Adjusting Entries and Adjusted Trial Balance

Lesson 5

Lesson Overview

Topics covered:
I. Adjusting Journal Entry
II. Types of Adjusting Journal Entries
III. The adjusted Trial Balance
Learning Objectives:

At the end of this lesson, you are expected to:

1. Define and know the importance of adjusting journal entries
2. Identify the types of adjusting journal entries
3. Able prepare the adjusted trial balance.

Assessment:
∙ No activity for this lesson

What is an Adjusting Journal Entry?

An adjusting journal entry is usually made at the end of an accounting period to recognize an
income or expense in the period that it is incurred. It is a result of accrual accounting and follows the
matching and revenue recognition principles. Generally, adjusting journal entries are made for accruals
and deferrals, as well as estimates. Sometimes, they are also used to correct accounting mistakes or adjust
the estimates that were made previously.

1. An adjusting journal entry is usually made at the end of an accounting period to recognize an
income or expense in the period that it is incurred.
2. Adjusting journal entries are a feature of accrual accounting as a result of revenue recognition
and matching principles.
3. The three most common types of adjusting journal entries are accruals, deferrals, and

estimates. Adjusting Journal Entries and Accrual Accounting

In accrual accounting,
revenues
and the corresponding costs should
be
reported in the same accounting
period
according to the matching principle.
The
revenue recognition principle also
determines that revenues and
expenses
must be recorded in the period when
they
are actually incurred.

However, in practice,
revenues
might be earned in one period, and
the
corresponding costs are expensed in
another period. Also, cash might not
be
paid or earned in the same period as the
expenses or incomes are incurred. To deal
with the mismatches between cash and
transactions, deferred or accrued accounts
are created to record the cash payments or
actual transactions.

Table 5..1 Guide accounts for Adjusting Entries

At a later time, adjusting entries

are made to record the associated revenue and expense recognition, or cash payment. A set of accrual or
deferral journal entries with the corresponding adjusting entry provides a complete picture of the
transaction and its cash settlement.

Similar to accrual or deferral entry, an adjusting journal entry also consists of an income statement
account, which can be revenue or expense, and a balance sheet account, which can be an asset or liability.
There are also many non-cash items in accrual accounting for which the value cannot be precisely
determined by the cash earned or paid, and estimates need to be made. The entries for the estimates are
also adjusting entries, i.e., impairment of non-current assets, depreciation expenses, and allowance
fordoubtful accounts.

Types of Adjusting Journal Entries

1. Accruals

An accrued revenue is the revenue that has been earned (goods or services have been delivered),
while the cash has neither been received nor recorded. A typical example is credit sales. The revenue is
recognized through an accrued revenue account and a receivable account. When the cash is received at a
later time, an adjusting journal entry is made to record the payment for the receivable account.

Figure 5.1 Sample Adjusting Entries

An accrued expense is the expense that has been incurred (goods or services have been
consumed) before the cash payment has been made. Examplesinclude utility bills, salaries, and taxes,
which are usually charged in a later period after they have been incurred.

When the cash is paid, an adjusting entry is made to remove the account payable that was
recorded together with the accrued expense previously.

Figure 5.1 Sample Adjusting Entries

 2. Deferrals

In contrast to accruals, deferrals are also known as prepayments for which cash payments are
made prior to the actual consumption or sale of goods and services.

For deferred revenue, the cash received is usually reported with an unearned revenue account,
which is a liability, to record the goods or services owed to customers. When the goods or services are
actually delivered at a later time, the revenue is recognized, and the liability account can be removed.

Figure 5.2 Sample Adjusting Entries

When expenses are prepaid, a debit asset account is created together with the cash payment. The
adjusting entry is made when the goods or services are actually consumed, which recognizes the expense
and the consumption of the asset.

Prepaid insurance premiums and rents are two common examples of deferred expenses. If the
rents are paid in advance for a whole year but recognized on a monthly basis, adjusting entries will be
made every month to recognize the portion of prepayment assets consumed in that month.

Figure 5.4 Sample Adjusting Entries

3. Estimates

When the exact value of an item cannot be easily identified, accountants must make estimates,
which are also reported as adjusting journal entries. Taking into account the estimates for non-cash items,
a company can better track its revenues and expenses, and the financial statements can reflect the financial
picture of the company more accurately.

For example, depreciation expenses for PP&E are estimated based on depreciation schedules
with assumptions on useful life and residual value. A depreciation expense is usually recognized at the
end of a month.

igure 5. 5 Sample Adjusting Entries

Allowance for doubtful accounts is also an account of an
estimate. It identifies the part of receivables that the company does not expect to be able to collect. It is a
contra asset account that reduces the value of the receivables. When it is definite that a certain amount
cannot be collected, the previously recorded allowance for the doubtful account is removed, and a bad
debt expense is recognized.
 Figure 5.

6 Sample Adjusting Entry

What is an Adjusted Trial Balance?

An adjusted trial balance is a listing of the ending balances in all accounts after adjusting entries
have been prepared. The intent of adding these entries is to correct errors in the initial version of the trial
balance and to bring the entity's financial statements into compliance with an accounting framework, such
as Generally Accepted Accounting Principles or International Financial Reporting Standards.

Once all adjustments have been made, the adjusted trial balance is essentially a summary-balance
listing of all the accounts in the general ledger - it does not show any detail transactions that comprise the
ending balances in any accounts. The adjusting entries are shown in a separate column, but in aggregate
for each account; thus, it may be difficult to discern which specific journal entries impact each account.

Uses for the Adjusted Trial Balance

The adjusted trial

balance is not part
of the
financial statements -
rather, it is an internal
report that
has two purposes:

To verify that the

total of the debit
balances in
all accounts equals the
total of all credit balances
in all
accounts; and

To be used to construct financial statements

(specifically, the income statement and balance sheet;
construction of the statement of cash flows requires
additional information).
The second application of the adjusted trial balance has
fallen into disuse, since computerized accounting
systems automatically construct financial statements.
However, it is the source document if you are manually
compiling financial statements. In the latter case, the adjusted trial Example of an Adjusted Trial Balance
balance is critically important - financial statements cannot be Figure 5. 7 Sample Adjusted Trial Balance
constructed without it.
The following report shows an adjusted trial balance, where the
initial, unadjusted balance for all accounts is located in the second column
from the left, various adjusting entries are noted in the third column from
the left, and the combined, net balance in each account is stated in the far
right column.

Simply, after getting the accounts that needs to be adjusted just

minus or add it to the unadjusted trial balance to get adjusted trial
balance. Adjusted trial balance will be the basis of your financial
statements such as Statement of Financial Position.

ABC International
Trial Balance
July 31, 20XX

Table 5.2 How adjusting entries works