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Chapter 2 Module 3: Adjusting Journal Entries

Overview of Adjusting Journal Entries:
When preparing financial statements in accordance with United States Generally Accepted
Accounting Principles (GAAP), adjusting journal entries (“AJE’s”) may need to be recorded at
the end of period to properly state a company’s financial statements. Adjusting entries are
used to “adjust” the company’s trial balance so that the trial balance accounts are accurate
and can be used to prepare the financial statements.

The visual below is our “mental map” for determining how we should go about determining
what adjusting journal entries a company should record.

The main reason an adjusting journal entry would be required is to properly match revenues
with expenses under the matching principle. However, there could be other reasons like
adjusting the general ledger to reconcile with the subledger.

Timing and procedures:

As part of the monthly or annual close process for a company, the accounting team would go
through all types of accounts (accruals, deferrals, estimates, etc.) and determine if the
balance needs to be adjusted. Every single trial balance account should be checked to
determine if the balance is properly stated in the general ledger. It is important that the
general ledger balances are accurate, as the general ledger is utilized to create the trial
balance and eventual financial statements. These adjusting entries that are recorded at the
end of a period may reverse in subsequent periods when the cash inflow/outflow occurs.

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Preparing the Adjusted Trial Balance:

We learned what an adjusting journal entry (“AJE”) is, but how does it fit into the preparing
the final adjusted trial balance that will be utilized to create the company’s financial
statements. We will always start with the unadjusted trial balance, record any adjusting
journal entries, and that will give us our adjusted trial balance. The process is the same as
taking a broken car, adjusting it, and getting to a final working car!

As you can see below, there are no adjusting entries recorded yet, but that is what we are
going to do in the rest of the module. At the end, we will have all the necessary adjusting
journal entries, and that will help finalize the adjusted trial balance that will utilized to create
the financial statements.

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Prepare adjusting entries:

The list goes on for the types of adjusting entries that companies would record, or you could
see on the CPA exam. It is extremely important to focus on the big picture and not try and
memorize the examples below. You will need to use your own intuition to evaluate a
business event and determine what the proper adjusting journal entry would be.

Accounts receivable (gross):

A company often must adjust their gross accounts receivable balance at period-end to
record revenue and the associated receivable for goods that were shipped to a customer on
the last day of the year. Then, when the customer remits payment in the subsequent year,
the receivable is removed as cash has been collected from the customer.

Allowance for bad debt:

A company maintains an allowance for bad debt reserve for any gross accounts receivable
amounts that the company will not collect. You will learn about the different methods to
calculating the allowance for bad debt reserve in later modules. A company will often
calculate the required allowance for bad debt reserve at the of the period and an
adjustment will be made to the current balance.

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Inventory:
A company will often need to adjust their inventory balance at period-end due to the physical
inventory count, in-transit inventory, reserve balances, etc. You will learn more about
inventory in more detail in later modules.

In the example below, a company would perform a physical inventory count on the last day
of the year to know the actual inventory in the warehouse. The inventory balance on the
balance sheet would be adjusted to reflect the amount of inventory that was counted in the
company’s warehouse. Since inventory increased, we would debit inventory and credit cost
of goods sold (reduces the expense for the period).

Prepaid expenses:
If a company makes prepayments throughout the year, they may need to record an adjusting
entry to defer a portion of the expense that relates to future periods for when the expense
should be recognized. You will learn about prepaid expenses in more detail in later modules.

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Accounts payable:
A company will often need to record adjusting entries to record invoices that were received
after period-end for services that relates to the current year financial statements. As we
know, the expense should be recorded in the same period that services by the vendor or
supplier were performed.

Accrued payroll:
Unless a company pays its employees on the last day of the year, the company will typically
need to record an adjusting entry for accrued payroll. The adjusting entry would capture
payroll expense incurred for any employees who worked but have not yet received their
paycheck. This often occurs when the period-end date falls on a weekend and employees do
not receive their paychecks.

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Income taxes:
A company will record an income tax provision throughout the year, but at the end of the
year, the company will typically hire a CPA or Tax firm to calculate the annual income tax
provision. Depending on the final income tax provision, the company may need to record an
adjustment to “true-up” the income tax provision in their financial records.

Record AJE’s to Adjusted Trial Balance:

Now that we have prepared the necessary adjusting entries, we record the entries and you
can see the debits and credits, which are summed with the unadjusted trial balance to
create the final adjusted trial balance that is used to prepare the financial statements.

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AJE Workbook:
If you would like to use the Excel workbook that was used to create the adjusted trial
balance in this lecture, please navigate to the link below and you will be able to download
the Excel file:
https://www.universalcpareview.com/ask-joey/aje-workbook-for-lecture/

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