Adjusting Entry

Noun phrase. (Accounting.) Adjusting Entries are general journal entries made on the

last day of an accounting period. The purpose of adjusting entries is to ensure
that revenues are recognized in the period during which they were earned
and expenses are recorded in the period during which they were incurred. Adjusting
entries are required in the accrual basis accounting method, in order to comply with
the revenue recognition principle and the matching principle.

Adjusting entries, in other words, are a tool to record any additional revenues and
expenses for a period and to update the balances of the related asset and liability
accounts. Once adjusting entries are prepared, they are then posted from the general
journal to the general ledger, and the general ledger balances are adjusted (updated)
accordingly. The adjusted account balances then appear in the adjusted trial balance,
which is used in the preparation of the financial statements.

Adjusting entries are grouped into prepaid (deferrals) and accruals, which in turn are
divided into the following categories:

1. Prepaid expenses
2. Depreciation of plant assets
3. Accrued expenses
4. Accrued revenues
5. Unearned revenue

Following are examples of adjusting entries with explanations.

1. Prepaid Expenses, such as Prepaid Insurance:

 Prepaid Insurance:

When insurance coverage is purchased earlier in the year, Prepaid Insurance, an

asset account, is debited (increased), and Cash is credited (decreased). In
accrual based accounting, an adjusting entry is required at the end of the
accounting period. The purpose of the adjusting entry is to reduce the prepaid
(asset) account balance and to increase the expense account balance by the
amount used during the period and up to the end of the year.

Example: At year-end (Dec. 31), the Prepaid Insurance account had a balance of
$2,400, representing one year's (12 months') premiums paid in advance on April
1.

The adjusting entry on Dec. 31 allocates the amount of expired insurance,

$1,800, from Prepaid Insurance to Insurance Expense.

Insurance used (expired) between April 1 and December 31 represents 9 months

of a total insurance policy life of 1 year or 12 months.

Amount of expired insurance = $2,400 × 9

 12

The adjusting entry debits (increases) Insurance Expense, and credits

(decreases) Prepaid Insurance:

  Debit Credit
Insurance Expense $1,800
Prepaid Insurance $1,800

When the adjusting entry is posted to the general ledger, the balance of Prepaid
Insurance will decrease from $2,400 to $600. The balance of Insurance Expense
will increase by $1,800.

 Supplies:

Supplies (an asset) are considered a prepayment because an organization

purchases supplies on a certain date with the intention of using them in the
future. When, during the year, supplies are purchased for cash, the Supplies
account is increased (debited), and the Cash account is decreased (credited). By
the end of the year, some of the supplies will have been used, and an adjusting
entry is required. The adjusting entry reduces the balance of Supplies and
increases the balance of Supplies Expense by the amount used.

Example: At year-end (Dec. 31), the Supplies account had a balance of $3,550,
representing the cost of supplies purchased during the year. At year-end, a
physical count of supplies revealed that $820 remained on hand.

The adjusting entry on Dec. 31 reduces the asset account Supplies and allocates
the amount spent ($3,550 - $820 = $2,730) to Supplies Expense.

  Debit Credit
Supplies Expense $2,730
Supplies $2,730
2. Depreciation of Plant Assets:

Plant assets such as equipment and buildings are purchased with the intention of using
them for several years in operating the business. In a sense, this is similar to buying
insurance or supplies in advance. Depreciation allocates the acquisition cost of the asset
(equipment) to the various periods of the asset's life.

Example: At year-end (Dec. 31), the Equipment account had a balance of $12,000,
representing the cost of equipment purchased January 4. The equipment is expected to
have a useful life of 4 years and no salvage value. The company uses the straight-line
depreciation method; therefore, the depreciation for the first year is $3,000.
The adjusting entry on Dec. 31 allocates the amount used ($3,000) to Depreciation
Expense:

  Debit Credit
Depreciation Expense, Equipment $3,000
Accumulated Depreciation, Equipment $3,000
3. Accrued Expenses:

Accrued expenses are amounts due but not recorded or paid at year-end. Examples
include utility bills and other expenses for which the bills have not been received at
year-end. The purpose of the adjusting entry is to record the expenses in the period
during which they were incurred.

Example: On December 31, the utility bill for December had not been received. The
average monthly bill is $430. The actual bill will be received and paid in January.

The adjusting entry required on Dec. 31 recognizes the amount of expense incurred
during the period (approximately $430) and records it as an increase to an expense
account, Utilities Expense, and to a liability account, Utilities Payable:

  Debit Credit
Utilities Expense $430
Utilities Payable $430
4. Accrued Revenues:

Accrued revenues are amounts due from customers for services performed that have
not been recorded or received at year-end. An adjusting entry is required to record the
revenue earned during the period in which it was earned.

Example: On December 31, certain customers have not been billed for the services
rendered by year-end. The total value of these services is $14,600. The customers will
be billed in January.

The adjusting entry on Dec. 31 recognizes the amount of revenue earned during the
period ($14,600) and records it as an increase to a revenue account, Service Revenue,
and to an asset account, Accounts Receivable:

  Debit Credit
Accounts Receivable $14,600
Service Revenue $14,600
5. Unearned Revenue:

Unearned revenue represents cash received from customers in advance (prepaid to us).
Examples include tuition fees for schools, magazine subscriptions for publishers, and
insurance premiums for insurance companies.
When cash is received in advance, it is recorded as a debit (increase) to Cash and a
credit (increase) to Unearned Revenue, a liability account. At year-end, an adjusting
entry is required to record the amount earned. The liability account Unearned Revenue
is debited (reduced) by the amount earned. A revenue account, Revenue Earned, is
increased (credited) by the amount earned.

Example: The Unearned Revenue account has a balance of $194,000, representing cash
received as deposits on future projects. An analysis of these projects indicates that
$160,000 of services has been delivered by year-end.

The adjusting entry on December 31 allocates the amount earned ($160,000) to

Service Revenue:

  Debit Credit
Deferred Revenue $160,000
Service Revenue $160,000