Adjusting Entries

At the end of an accounting period, an adjustment journal entry (sometimes known as a "adjustment" entry) is made to the general ledger to record any unrealized revenue or costs during the period. An adjusting journal entry is necessary to correctly account for a transaction that began in one accounting period and ended in another.

Example Of An Adjusting Entry

Let's say a vehicle repair shop gives its customers repair services in October with the understanding that they will be reimbursed after three months.

Cash is recorded as accounts receivable in October as cash anticipated to be received. The adjustment entry must then be made when the client delivers the payment in December.

In this instance, the adjusting entry is created to turn the receivable into revenue.

The Importance Of Adjusting Entries

You may record business transactions accurately and on time by creating modifying entries. This makes it very easy to keep track of your payables and receivables and to calculate the precise profit and loss for the company at the conclusion of the fiscal year.

The financial health of your company will be entirely distorted if you prepare financial statements without taking adjusting entries into account. The owner's equity and net income will be inflated, while costs and obligations will be minimized.

Types Of Adjusting Journal Entries

1. Accruals

Accruals are revenues and costs that have not yet been received or paid and have not yet been documented in a conventional accounting transaction. Even though a company is permitted to occupy the premises at the beginning of the month even though the rent is not yet paid, rent that is paid at the end of the month may be an example of an accumulated expense.

2. Deferrals

Revenues and expenses that have been collected or paid in advance but have not yet been earned or used are referred to as deferrals.

Money received for things that haven't yet been delivered is referred to as unearned revenue, for instance.

3. Estimates

Estimates are adjusting entries that list non-cash items like depreciation expense, an allowance for doubtful accounts, or an obsolescence reserve for inventory.

Example Of An Adjusting Entry

Depreciation is a technique for devaluing assets that endure longer than a year so that the cost of ownership is based on how long the asset is used by the company (not at the time of pay). Depreciation is only an estimate of how much a physical asset is utilized during one accounting period because it doesn't include any actual financial exchange. The commonly used formula to calculate depreciation is by the straight-line method.

For instance, if a business spends $20,000 on a facility that it expects to use for 10 years, the $20,000 will be expensed over the course of the 10 years rather than at the time the structure is bought.

Depreciation (per accounting period) = Cost of the asset / Estimated Useful Life

Key Takeaways

• The three most frequent types of modifying journal entries are estimates, deferrals, and accruals.
• To comply with the matching and revenue recognition rules, adjusting journal entries are added to a company's general ledger at the conclusion of an accounting period.
• It is used for accrual accounting at the end of one accounting period and the beginning of the next.
• Businesses using cash accounting are exempt from the requirement to create adjusting journal entries.