Adjusting Entries: Definition, Types and Examples

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Yarab A | Jan-13-2020

Definition of Adjusting Entries

Adjusting entries refers to a set of journal entries recorded at the end of the accounting period to have an updated and accurate balances of all the accounts. Adjusting entries are mere application of the accrual basis of accounting.

Sounds bookish? Let’s make it easier for you.

It’s so common in business that you pay or receive or buy something who’s benefit is either yet to be consumed in full or something is paid today for tomorrows use.

For example, if you are paying an insurance premium of 65,000 Rs on 1st October and insurance covers for a period of 12 months from 1st October,2018 to 30th September,2019.

definition of adjusting entries

Now, if you closely look at the above example, an expense of 65,000 towards insurance premium is incurred in the accounting period 1st April,2018 to 31st March,2019 but the entire expense is not attributable to the financial year 2018-2019.

The reason is the premium covers till 30th September,2019 and only the portion of expenses till 31st March 2019 is attributable to F.Y 18-19. The remaining portion is treated as ‘Pre-paid’ expenses’ as on 31st March,2019.

For you to bring this impact in the books of accounts, you need to record an adjusting entry at the end of the accounting period so that expenses are rightly reflected in the financial statements.

Like the above examples, there are many situations in which expenses may have been incurred but not yet recorded in the journals. And also some of the income may also have been earned but not entered in the books.

Thus, adjusting entries help you keep your accounts updated before they are summarized into the financial statements. Adjusting entries are made for accrual of income, accrual of expenses, deferrals (income method or liability method), prepayments (asset method or expense method), depreciation, and allowances.

Importance of Adjusting Entries

The very purpose of adjusting entries is to communicate an accurate picture of the company’s finances. The management can have a complete look into the financial statements knowing that everything that occurred during the month is reported even if the financial part of the transaction would have warranted to have occurred at a later stage. A statement of finance prepared without considering adjusting entries would misrepresent the financial health of the company.

Types of Adjusting Entries

The following entries are the most common types of adjusting entries recorded in books of accounts.

  • Accrued Revenues

If you perform a service for a customer in one month but don't bill the customer until the next month, you would make an adjusting entry showing the revenue in the month you performed the service and would also debit accounts receivable and credit service revenue.

  • Accrued Expenses

One fine example of accrued expenses is wages paid to employees. When a business entity owes wages to employees at the end of an accounting period, they make an adjusting journal entry by debiting wages expense and crediting wages payable.

  • Unearned Revenues

Unearned revenues refer to payments received for goods to be delivered in the future or services to be performed. In this case, the company would make an adjusting entry debiting unearned revenue and crediting revenue account.

  • Prepaid Expenses

These are the assets that are paid for and which gradually get used up during the accounting period. It’s similar to the example of pre-paid insurance premium we discussed above.

  • Deprecation

Depreciation is the process of allocating the cost of an asset, such as a building or a piece of equipment, over the serviceable or economic life of the asset. Due to various reasons, the asset value depreciates by some amount and adjusting entry is made to account the depreciation expenses.

Examples of Adjusting Entries

As learnt, that to arrive at a correct figure of profits and loss as well as true figures in the balance sheet, certain accounts require some adjustments. Entries for making such adjustments are called as adjusting entries. Following are some of the examples of adjusting entries.

Example 1: Depreciation on Machinery Rs. 1,00,000 /- @ 10% per annum. The adjustment entry as on March. 31, 2019 will be as follows:

Date

Particulars

L.F

Debit ( Rs. )

Credit ( Rs. )

31.12.2013

Depreciation A/c.          DR.
Machinery A/c
[ Depreciation charged on machinery ]

 

               10,000

 

 

 

10,000

Example 2: Max Ltd, which owed 65,000 /- KES to the company has been adjudged insolvent since they are unable to pay. The adjusting entry to provide the effect to the above transaction is :

Date

Particulars

L.F

Debit ( KES )

Credit ( KES )

31.03.2018

Bad debts.  A/c.           DR.
To ABC Ltd A/c
[ Loss on account of bad debts provided in the books of accounts ]

 

               65,000

 

 

 

65,000

Example 3: Puspak Publications received subscriptions amounting to. 40,000 TAK during the financial year ending 30th June 2019. Out of this, 7,500 TAK represent subscriptions relating to the next financial year.

The adjusting entry to provide the effect to the above transaction is :

Date

Particulars

L.F

Debit ( TAK )

Credit ( TAK )

31.12.2018

 Subscription A/c      DR.
To Subscription received in advance
[ Subscriptions received in advance ]

 

               7,500

 

 

 

 

7,500

Example 4: The Accounts Receivable of RST Ltd. was 1,50,000 /- Dirhams as on 31st December 2018. It was estimated that 8,000 /- of the amount due may turn out to be uncollectable during the forthcoming year.

For the creation of the provision, the following adjusting journal will be recorded:

Date

Particulars

L.F

Debit ( AED )

Credit ( AED)

31.03.2018

 Profit and loss A/c    DR.
To provision for bad & doubtful debts
[ Provided for bad and doubtful debts based on the estimate from management]

 

               8,000

 

 

 

 

8,000

 

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