Adjusting Entries:

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, revenues and associated costs 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 - cash paid or Accrual - cash paid or received after

received before consumption) consumption
Prepaid expenses: for expenses paid in
Accrued expenses: for expenses incurred
Expenses cash and recorded as assets before they
but not yet paid in cash or recorded
are used
Unearned revenue: for revenues received
Accrued revenues: for revenues earned but
Revenues in cash and recorded as liabilities before
not yet recorded or received in cash
they are earned

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 beginning of the subscription. The revenue, 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 depreciation 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 inventory 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.