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Knowing when money changes hands, as opposed to when your business first recognised income or expenses, is important. That’s why it’s essential to understand basic accounting adjusting entries in greater depth. But what are adjusting entries? Learn everything you need to know about how adjusting entries work, as well as the accounts that require adjusting entries, including accrued expense adjusting entries and bad debt expense adjusting journal entries.
Adjusting entries explained
Adjusting entries are accounting journal entries made at the end of the accounting period after a trial balance has been prepared. After you make a basic accounting adjusting entry in your journals, they’re posted to the general ledger, just like any other accounting entry. But why do you need to use adjusting entries? Let’s find out.
What is the purpose of basic accounting adjusting entries?
Adjusting entries enable you to adjust revenues and expenses to the accounting period within which they occurred. When you record journal transactions normally, it should be done in real-time. This is because, under the accrual basis of accounting, you need to register income/expenses as soon as invoices are raised or bills are received. The adjusting entry, therefore, shows that money has been officially transferred. In most cases, it’s not possible to remain in compliance with accounting standards – such as the International Financial Reporting Standards (IFRS) – without using adjusting entries.
Accounts that require basic accounting adjusting entries
Adjusting entries can be used for any accounting transaction. The five most common are accrued revenues, accrued expenses, unearned revenues, prepaid revenues, and depreciation. Here’s a little more about these basic accounting adjusting entries:
1. Accrued revenues
Accrued revenues are services performed in one month but billed in another. You’ll need to make an adjusting entry showing the revenue in the month that the service was completed. This is referred to as an accrued revenue adjusting entry.
2. Accrued expenses
Also known as accrued liabilities, accrued expenses are expenses that your business has incurred but hasn’t yet been billed for. Wages paid to your employees at the end of the accounting period is an excellent example of an accrued expense. You’ll need to make an accrued expense adjusting entry to debit the expense account and credit the corresponding payable account.
3. Unearned revenues
Unearned revenues are payments for goods/services that are yet to be delivered. For example, if you place an order in January, but it doesn’t arrive (and you don’t make the payment) until January, the company that you ordered from would record the cost as unearned revenue. Then, in the month you make the purchase, an adjusting entry would debit unearned revenue and credit revenue.
4. Prepaid expenses
Prepaid expenses are assets that you pay for and use gradually throughout the accounting period. Office supplies are a good example, as they’re depleted throughout the month, becoming an expense. Essentially, in the month that the expense is used, an adjusting entry needs to be made to debit the expense account and credit the prepaid account.
Depreciation adjusting entries are slightly different, as you’ll need to consider accumulated depreciation (i.e., the accumulated depreciation of assets over the company’s lifetime). This is referred to as a contra-asset account. Essentially, from the point at which the asset is purchased, it depreciates by the same amount each month. For that month, a depreciation adjusting entry is made, debiting depreciation expense and crediting accumulated depreciation.
Other types of accounting adjusting entries
Besides the five basic accounting adjusting entries, it’s important to remember that you can use adjusting entries for any transaction. This includes bad debt expense adjusting journal entries, asset impairment adjusting entries, working capital adjustment journal entries, entries to adjust cash balances for reconciling items, and WIP adjustment journal entries.
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