At the end of any accounting period, it’s crucial to make adjusting entries to your accounting journals. This process is meant to adjust the revenues and expenses you recorded on an accounting cycle, to create a more accurate balance sheet and income statement. Adjusting journal entries is typically the next step in the end-of-cycle accounting process after the preparation of a trial balance, which includes a statement of all debits and credits.
The purpose of adjusting entries is to “adjust” your accounting to reflect when income or expenses actually occurred. Most businesses use a cash accounting method, which means they record debits or credits when cash changes hands. Sometimes, those events do not happen at the same time as the service or product sale that is actually being accounted. For instance, if you perform a service in January but don’t get paid for it in February, your general ledger would include the income on February’s books. An adjusting entry would report that income in January, when the service occurred and the income was actually earned.
The five most common ways in which you can go about adjusting a journal entry include:
- Accrued revenues: You perform a service in one month but don’t bill the client until the next month. This “accrued revenue” would be adjusted so that it was on the books for the previous month.
- Accrued expenses: You owe wages to employees at the end of a pay period but don’t issue paychecks until the beginning of the next month. Your adjusted entry would allocate the expenses in the month where the work you are paying wages for actually occurred.
- Unearned revenues: This one is the opposite of accrued revenues. Instead of receiving payment for a service after the fact, you might receive a deposit or prepayment in January for work to be completed in February or March. The adjusting entry would credit the revenue to the month where you complete the service.
- Prepaid expenses: Prepaid expenses are things you buy at the beginning of an accounting period and then proceed to use up throughout that accounting period. An example is printer paper, or perhaps other types of office supplies. You buy printer paper at the beginning of each quarter and then proceed to use that paper up throughout the quarter. Your adjusting entry would reflect when the supplies were being used (and thus becoming “expenses”), rather than recording the entire cost upfront. Other prepaid expenses, such as prepaid insurance or travel expenses, would fall into this category as well.
- Depreciation: Most assets have reasonably long usable life, such as computers or equipment. Rather than recording the entire cost of one of these assets upfront, you would track it as a depreciation expense. The adjusting entry would reflect the value amount that the asset was depreciating by each month.
At the end of an accounting period—be it the end of a pay period, the end of your company’s fiscal year, or December 31—you would prepare the trial balance and then make the adjusted entries. You would then post these adjusted entries to your company’s general ledger accounts, and use the differences to create updated company financial systems. The adjusted entries are important to track, as they generally help to even out revenues and expenses on a month-to-month basis, and avoid inconsistent and unpredictable swings in spending and earning.