Definition
Adjusting entries are a key part of the accrual basis of accounting, allowing companies to appropriately spread out their revenues and expenses over different periods. Examples of adjusting entries include adjusting accrued interest on a loan, adjusting for goods or services billed but not yet received, and recognizing depreciation on assets. These entries can adjust for things like prepaid expenses, unearned revenues, accrued revenues, or accrued expenses, to ensure financial statements are accurate.
Key Takeaways
- Adjusting entries are accounting journal entries that convert a company’s accounting records to the accrual basis of accounting. They are usually made at the end of an accounting period to align the revenues and expenses to the “right” period, on a principle called the matching principle.
- An example of an adjusting entry include accrued interest: If a company has a loan from a bank, the loan will accumulate interest over time, but this interest might not be due to be paid until a later date. To accurately represent the liability the company has in the current period, an adjusting entry is made to debit (increase) interest expense and credit (increase) interest payable.
- Another example would be prepaid expenses: A company pays in advance for office supplies. To match the expense to the right period, when these supplies are used, an adjusting entry is made to debit (increase) office supplies expense and credit (decrease) prepaid office supplies. This reflects the consumption of the asset (office supplies), turning it into an expense.
Importance
Adjusting entries examples are crucial in the finance field as they play a vital role in ensuring the accuracy of a company’s financial records and statements.
These are typically made at the end of an accounting period to accurately reflect income and expenditure for that period.
Examples of adjusting entries could include accrued revenues and expenses, deferred revenues and expenses, estimated items like bad debts, etc.
They are essential in adherence to the revenue recognition and matching principles of accounting, which state that revenues must be matched to the expenses incurred in earning them.
The knowledge of how to make these entries, therefore, is crucial in maintaining the integrity, accuracy, and compliance of a company’s financial records.
Explanation
The primary purpose of adjusting entries in finance is to ensure that revenues and expenses are recognized in the period in which they are incurred, which adheres to the matching principle of accounting. Essentially, adjusting entries enable businesses to adjust their books in order to display a precise depiction of their financial position.
They facilitate keeping track of revenue and expenses, even if no cash transactions or actual payments are made. This is significant for accurate reporting and can help a business better understand its profitability, liquidity, and overall financial health.
For instance, an insurance company may collect premiums from its clients at the beginning of the year, but the service (insurance coverage) extends over the course of that year. The revenue, therefore, is not all recognized upfront in January, but gradually adjusted each month to reflect the monthly earnings from providing insurance services.
Such adjustments ensure that earned revenues and incurred expenses are reflected correctly in the company’s financial statements, and they contribute to the accuracy and reliability of these statements. Without adjusting entries, a company’s financial reports would not give a true and fair view of the company’s financial condition.
Examples of Adjusting Entries Examples
Depreciation Expense: Suppose you own a business that bought a delivery truck for $50,000 with a useful life of 5 years. The cost of this asset will not be recognized entirely in the year it was purchased. Instead, the expense will be spread out over the useful life of the asset. Therefore, at the end of each accounting period, an adjusting entry will be made to account for the amount of the truck’s value that has been used up.
Accrue Unpaid Salaries: Imagine that your company’s accounting period ends on December 31, and you pay your employees on January 5 for the work they completed between December 16 to December
Because the employees earned that money by December 31, you are supposed to recognize the salary expense and related payable in December. Therefore, you would make an adjusting entry to record the salaries expense and salaries payable.
Prepaid Rent: Suppose a company pays its annual rent of $12,000 upfront on January
The adjusting entry for each month would involve decreasing the prepaid rent account by $1,000 ($12,000/12) and recognizing a $1,000 rent expense. That’s because the rent relates to the usage of the rented property throughout the year, and each accounting period that the property is utilized should reflect an allocation of the cost.
FAQ: Adjusting Entries Examples
What are adjusting entries?
Adjusting entries are journal entries made at the end of an accounting period to allocate income and expenditure to the period in which they actually occurred. The goal of making these entries is to ensure the most accurate financial statements at the end of the accounting period.
What are some examples of adjusting entries?
Examples of adjusting entries include accrued income, accrued expenses, deferred income, deferred expenses, and depreciation. Each of these entries are made to record costs or revenue in the correct accounting period.
How is accrued income recorded as an adjusting entry?
Accrued income is recorded as a debit to an “Accrued Revenue” account and a credit to a “Revenue” account.
What about accrued expenses?
Accrued expenses are recorded as a debit to an “Expense” account and a credit to an “Accrued Expenses” account.
Can you explain deferred income?
Deferred income is revenue that is received in advance but which is not yet earned. It is recorded as a credit to a “Deferred Revenue” account and a debit to a “Revenue” account.
And what about deferred expenses?
Deferred expenses are expenses that have been paid in advance and will benefit more than one accounting period. They are recorded as a debit to an “Asset” account and a credit to an “Expense” account.
Finally, what is depreciation in terms of adjusting entries?
Depreciation is the decrease in value of an asset over time. It is recorded as a debit to “Depreciation Expense” and a credit to “Accumulated Depreciation”.
Related Entrepreneurship Terms
- Accrued Expenses: These are expenses that have been incurred but not yet paid. Adjusting entries for accrued expenses record the obligation to pay in the future.
- Accrued Revenues: It occurs when a company has earned revenue, but has not yet received payment. An adjusting entry is made to record the revenue.
- Prepaid Expenses: Expenses paid in advance before they are used or consumed. An adjusting entry is needed to show the portion of the prepaid expense that has been used up over a period of time.
- Unearned Revenues: These are funds received for goods or services that have not yet been provided. An adjusting entry ensures that revenue is recognized when the goods or services are delivered.
- Depreciation Expense: It is an expense recorded to allocate a tangible asset’s cost over its useful life. An adjusting entry for depreciation reduces the asset’s value and transfers the expense to the income statement.
Sources for More Information
- Investopedia: This website offers a wealth of financial terms and concepts, including adjusting entries.
- AccountingCoach: It offers not only the definition but also numerous examples and exercises on accounting and finance topics such as adjusting entries.
- Corporate Finance Institute (CFI): This institute provides a large library of finance and accounting related concepts, including adjusting entries examples.
- My Accounting Course: It’s a useful online platform that provides plenty of examples and detailed explanations of different accounting terms, including adjusting entries.
