Adjusting entries
Encyclopedia
In accounting/accountancy
, adjusting entries are journal
entries usually made at the end of an accounting period to allocate income
and expenditure to the period in which they actually occurred. The revenue recognition principle is the basis of making adjusting entries that pertain to unearned and accrued revenues under accrual-basis accounting
. They are sometimes called Balance Day adjustments because they are made on balance day.
Based on the matching principle
of accrual accounting, revenue
s and associated cost
s are recognized in the same accounting period. However the actual cash may be received or paid at a different time.
A company receiving the cash for benefits yet to be delivered will have to record the amount in an unearned revenue liability account. Then, an adjusting entry to recognize the revenue is used as necessary.
Debit | Credit
----------------
Cash £12 |
Unearned Revenue | £12
|
The adjusting entry reporting each month after the delivery is:
Debit | Credit
----------------
Unearned Revenue £1 |
Revenue | £1
|
The unearned revenue after the first month is therefore £11 and revenue reported in the income statement is £1.
Accrued expenses have not yet been paid for, so they are recorded in a payable account. Expenses for interest, taxes, rent, and salaries are commonly accrued for reporting purposes.
of fixed assets, for example, is an expense which has to be estimated.
The entry for bad debt expense can also be classified as an estimate.
system, an adjusting entry is used to determine the cost of goods sold
expense. This entry is not necessary for a company using perpetual inventory
.
Accountancy
Accountancy is the process of communicating financial information about a business entity to users such as shareholders and managers. The communication is generally in the form of financial statements that show in money terms the economic resources under the control of management; the art lies in...
, adjusting entries are journal
General journal
The general journal is where double entry bookkeeping entries are recorded by debiting one or more accounts and crediting another one or more accounts with the same total amount...
entries usually made at the end of an accounting period to allocate income
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
and expenditure to the period in which they actually occurred. The revenue recognition principle is the basis of making adjusting entries that pertain to unearned and accrued revenues under accrual-basis accounting
Accrual
Accrual of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabilities and non-cash-based assets used in accrual-based accounting...
. They are sometimes called Balance Day adjustments because they are made on balance day.
Based on the matching principle
Matching principle
The matching principle is a culmination of accrual accounting and the revenue recognition principle. They both determine the accounting period, in which revenues and expenses are recognized. According to the principle, expenses are recognized when obligations are incurred The matching principle...
of accrual accounting, revenue
Revenue
In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is referred to as turnover....
s and associated cost
Cost
In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this...
s are recognized in the same accounting period. However the actual cash may be received or paid at a different time.
Types of adjusting entries
Most adjusting entries could be classified this way:| Prepayments (Deferral Deferral Deferred, in accrual accounting, is any account where the asset or liability is not realized until a future date , e.g. annuities, charges, taxes, income, etc. The deferred item may be carried, dependent on type of deferral, as either an asset or liability... - cash paid or received before consumption) |
Accrual Accrual Accrual of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabilities and non-cash-based assets used in accrual-based accounting... - cash paid or received after consumption |
|
| Expenses | Prepaid expenses: for expenses paid in cash and recorded as assets before they are used | Accrued expenses: for expenses incurred but not yet paid in cash or recorded |
| Revenues | Unearned revenue: for revenues received in cash and recorded as liabilities before they are earned | Accrued revenues: for revenues earned but not yet recorded or received in cash |
Prepayments
Adjusting entries for prepayments are necessary to account for cash that has been received prior to delivery of goods or completion of services. When this cash is paid, it is first recorded in a prepaid expense asset account; the account is to be expensed either with the passage of time (e.g. rent, insurance) or through use and consumption (e.g. supplies).A company receiving the cash for benefits yet to be delivered will have to record the amount in an unearned revenue liability account. Then, an adjusting entry to recognize the revenue is used as necessary.
Example
Assume a magazine publishing company charges an annual subscription fee of £12. The cash is paid up-front at the start of the subscription. The income, based on sales basis method, is recognized upon delivery. Therefore the initial reporting of the receipt of annual subscription fee is indicated as:Debit | Credit
----------------
Cash £12 |
Unearned Revenue | £12
|
The adjusting entry reporting each month after the delivery is:
Debit | Credit
----------------
Unearned Revenue £1 |
Revenue | £1
|
The unearned revenue after the first month is therefore £11 and revenue reported in the income statement is £1.
Accruals
Accrued revenues are revenues that have been recognized (that is, services have been performed or goods have been delivered), but their cash payment have not yet been recorded or received. When the revenue is recognized, it is recorded as a receivable.Accrued expenses have not yet been paid for, so they are recorded in a payable account. Expenses for interest, taxes, rent, and salaries are commonly accrued for reporting purposes.
Estimates
A third classification of adjusting entry occurs where the exact amount of an expense cannot easily be determined. The depreciationDepreciation
Depreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
of fixed assets, for example, is an expense which has to be estimated.
The entry for bad debt expense can also be classified as an estimate.
Inventory
In a periodic inventoryInventory
Inventory means a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. This remains the prime meaning in British English...
system, an adjusting entry is used to determine the cost of goods sold
Cost of goods sold
Cost of goods sold refers to the inventory costs of those goods a business has sold during a particular period. Costs are associated with particular goods using one of several formulas, including specific identification, first-in first-out , or average cost...
expense. This entry is not necessary for a company using perpetual inventory
Perpetual inventory
In business and accounting/accountancy, perpetual inventory or continuous inventory describes systems of inventory where information on inventory quantity and availability is updated on a continuous basis as a function of doing business. Generally this is accomplished by connecting the inventory...
.
See also
- Accruals & DeferralDeferralDeferred, in accrual accounting, is any account where the asset or liability is not realized until a future date , e.g. annuities, charges, taxes, income, etc. The deferred item may be carried, dependent on type of deferral, as either an asset or liability...
s - Accounting methods
- US Generally Accepted Accounting Principles
- International Financial Reporting StandardsInternational Financial Reporting StandardsInternational Financial Reporting Standards are principles-based standards, interpretations and the framework adopted by the International Accounting Standards Board ....
External links
Further reading:- Adjusting Entries Explanation with examples.