Account adjustments are entries made in the general journal at the end of an accounting period to bring account balances up-to-date. They are the result of internal events, which are events that occur within a business that don’t involve an exchange of goods or services with another entity.
Adjusting entries are generally made in relation to prepaid expenses, prepayments, accruals, estimates and inventory. Throughout the year, a business may spend funds or make assumptions that might not be accurate regarding the use of a good or service during the accounting period. Adjusting entries allow the company to go back and adjust those balances to reflect the actual financial activity during the accounting period.
An adjusting journal entry involves an income statement account (revenue or expense) along with a balance sheet account (asset or liability). Income statement accounts that may need to be adjusted include interest expense, insurance expense, depreciation expense, and revenue. The entries are made in accordance with the matching principle to match expenses to the related revenue in the same accounting period.
The income statement account that is pertinent to this adjusting entry and which will be debited for $1,500 is Depreciation Expense – Equipment. Note that the ending balance in the asset Prepaid Insurance is now $600—the correct amount of insurance that has been paid in advance. The income statement account Insurance Expense has been increased by the $900 adjusting entry. It is assumed that the decrease in the amount prepaid was the amount being used or expiring during the current accounting period.
The balance in Accounts Receivable also increases if the sale was on credit (as opposed to a cash sale). However, Accounts Receivable will decrease whenever a customer pays some of the amount owed to the company. Therefore the balance in Accounts Receivable might be approximately the amount of one month’s sales, if the company allows customers to pay their invoices in 30 days. A company needs to book adjusting entries when it has prepayments, accruals or estimates in its accounting records. When a company receives cash but hasn’t earned it yet, it’s considered a prepayment.
Adjusted Trial Balance
The balance in Insurance Expense starts with a zero balance each year and increases during the year as the account is debited. The balance at the end of the accounting year in the asset Prepaid Insurance will carry over to the next accounting year.
An unadjusted trial balance is a list of a company’s account balances from its general ledger that it uses to determine the adjusting entries it must make to its accounts. Adjusting entries record revenues and expenses that a company has earned or incurred but has not yet recorded. You can calculate your small business’s net income from your unadjusted trial balance to get an idea of your profit before making adjusting entries. Because adjusting entries will change your account balances, your actual net income will likely differ from the net income you calculate from the unadjusted trial balance.
The company will book an adjusting entry to recognize the revenue after it has completed the job. The opposite situation is an accrual; a company has incurred expenses but hasn’t paid money for them yet. GAAP requires accountants to record some estimates, such as bad debt expense.
The adjusting entry will debit interest expense and credit interest payable for the amount of interest from December 1 to December 31. In summary, adjusting journal entries are most commonly accruals, deferrals, and estimates. Accruals are revenues and expenses that have not been received or paid, respectively, and have not yet been recorded through a standard accounting transaction.
- An adjusting journal entry involves an income statement account (revenue or expense) along with a balance sheet account (asset or liability).
There are four types of accounts that will need to be adjusted. They are accrued revenues, accrued expenses, deferred revenues and deferred expenses. Similarly, the income statement should report all revenues that have been earned—not just the revenues that have been billed.
What goes on the unadjusted trial balance?
The unadjusted trial balance is the listing of general ledger account balances at the end of a reporting period, before any adjusting entries are made to the balances to create financial statements. The unadjusted trial balance is used as the starting point for analyzing account balances and making adjusting entries.
After further review, it is learned that $3,000 of work has been performed (and therefore has been earned) as of December 31 but won’t be billed until January 10. Because this $3,000 was earned in December, it must be entered and reported on the financial statements for December. An adjusting entry dated December 31 is prepared in order to get this information onto the December financial statements. At the end of the accounting year, the ending balances in the balance sheet accounts (assets and liabilities) will carry forward to the next accounting year. Since the firm is set to release its year-end financial statements in January, an adjusting entry is needed to reflect the accrued interest expense for December.
A review indicates that as of December 31 the accumulated amount of depreciation should be $9,000. Therefore the account Accumulated Depreciation – Equipment will need to have an ending balance of $9,000. This will require an additional $1,500 credit to this account.
Unadjusted trial balance
The adjustments made in journal entries are carried over to the general ledger which flows through to the financial statements. An adjusting entry is a journal entry made at the end of an accounting period that allocates income and expenditure to the appropriate years.
Accountants estimate the expense so they can record it in the period they receive the corresponding revenue. At the end of an accounting period, a company typically needs to post some adjusting journal entries to ensure their accounting records conform with generally accepted accounting principles. Adjusting entries allow accountants to match revenues and expenses to the period they were incurred. However, there are a few accounts that normally will not require adjusting journal entries.
What is an adjusting entry?
Notice that the ending balance in the asset Accounts Receivable is now $7,600—the correct amount that the company has a right to receive. The balance in Service Revenues will increase during the year as the account is credited whenever a sales invoice is prepared.
Accrued revenues
Deferrals refer to revenues and expenses that have been received or paid in advance, respectively, and have been recorded, but have not yet been earned or used. Estimates are adjusting entries that record non-cash items, such as depreciation expense, allowance for doubtful accounts, or the inventory obsolescence reserve. Accumulated Depreciation – Equipment is a contra asset account and its preliminary balance of $7,500 is the amount of depreciation actually entered into the account since the Equipment was acquired. The correct balance should be the cumulative amount of depreciation from the time that the equipment was acquired through the date of the balance sheet.