Provide three example journal entries with a description of the adjustment.

An adjusting entry is a type of accounting entry that is crucial to closing the accounting period. According to the accrual method of accounting, a company must adjust its initial trial balance as the accrual period closes. An adjusting entry records a change in an account and adjusts the ledger to accurately reflect the company’s finances after a given accounting period.

Classification of Adjusting Entries

Below are the main types of adjusting journal entry used in accounting:

1. Prepaid expenses – money paid in advance for assets yet to be in the accounting period;
2. Unearned revenue/deferred revenue – income received in advance that is not yet earned.

1. Accrued expenses – expenses were incurred, but with no record of payment;
2. Accrued revenues – income earned but not yet recorded, nor money received for assets;
3. Periodic inventory – adjusts for inventory acquired and remaining.

• Non-cash expenses (estimates)

1. Estimated expenses – value of an expense cannot be determined
2. Fixed assets depreciation – allocation of the cost of a depreciable asset, as assets lose value over the course of their useful life

Adjusting entries concern only the above account changes, and not every entry recorded is an adjusting entry. For instance, if a company accrues an expense on the last day of the accounting period, the entry for this expense would not be an adjusting entry.

Adjusting Journal Entries Examples

Below are some examples for each type of adjusting journal entry used in accounting.

A company’s insurance is $1800 for a year (paid on Jan, 1st). The company has yet to use this prepaid expense in the current accounting period, as an adjusting entry in the account denotes.

The monthly insurance cost is 1800/12 months= $150 per month.

1. Unearned revenue or deferred revenue

In this example, a company has received payment for services it has not yet provided during the accounting period. The initial accounting entry below needs to be adjusted by the second entry, which records a debit of $3000 in unearned revenue as a liability account.

Fees incurred:

Unearned revenue:

A/CDrCrSales3000Unearned revenue3000

In this example, a company has yet to pay its $250 electricity bill for January, which is due on February 15th.

The entry accounting for this expense, below, will be recorded on January 31st:

Jan. 31

A/CDrCrUtility expense250Accrued expense250

This accounting entry adjusts the ledger for the accrual of expenses that have yet to be paid during the given period.

A company delivered $3500 worth of services on the last day of July, accruing revenue without receiving payment during the accounting period. An accounting entry adjusts for this accrued revenue:

A/CDrCrReceivable3500Accrued revenue3500

A company estimates depreciation of its equipment to be $350 per month.  Accounting for this loss, the adjusting entry for the accounting period (say, September) would be:

Sept. 30

A/CDrCrDepreciation expense350Accumulated depreciation350

A company starts the year with $5000 of inventory, goes on to purchase $2500 of additional stock during a three-month period. The accounting entry below shows that there is $4000 remaining in ending inventory, which becomes the beginning amount for the next quarter.

A/CDrCrInventory (Beginning) 5000Purchases2500Inventory decrease3500Inventory (Ending)4000

These entry examples show the uses of adjusting entries in accounting. Adjusting journal entries record changes in asset or liability accounts, such as revenue or expenses, to adjust the ledger at the end of the accrual period. Adjusting journal entries are vital pieces of the summarized general ledger information required to release the company’s financial statements under Generally Accepted Accounting Principles (GAAP) at the end of the accounting period.  Thus, adjusting journal entries are crucial records in the accounting process and allow companies to more accurately evaluate their position at the end of the period.

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Adjusting entries, also called adjusting journal entries, are journal entries made at the end of a period to correct accounts before the financial statements are prepared. This is the fourth step in the accounting cycle. Adjusting entries are most commonly used in accordance with the matching principle to match revenue and expenses in the period in which they occur.

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Types of Adjusting Entries

There are three different types of adjusting journal entries as follows:

1. Prepayments
2. Accruals
3. Non-cash expenses

Each one of these entries adjusts income or expenses to match the current period usage. This concept is based on the time period principle which states that accounting records and activities can be divided into separate time periods.

In other words, we are dividing income and expenses into the amounts that were used in the current period and deferring the amounts that are going to be used in future periods.

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Why are Adjusting Entries Necessary?

What Does an Adjusting Journal Entry Record?

Here are the main financial transactions that adjusting journal entries are used to record at the end of a period.

Prepaid expenses or unearned revenues – Prepaid expenses are goods or services that have been paid for by a company but have not been consumed yet. Insurance is a good example of a prepaid expense. Insurance is usually prepaid at least six months. This means the company pays for the insurance but doesn’t actually get the full benefit of the insurance contract until the end of the six-month period. This transaction is recorded as a prepayment until the expenses are incurred. The same is true at the end of an accounting period. Only expenses that are incurred are recorded, the rest are booked as prepaid expenses.

Unearned revenues are also recorded because these consist of income received from customers, but no goods or services have been provided to them. In this sense, the company owes the customers a good or service and must record the liability in the current period until the goods or services are provided.

Accrued expenses and accrued revenues – Many times companies will incur expenses but won’t have to pay for them until the next month. Utility bills are a good example. December’s electric bill is always due in January. Since the expense was incurred in December, it must be recorded in December regardless of whether it was paid or not. In this sense, the expense is accrued or shown as a liability in December until it is paid.

Non-cash expenses – Adjusting journal entries are also used to record paper expenses like depreciation, amortization, and depletion. These expenses are often recorded at the end of period because they are usually calculated on a period basis. For example, depreciation is usually calculated on an annual basis. Thus, it is recorded at the end of the year. This also relates to the matching principle where the assets are used during the year and written off after they are used.

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How to Record Adjusting  Entries

Recording AJEs is quite simple. Here are the three main steps to record an adjusting journal entry:

1. Determine current account balance
2. Determine what current balance should be
3. Record adjusting entry

These adjustments are then made in journals and carried over to the account ledgers and accounting worksheet in the next accounting cycle step.

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Example

Following our year-end example of Paul’s Guitar Shop, Inc., we can see that his unadjusted trial balance needs to be adjusted for the following events.

— Paul pays his $1,000 January rent in December.

— Paul’s December electric bill was $200 and is due January 15th.

— Paul’s leasehold improvement depreciation is $2,000 for the year.

— On December 31, a customer prepays Paul for guitar lessons for the next 6 months.

— Paul’s employee works half a pay period, so Paul accrues $500 of wages.

Now that all of Paul’s AJEs are made in his accounting system, he can record them on the accounting worksheet and prepare an adjusted trial balance.

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