Adjusting Entries
Key Things To Know
Key Things To Know
Transactions are typically recorded at the time cash is paid and cash is received (the cash basis) and accounts must be adjusted to the accrual basis (earned and incurred) by making “adjusting journal entries”
The purpose of adjusting journal entries is to get:
1) revenues to be what is earned in this period only
2) expenses to be what is incurred in this period only
3) assets to be what you have in future benefit at the end of the period
4) liabilities to be what you owe at the end of this period
The adjustment is for things that have not yet been recorded or for changes that have occurred since the original journal entry was made.
Adjustments must be made when the following occurs:
For Expenses:
Payment is made for a service before it is provided to the company
— This creates a prepaid expense (asset) that must be reduced and an expense recorded as the asset is used up
Payment is made for a service after it is provided to the company
— A liability and an expense must be recorded since no entry has been recorded since no cash has been paid yet.
No Adjustment is required when payment is made in the same time period that the service is provided. The expense will be recorded in the same period it is incurred.
The final balance in the expense account must be the expense incurred for this period only
For Revenues:
The company is paid for a service or goods before the service or good is provided to the customer.
— This creates unearned revenue, a liability account. When the service or goods are provided, the unearned revenue must be reduced and moved to revenue because it is now earned.
The company is paid for a service or goods after the service or goods is provided to the customer and the sales were not recorded automatically when shipped
— This creates a revenue as it is earned and a receivable since they have not yet been paid (typical for rent, interest, dividend revenues)
No adjustment is required when the goods or service is provided and the company is paid by the customer in the same time period.
The final balance in the revenue account must be the amount earned for this period only
Adjusting Journal Entries:
Are made at the end of the period after all cash transactions have been recorded and before preparing financial statements from the final numbers
Are made after examining what the company has already recorded to see if what is already recorded on the books for this period is correct
Are made to get the account balances correct, which means:
1) an asset account balance = what you really have now
2) a liability account balance = what is really owed now
3) a revenue account balance = what was earned this period only
4) an expense account balance = what was incurred this period only
Common accounts that are used for adjusting journal entries that go together:
The adjustment made to the account can be a debit or a credit depending on what the company has already recorded.
| Insurance Expense | — | Prepaid Insurance |
| Rent Expense | — | Prepaid Rent |
| Supplies Expense | — | Supplies |
| Salaries Expense | — | Salaries Payable |
| Interest Expense | — | Interest Payable |
| Tax Expense | — | Tax Payable |
| Bad Debt Expense | — | Allowance for Uncollectible Accounts |
| Depreciation Expense | — | Accumulated Depreciation |
| Interest Revenue | — | Interest Receivable |
| Sales | — | Accounts Receivable |
| Fee Revenue | — | Accounts Receivable |
| Unearned Revenue | — | Revenue |
Common reasons for adjustments:
1) Prepaid expenses are used up as time passes
2) Supplies are used up during the period
3) Unearned revenue is earned during the period
4) Plant & Equipment is used during the period – depreciation expense
5) Long term receivables earn interest revenue
6) Notes payable incurs interest expense
7) An unpaid expense is not yet recorded
8) A service was provided that has not yet been recorded.
In order to make adjusting journal entries you must have additional information related to the reasons for adjustments. The information will tell you or enable you to calculate what was earned, incurred, what you have, or what you owe for this period. Pay particular attention to the dates things happen
General rules to follow:
Do:
1) Use an expense with an asset (prepaid/inventory) or a liability (payable)
2) Use a revenue with a receivable or unearned revenue
3) calculate how much was earned or how much has been incurred during the year for revenues and expenses:
Total $ / # months = $ per month for the revenue or expense
Principle x % x (# months this period / 12) = interest expense or revenue
Total cost$ / useful life = depreciation expense per year
4) Adjust the asset amount in the account now to what you really have
5) Record liabilities you owe that have not yet been recorded
Do Not:
1) Use cash in an adjusting journal entry
2) Use an expense and revenue in the same adjusting journal entry
3) Use a revenue with a payable in the same adjusting journal entry
4) Use an expense with a receivable in the same adjusting journal entry