Adjusting entries
Journal entries made at the end of a period so that revenue and expenses are recorded in the period they belong to.
In short
- They are made at period end, before the financial statements.
- Each one touches an income statement account and a balance sheet account, and no cash.
- Accruals, deferrals, depreciation and estimates are the main types.
Adjusting entries are journal entries recorded at the end of an accounting period, before the financial statements are prepared, to bring the books in line with accrual accounting. Day-to-day bookkeeping records transactions when invoices and payments happen. Adjusting entries move revenue and expenses into the period in which they were actually earned or incurred.
The main types
- Accrued expenses: costs incurred but not yet billed, such as wages earned in the last days of the month or a utility bill that arrives after month end.
- Accrued revenue: revenue earned but not yet invoiced, such as project work billed next month.
- Prepaid expenses: the part of an advance payment, such as insurance or an annual subscription, used up this period.
- Unearned revenue: the part of a customer's advance payment that has now been earned.
- Depreciation and amortization: the period's share of the cost of long-lived assets.
- Estimates: such as an allowance for bad debts.
How to recognize one
Every adjusting entry touches one income statement account and one balance sheet account, and none of them involves cash: the cash moved, or will move, in another period. Many are reversed on the first day of the next period. The actual invoice can then be recorded normally when it arrives, without counting the cost twice.
Where they fit in the close
Adjusting entries come after the bank reconciliation and the unadjusted trial balance, and before the statements are prepared. The more complete the bookkeeping during the month, the fewer adjustments the close needs: a supplier bill recorded the week it arrives no longer has to be estimated as an accrual.
Worked example
Two March 31 adjustments
On March 31, a company owes $6,000 of wages earned since the last payday and has a $3,600 annual insurance policy it paid in January. It records one adjusting entry debiting wages expense and crediting wages payable for $6,000, and another moving $300 from prepaid insurance to insurance expense for March. Neither entry involves cash.