ADJUSTING ENTRIES

In this topic we will be discussing the following three Adjustments:

1. Adjusting Journal Entries

2. Adjusting Trial Balance
3. Closing Entries
 ADJUSTING JOURNAL ENTRIES
Adjusting journal entries are changes to the journal entries you've already recorded, that
involve revenue and expenses accounts. Adjustments to journal entries are made at the end of
an accounting cycle (fiscal year) to update certain revenue and expense accounts.  There are six
main types of accounts that need to be adjusted:

1. Prepaid expenses (also regarded as prepaid assets)

2. Accrued expenses
3. Depreciation expenses
4. Unearned revenues
5. Accrued revenues
6. Doubtful accounts or Bad debt expenses.

Prepaid Expenses:- This is where company buy’s an asset and use up its value over time.
Prepaid insurance, prepaid rent and prepaid supplies are some examples of prepaid expenses
(i.e. prepaid assets). As the company starts using up the prepaid asset, prepaid asset expense
starts building up.

Accrued Expenses:- These are expenses that have been built up over time (e.g. interest
expense) but the company hasn’t paid yet. Therefore, when adjusting a journal entry that
involves accrued expenses, a “payable” (liability) is created.

Depreciation Expense:- This is pretty much similar to prepaid expenses. The setup here is that
when a company buy’s an asset (e.g. a “car”), its value or worth deceases over time even if the
asset is not in the company’s use. The lost value of the asset becomes a depreciation expense
of the asset over an accounting period of the company.

Accrued Revenues:- These are revenues that have been built up but the company hasn’t been
paid yet by its customers. Therefore, when adjusting a journal entry that involves accrued
revenues, a “receivable” is created.

Unearned Revenues:- These are the revenues that the company has been paid for its good or
services in advance by the customers and the company has yet to deliver the goods or provide
service to those customers. An unearned consulting revenue is a liability because the company
owes its clients goods or service.

Bad Debt Expenses:- These are the revenues turned expenses because some customers won’t
pay the company for the goods or services provided by the company on credit; and the
company do not want to get into the hectic and costly legal procedures to collect the revenue
for their goods/services. The accounts receivables of such customers are called doubtful
accounts or bad debt accounts. The company uses its allowance for doubtful accounts to write
off or cover off these bad accounts receivables or bad debt expenses.
Note:- Prepaid expenses and Unearned revenues are also regarded as Deferred expenses and
Deferred revenues respectively.

Note:- I have used the terms “revenue” and “consulting revenue” interchangeably. Don’t get
confused as they both mean the same thing which is the income or money earned by a
company from its goods or services.

FORMAT FOR ADJUSTING JOURNAL ENTRIES:

Original journal entry Adjusted journal entry

Prepaid Expense: Debit Prepaid Asset Debit Prepaid Asset expense

Credit Cash Credit Prepaid Asset

Setup Adjustment relating to a payable

(e.g. Bank loan payable or Note payable)

Accrued Expense: Some expense built up Debit ______ expense (e.g. interest expense)
but the company is yet to Credit ______payable (e.g. interest payable)
pay.

Original journal entry Adjusted journal entry

Depreciation Expense: Debit Long-term Asset Debit Depreciation expense – LT Asset

Credit Cash Credit Accumulated Depreciation – LT
Asset

Setup Adjustment (No previous Journal Entry)

Accrued Revenue: Some revenue built up Debit ____ receivable (e.g. Note receivable-rent)
but the company is yet to Credit ____revenue (e.g. rent revenue)
get paid by the customer.

Original journal entry Adjusted journal entry

Unearned Revenue: Debit Cash Debit unearned _____ revenue

Credit Unearned _____ revenue Credit _____ revenue
 (e.g. unearned rent revenue)

Setup Adjustment relating to a

bad accounts receivable

Bad Debt Expense: Some customers would Debit Allowance for doubtful accounts
not pay for the company’s Credit Accounts Receivable – bad customer
goods/services.

ADJUSTED TRIAL BALANCE

This is the second step in making adjustments to a company’s revenues and expense
accounts. Follow the following steps to make an Adjusted Trial Balance Sheet:

STEP1:- Map adjustments made to the journal entries to the Trial Balance Table. Now we will
have two columns in the trial balance table. One “The Unadjusted Trial Balance Sheet’ and
second “The Adjustments that need to be mapped to the Trial Balance Sheet”.

STEP2:- For each concerned account we do one of the following things to it:
1. If the account’s Balance is in credit (Cr) on both the unadjusted side and the
adjustment side of the trial balance table, then we add the credit balances on both
sides and map the total as a credit balance (Cr) to the Adjusted side of the trial
balance table which will be the 3rd column of the table that comprises the Adjusted
Trial Balance Sheet.

2. If the account’s Balance is in debit (Dr) on both the unadjusted side and the
adjustment side of the trial balance table, then we add the debit balances on both
sides and map the total as a debit balance (Dr) to the adjusted side of the trial
balance table.

3. If the account’s Balance is in credit (Cr) on the unadjusted side and in debit (Dr) on
the adjustment side of the trial balance table, then we subtract the smaller balance
from the larger balance and map the resulting balance as either credit balance (Cr)
or debit balance (Dr) to the adjusted side of the trial balance table depending on
whichever balance from the subtracting quantities was larger.
So if Cr Balance>Dr Balance then map [Cr Balance – Dr Balance] as a credit balance
(Cr) to the adjusted side of the trial balance table. Else if Dr Balance>Cr Balance then
map [Dr Balance – Cr Balance] as a debit balance (Dr) to the adjusted side of the trial
balance table.
 Note:- The same will apply if the account’s Balance is in debit (Dr) on the unadjusted
side and in credit (Cr) on the adjustment side of the trial balance table.
4. For solo debit or credit entries on the adjustment side where there is no account’s
balance on the unadjusted side of the trial balance table. Simply map the
adjustment entry to its respective credit or debit balance on the adjusted side of the
trial balance table. So if the adjustment entry is a credit (Cr) balance, map it as a
credit (Cr) balance on the adjusted side of the trial balance table. In the contrary, if
the adjustment entry is a debit (Dr) balance, then map it as a debit (Dr) balance on
the adjusted side of the trial balance table.

STEP3:- Put dollar ($) signs in all columns.

VERIFY YOUR TRIAL BALANCE TABLE

Make sure that the sum of all credit balances equals the sum of all debit balances on the
adjustment side and as well as the adjusted side of the Trial Balance Table. This will ensure
that all of your adjustment entries are correct and your adjusted trial balance is correct
respectively.

CLOSING ENTRIES
This is the final part in making adjustments to a company’s revenues and expense accounts
with an addition of dividends account. When a business firm ends its operating year and starts
its new operating year, some entries need to reset to zero. The company needs to reset their
revenues, expenses and dividend accounts to zero, i.e. Revenues + Expenses + Dividends = 0.

This is how we do this:

1. Use the Adjusted Trial Balance.

2. If a revenue is credited (Cr) – debit (Dr) it.
If an expense is debited (Dr) – credit (Cr) it.
If dividend account is debited (Cr) – credit (Cr) it.
3. Now in the closing entries sheet, total the debit (Dr) and credit (Cr) columns of balances
and subtract the smaller balance sum from the larger balance sum. Now put the
resulting difference as retained earnings in the smaller balance column in order to
balance the debit (Dr) and credit (Cr) balances on the closing entries sheet (i.e. Total
Debit Balance = Total Credit Balance).
4. Now we debit (Dr) the dividends account; and as we debit the dividends account, we
credit (Cr) the retained earnings to balance out credits and debits on the closing entry
sheet.
This is how we close entries.
 5. Also make sure that you do not add dollar ($) signs.

Let’s dive into the Practice Questions to see how all of this works out

PRACTISE QUESTIONS