Definition
Adjusting Entries also referred to adjusting journal entries which are made at the end of the accounting period to correct accounts before the financial statements are prepared.
Adjusting entries usually passed with un-adjusted Trial Balance to prepare an Adjusted Trial Balance. The purpose of an adjusted trial balance is to present a financial statement in a more accurate form. Adjusting Entries is the fourth step in the accounting cycle, and commonly used in accordance with the matching principle to match revenue and expenses in the period in which they occur.
Types of Adjusting Entries
There are five types of adjusting entries, such as :
- Adjust Prepaid Assets
- Adjust Unearned Revenue Account
- Adjust Plant and Equipment Assets
- Adjust Accrued Revenue; and
- Adjust Accrued Expenses
- Adjusting Prepaid Assets Accounts:
This is miscellaneous assets that are paid for in advance. This kind of payments is made for more than a year. Adjusting Prepaid assets account also referred to as Mixed Account due to its Revenue and Capital nature, i.e it includes both a Balance Sheet Portion and Income Statement Portion. The income statement portion must be separated from the balance sheet portion.
When you pass journal entries, you will Debit the Expenses A/c and Credit the prepaid asset account.
Example: Advertisement Expenses paid $ 3,000 for the three years.
In un-adjusted Trial Balance shows $ 3,000 as the balance in the Prepaid Advertisement Account. To record this transaction following entry to be passed:
| To initial record of this Transaction | Prepaid Advertisement Account Dr $ 3,000 Cash/ Bank A/c Cr $ 3,000 | Shown as asset when transaction is made. |
| Adjusting Entry in the year end | Advertisement Expenses Dr (3,000 /3) = $ 1,000 Prepaid Advertisement A/c Cr $ 1,000 | Advertisement Expenses paid for 3 years including the current year. Hence Current year’s expenses transferred to revenue account and adjusted with Income Statement Account. |
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2. Adjusting Unearned Revenue Account:
This is the situation where cash is collected from the customers before delivery the goods or services. In this respect, the company is liable to provide products or render the services to the customers against the received money in advance. The Adjusting journal entry would be :
| Unearned Revenue Account Revenue Account | Dr Cr |
3. Adjusting Plant and Equipment Assets Account:
Depreciation is to be charged against fixed assets due to use the assets over its useful life. The following journal entry to be made:
| Depreciation Expenses Account Accumulated Depreciation Account | Dr Cr |
A question may come why use Accumulated Depreciation Account instead of just crediting the original asset account. The reason is:
- If the original asset account
was use , then the original costs of the assets would not be reflected in any of the asset accounts - The original cost is needed when the assets are sold or disposed
- The original cost of the asset must be reported on the income tax return of the company.
4. Adjusting Accrued Revenue A/c:
Business earned the revenue but yet not received is called accrued revenue. When you will pass a journal entry you will debit an asset account and credit a revenue account.
Adjusting Journal Entry for Accrued Revenue are as follows:
| Account Receivable A/c Revenue A/c | Dr Cr |
5. Adjusting Accrued Expenses A/c:
Accrued expenses is the expenses that is incurred in the accounting year but paid in the subsequent year. This is an year end adjustment to record expenses which is incurred in the current year but paid following year. A good example of accrued expenses is the Electricity Bill, Interest , Salary & Allowances etc.
Adjusting Journal Entry for Accrued Expenses are as follows:
| If Electricity bill Accrued: Electricity Expenses Electricity Bill Payable A/c | Dr Cr |
| If Salary Accrued: Salary & Allowances A/c Salary & Allowances Payable A/c | Dr Cr |
Closing Procedure of Adjusting Entries
After the adjusting entries have been posted, all of the temporary owner’s equity accounts should be closed. The purpose of the closing procedure is to transfer the balances of temporary owner’s equity to the permanent owner’s equity account, and entries made to accomplish this are known as closing entries. After the temporary owner’s equity and drawing accounts are transferred to the permanent owner’s equity , only the asset accounts, liability accounts and the permanent owner’s equity account will have balances. The sum of the balances of the asset accounts ( less balances of any contra accounts) will be equal to the sum of the balances of the liability accounts plus the balance of the permanent owner’s equity accounts.