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In
accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to compare with other ob ...
/
accountancy Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to compare with other obj ...
, adjusting entries are
journal A journal, from the Old French ''journal'' (meaning "daily"), may refer to: *Bullet journal, a method of personal organizations *Diary, a record of what happened over the course of a day or other period *Daybook, also known as a general journal, a ...
entries usually made at the end of an accounting period to allocate
income In microeconomics Microeconomics is a branch of mainstream economics Mainstream economics is the body of knowledge, theories, and models of economics, as taught by universities worldwide, that are generally accepted by economists as a bas ...
and
expenditure Expenditure is an outflow of money, or any form of Wealth, fortune in general, to another person or group as payment for an item, service, or other category of costs. For a leasehold estate, tenant, renting, rent is an expense. For students or paren ...
to the period in which they actually occurred. The revenue recognition principle is the basis of making adjusting entries that pertain to unearned and accrued revenues under accrual-basis accounting. They are sometimes called Balance Day adjustments because they are made on balance day. Based on the
matching principle In accrual accounting, the revenue recognition principle states that revenues should be recorded during the period in which they are earned, regardless of when the transfer of cash occurs. And the matching principle instructs that an expense shou ...
of
accrual accountingAccrual (''accumulation'') of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabili ...
,
revenue In accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to comp ...
s and associated
cost In production Production may be: Economics and business * Production (economics) * Production, the act of manufacturing goods * Production, in the outline of industrial organization, the act of making products (goods and services) * Production ...

cost
s are recognized in the same accounting period. However the actual cash may be received or paid at a different time.


Types of adjusting entries

Most adjusting entries could be classified this way:


Prepayments

Adjusting entries for prepayments are necessary to account for cash that has been received prior to delivery of goods or completion of services. When this cash is paid, it is first recorded in a prepaid expense asset account; the account is to be expensed either with the passage of time (e.g. rent, insurance) or through use and consumption (e.g. supplies). A company receiving the cash for benefits yet to be delivered will have to record the amount in an unearned revenue
liability Liability may refer to: Law * Legal liability, in both civil and criminal law ** Public liability, part of the law of tort which focuses on civil wrongs ** Product liability, the area of law in which manufacturers, distributors, suppliers, retai ...
account. Then, an adjusting entry to recognize the revenue is used as necessary.


Example

Assume a magazine publishing company charges an annual subscription fee of $12. The cash is paid up-front at the start of the subscription. The income, based on sales basis method, is recognized upon delivery. Therefore, the initial reporting of the receipt of annual subscription fee is indicated as: Debit , Credit ---------------- Cash $12 , Unearned Revenue , $12 , The adjusting entry reporting each month after the delivery is: Debit , Credit ---------------- Unearned Revenue $1 , Revenue , $1 , The unearned revenue after the first month is therefore $11 and revenue reported in the income statement is $1.


Accruals

Accrued revenues are revenues that have been recognized (that is, services have been performed or goods have been delivered), but their cash payment have not yet been recorded or received. When the revenue is recognized, it is recorded as a receivable. Accrued expenses have not yet been paid for, so they are recorded in a payable account. Expenses for interest, taxes, rent, and salaries are commonly accrued for reporting purposes. An income which has been earned but it has not been received yet during the accounting period. Incomes like rent, interest on investments, commission etc. are examples of accrued income.


Estimates

A third classification of adjusting entry occurs where the exact amount of an expense cannot easily be determined. The
depreciation In accountancy, depreciation refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the allocation in a ...

depreciation
of fixed assets, for example, is an expense which has to be estimated. The entry for bad debt expense can also be classified as an estimate.


Inventory

In a periodic
inventory Inventory (American English American English (AmE, AE, AmEng, USEng, en-US), sometimes called United States English or U.S. English, is the set of varieties of the English language native to the United States. Currently, American English ...
system, an adjusting entry is used to determine the
cost of goods sold Cost of goods sold (COGS) is the carrying value In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization ...
expense. This entry is not necessary for a company using perpetual inventory.


See also

*
AccrualsAccrual (''accumulation'') of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabili ...
&
Deferral A deferral, in ''accrual accountingAccrual (''accumulation'') of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts ...
s *
Accounting methods A basis of accounting is the time various financial transactions are recorded. The cash basis (EU VAT vocabulary ''cash accounting'') and the accrual basisAccrual (''accumulation'') of something is, in finance, the adding together of interest or ...
*
US Generally Accepted Accounting Principles Generally Accepted Accounting Principles (GAAP or U.S. GAAP) is the accounting standard Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus any ...
*
International Financial Reporting Standards International Financial Reporting Standards, commonly called IFRS, are accounting standard Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus ...


External links

Further reading:
Adjusting Entries
Explanation with examples.

{{DEFAULTSORT:Adjusting Entries Accounting terminology