventory used during the accounting period (only used for periodic not perpetual inventory accounting systems).
|Cost of sales||XXX|
To credit cost of sales with the closing inventory (only used for periodic not perpetual inventory accounting systems).
|Income tax expense||XXX|
|Income tax payable||XXX|
An accrual for estimated income taxes expense incurred but not yet paid which is carried as a liability (income tax payable) in the current accounting period.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.