Adjusting Entries

Adjusting entries are journal entries that are used at the end of
an accounting period to adjust the balances in various general
ledger accounts. These adjustments are made to more closely
align the reported results and financial position of a business to
meet the requirements of an accounting framework, such as
GAAP or IFRS. This generally involves the matching of revenues
to expenses under the matching principle, and so impacts
reported revenue and expense levels.
The use of adjusting journal entries is a key part of the period
closing processing, as noted in the accounting cycle, where
you convert a preliminary trial balance into a final trial
balance. It is usually not possible to create financial
statements that are fully in compliance with accounting
standards without the use of adjusting entries.

TYPES OF ADJUSTING
ENTRIES
An adjusting entry can used for any type of accounting transaction; here are some of the
more common ones:
To record depreciation and amortization for the period
To record an allowance for doubtful accounts
To record a reserve for obsolete inventory
To record a reserve for sales returns
To record the impairment of an asset
To record a warranty reserve
To record any accrued revenue
To record previously billed but unearned revenue as a liability
To record any accrued expenses
To record any previously paid but unused expenditures as prepaid expenses
To adjust cash balances for any reconciling items noted in the bank reconciliation.
As shown in the preceding list, adjusting entries are most commonly of three types, which are:
Accruals. To record a revenue or expense that has not yet been recorded through a standard accounting
transaction.
Deferrals. To defer a revenue or expense that has been recorded, but which has not yet been earned or used.
Estimates. To estimate the amount of a reserve, such as the allowance for doubtful accounts or the inventory
obsolescence reserve.

IMPACT OF ADJUSTING
ENTRIES
When you record an accrual, deferral, or estimate journal entry, it usually
impacts an asset or liability account. For example, if you accrue an expense,
this also increases a liability account. Or, if you defer revenue recognition to
a later period, this also increases a liability account. Thus, adjusting entries
impact the balance sheet, not just the income statement.
Since adjusting entries so frequently involve accruals and deferrals, it is
customary to set up these entries as reversing entries. This means that the
computer system automatically creates an exactly opposite journal entry at
the beginning of the next accounting period. By doing so, the effect of an
adjusting entry is eliminated when viewed over two accounting periods.
A company usually has a standard set of potential adjusting entries, for
which it should evaluate the need at the end of every accounting period.
You should have a list of these entries in the standard closing checklist.
Also, consider constructing a journal entry template for each adjusting entry
in the accounting software, so there is no need to reconstruct them every
month.

Adjusting Entry Examples:

ESTIMATES (1)
Depreciation: Arnold Corporation
records the $12,000 of depreciation
associated with its fixed assets
Credit
during the month. TheDebit
entry is:
Depreciation expense
Accumulated
depreciation

12,000

12,000

Adjusting Entry Examples:

ESTIMATES (2)
Allowance for bad debts: Arnold
Corporation adds $5,000 to its
allowance for doubtful accounts. The
entry is:
Debit
Bad debts expense
Allowance for
doubtful accounts

Credit

5,000

5,000

Adjusting Entry Examples:

ACCRUALS: REVENUES (1)
Accrued revenue: Arnold Corporation
accrues $50,000 of earned but
unbilled revenue. The entry is:
Debit
Accounts receivable accrued
Sales

Credit

50,000

50,00

Adjusting Entry Examples:

ACCRUALS: EXPENSES (2)
Accrued expenses: A supplier is late
in sending Arnold Corporation a
materials-related invoice for
$22,000, so the company accrues
the expense. The entry is:
Debit
Purchases (expense)
Accounts Payable/
Accrued expenses
(liability)

Credit
22,000

22,000

Adjusting Entry Examples:

DEFERRALS: REVENUES (1A)
Billed but unearned revenue: Arnold
Corporation bills a customer for
$10,000, but has not yet earned the
revenue, so it creates an entry to
record the billed amount as a liability.
The entry is:
Debit
Debtors
Unearned sales
(liability)

Credit

10,000

10,000

Adjusting Entry Examples:

DEFERRALS: REVENUES (1A)
An adjusting entry to record the
previously billed amount unearned as
a liability but now earned e.g.
$10,000. The entry is:
Debit
Unearned sales
(liability)
Sales (earned
revenues)

Credit

10,000

10,000

Adjusting Entry Examples:

DEFERRALS: EXPENSES (2A)
Prepaid assets: Arnold Corporation
pays $30,000 toward the next month's
rent. The company records this as a
prepaid expense. The entry is:
Debit
Prepaid expenses
(asset)
Cash

Credit

30,000

30,000

Adjusting Entry Examples:

DEFERRALS: EXPENSES (2B)
Adjustment at year end, when the
expense has expired, and the
amount is known, e.g. $15,000:

Debit
Rent expense
Prepaid expenses
(asset)

Credit

15,000

15,000