Adjusting entries

An adjusting journal entry is an entry in a company's general ledger

that occurs at the end of an accounting period to record any
unrecognized income or expenses for the period. When a transaction
is started in one accounting period and ended in a later period, an
adjusting journal entry is required to properly account for the
transaction.

What Is the Purpose of Adjusting Journal Entries?

Adjusting journal entries are used to reconcile transactions that have

not yet closed, but which straddle accounting periods. These can be
either payments or expenses whereby the payment does not occur at
the same time as delivery.

What Are the Types of Adjusting Journal Entries?

The main two types are accruals and deferrals.

Accruals refer to payments or expenses on credit that are still owed.

Deferrals refer to prepayments where the products have not yet been
delivered.
1. Accrued revenues

Accrued revenues are services performed in one month but billed in

another. You’ll need to make an adjusting entry showing the revenue
in the month that the service was completed. This is referred to as an
accrued revenue adjusting entry.

Example

Your business makes custom tote bags. In February, you make $1,200
worth for a client, then invoice them. The client pays the invoice on
March 7.

You incurred expenses making the bags—cost of materials and labor,

workshop rent, utilities—in February. To accurately reflect your
income for the month, you need to show the revenue you generated.
(Remember: Revenue minus expenses equals income.)

First, you make an adjusting entry, moving the revenue from a

“holding account” (accrued receivables) to a revenue account
(revenue.) Then, on March 7, when you get paid and deposit the
money in the bank, you move the money from revenue to cash.

Example adjusting entry

In your general ledger, the adjustment looks like this. First, during
February, when you produce the bags and invoice the client, you
record the anticipated income.

For the sake of balancing the books, you record that money coming
out of revenue. Then, when you get paid in March, you move the
money from accrued receivables to cash.
2. Accrued expenses

Also known as accrued liabilities, accrued expenses are expenses that

your business has incurred but hasn’t yet been billed for. Wages paid
to your employees at the end of the accounting period is an excellent
example of an accrued expense. You’ll need to make an accrued
expense adjusting entry to debit the expense account and credit the
corresponding payable account.

Example

Suppose in February you hire a contract worker to help you out with
your tote bags. You agree in advance to pay them $400 for a
weekend’s work. However, they don’t invoice you until early March.
In March, when you pay the invoice, you move the money from
accrued expenses to cash, as a withdrawal from your bank account.

Example adjusting entry

In February, you record the money you’ll need to pay the contractor
as an accrued expense, debiting your labor expenses account.
3. Deferred /Unearned revenues

Unearned revenues are payments for goods/services that are yet to

be delivered. For example, if you place an order in January, but it
doesn’t arrive (and you don’t make the payment) until January, the
company that you ordered from would record the cost as unearned
revenue. Then, in the month you make the purchase, an adjusting
entry would debit unearned revenue and credit revenue.

Example

Over the years, you’ve become well-respected in the tote bag

community. You’re invited to speak at the annual Tote Symposium, in
Lodi, California.

The conference show runners will pay you $2,000 to deliver a talk on
the changing face of the tote bag industry. They pay you in January,
after you confirm you’ll be attending. You’ll speak at the conference
in March.

Example adjusting entry

First, record the income on the books for January as deferred

revenue. You’ll credit it to your deferred revenue account for now.
Then, in March, when you deliver your talk and actually earn the fee,
move the money from deferred revenue to consulting revenue.
4. Prepaid expenses

Prepaid expenses are assets that you pay for and use gradually
throughout the accounting period. Office supplies are a good
example, as they’re depleted throughout the month, becoming an
expense. Essentially, in the month that the expense is used, an
adjusting entry needs to be made to debit the expense account and
credit the prepaid account.

Example

You rent a new space for your tote manufacturing business, and
decide to pre-pay a year’s worth of rent in December.

In December, you record it as prepaid rent expense, debited from an

expense account. Then, come January, you want to record your rent
expense for the month. You’ll move January’s portion of the prepaid
rent from an asset to an expense.

5. Depreciation

Depreciation adjusting entries are slightly different, as you’ll need to

consider accumulated depreciation (i.e., the accumulated
depreciation of assets over the company’s lifetime). This is referred
to as a contra-asset account. Essentially, from the point at which the
asset is purchased, it depreciates by the same amount each month.
For that month, a depreciation adjusting entry is made, debiting
depreciation expense and crediting accumulated depreciation.