Adjusting Entries in Journal

Tally Solutions | Updated on: January 13, 2023

• What is an adjusting entry?
• Why make adjusting entries?
• 5 Types of adjusting journal entries with examples

Accounting at its simplest is the recording of the company’s or individual's financial transactions. But when it is time to generate the financial reports for a time period, things may become more complicated. Since business processes keep flowing and do not stop at the juncture of accounting period endings and beginnings, transactions that may span two or more accounting periods need special handling. The accrual accounting principle specifies that all the revenues and related expenses must be accounted for within the same time period. However, in the real world, the income and expenses that are related may not happen within the same period. So, to compensate for this, adjusting entries are made. They balance the incomes and expenses that are related to each other. Read on to learn more about these special entries.

What is an adjusting entry?

When a company records its transactions, they are recorded with all the relevant details on the date of the transaction. However, at the close of that accounting period, the corresponding entries also have to be made. An adjusting entry is made within the accounting period to correspond with the first entry and ensure that there is a proper accounting record within the accounting period.

For example, if your company has provided a service to a client in March. You bill the customer and send them an invoice. The customer’s amount due is recorded in the Accounts Receivable. They release the payment in April and it is recorded as cash received in the bank. Suppose the customer negotiated a discount, you go back and alter the original accounts receivable by adding an adjusting entry for the discounted amount. So, by posting that entry in the same accounting period, you follow the matching principle of recording the relevant income and expenses within the same accounting period.

Accountants also use adjusting entries when they prepare the trial balance and the financial statements of the company. These entries record the unrecognized income or expenses for the accounting period. This is caused by a transaction in one accounting period and ending in a later accounting period. The adjusting journal entry properly accounts for the transaction in the first accounting period. If there has been some mistake in the accounting, an adjusting entry is also made to rectify it.

In short, adjusting entries are the entries that are made to keep the books of accounts in line with the principles of accrual accounting. They are usually made at the end of the accounting period to stay in compliance with the matching and revenue recognition principles. They are also useful when the company moves between one accounting period and the next and there are matching entries that are transacted after the change of accounting period. Adjusting journal entry is not used in companies that follow the cash accounting system.

Why make adjusting entries?

Adjusting entries are used to ensure that the company is compliant with the matching principles of accrual accounting. If adjusting entries are not used in this system of accounting, there will be a mismatch between income and expenses. To prevent this, adjusting entries are made to ensure the right match. Adjusting journal entries are also used to record depreciation which is an essential component of a company’s financial statements and tax computation.

We can also take an example of a product that is delivered over a period of six months and invoiced at the end of the six months. However, in accrual accounting, an entry will be made every month for 1/6th of the total invoice amount. This is so that the revenue is recognized in the same time period when the service is provided regardless of the invoice date. So, in other words, the revenue is recognized exactly when the service is provided and not when the invoice is generated. This provides a more accurate financial picture of the revenues of the company as it is.

Adjusting journal entries most often involves an income statement account or a balance sheet account. The income statement accounts are affected when the entry is for an income or an expense and the balance sheet is affected in terms of assets and liabilities. The most commonly affected balance sheet accounts are accumulated depreciation, accrued expenses, accrued income, prepaid expenses, allowance for doubtful accounts, deferred revenue, and unearned revenue. The most commonly adjusted income statement accounts are revenue, insurance expense, depreciation expense, and interest expense. When these adjustments are made in the journal they affect the general ledger and then flow to the financial statements.

5 Types of adjusting journal entries with examples

1. Accrued revenues

Revenue that is generated in an accounting period and recognized in another needs a corresponding accrued revenue adjusting entry. Let us take an example of clothing that is supplied to a client in March and then invoiced in April. The expense portion is the cloth and other supplies as well as labor that was used to make the clothing. The cost of the rent and utilities that were a part of the manufacturing process are also related expenses. So, if the expenses were made in March, you can only know how much your profit or loss for the time period is when you record the corresponding revenue in the same time period and compute the difference. So, an adjusting entry is made by moving the entry for the amount invoiced from the accrued receivables to the revenue account. When the money is actually received the entry moves from revenue to cash.

Adjusting journal entry example: The entries will be as follows. You create an invoice for the manufactured clothing in March and record the anticipated income of IDR2000.

The entries made when the invoice is paid are as follows:

2. Accrued expenses

Accrued expenses are expenses that have been generated in a time period and paid for later. One example is the rent for premises that is only paid at the end of the month but is generated on every day of the month without being paid until the end of the month.

Accrued expenses adjusting entries example: A temporary tailor that you hired to help produce the clothing order. You hire this person at a rate of IDR500 for a week. If they send you an invoice in the next month, you will have to make an adjusting entry for the same in the accounting period when the person worked. The entries will be as follows:

3. Deferred revenues

Sometimes, clients pay in advance for a product or service that they have purchased. The payment may be recorded before the product or service has been supplied to them. So, the revenue recorded is one that has not been earned yet. So, despite the advance payment, the payment must be recorded in the time period when the actual goods or services were provided to the client.

Deferred revenues adjusting entries example: So, a client who likes your clothing supply places an order for more and pays in advance for the order. You received the money in April but made the actual supply in May. You record it as deferred revenue in April.

Then in the month of May you will make adjusting entries as follows:

4. Prepaid expenses

Sometimes we pay upfront for something. One example would be prepaying for a year’s worth of broadband services. But, the actual use of the broadband is throughout the year. So, when you pay for the year, the entries are:

Through the year, you will add 1/12th of the total amount to the expenses for the broadband connection usage.

5. Depreciation expenses

Depreciation is the record of the value that an asset loses over time. Depreciation is a single amount that is divided across multiple accounting periods. Depreciation is a significant accounting calculation for large asset purchases such as a vehicle or a house. The depreciation amount for an asset changes in the balance sheet of every subsequent accounting period. It also gets recorded as an expense on the income statement of the company. Even if the calculation method of depreciation is different, the depreciation adjusting journal entry is an accounting adjustment entry that adjusts the value of an asset to reflect its loss of value through usage and/or time.

Being a comprehensive business management software, TallyPrime enables businesses to record invoices, quotations, orders, accept payments and receive bills in foreign currency. The daily gains or losses that happen due to daily variation in currency rates. The same gets auto-calculated and adjusted by simply recording a journal entry.  Not just that, you can easily track the bills and make  an adjustment as when the situation occurs.  Be it an adjustment  related to fixed assets or  outstanding receivables, all you need to do is to record journal entries in TallyPrime and all the reports will be automatically updated with adjusted value.

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