Adjusting entries

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Adjusting entries are journal entries usually made at the end of an accounting period to allocate income and expenditure 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 accounting system. They are sometimes called Balance Day adjustments because they are made on balance day.

Based on the matching principle of accrual accounting, revenues and associated costs are recognized in the same accounting period. However the actual cash may be received or paid at a different time.

Types of adjusting entries

Adjusting entries could be classified this way:

Prepayments

Prepaid expenses expire either with the passage of time (e.g. rent, insurance) or through use and consumption (e.g. supplies). At first prepaid expenses are included in assets, but are gradually expensed. If no adjusting entry is made, assets are overstated and expenses are understated. Depreciation is an extremely long-term case of prepaid expenses.

Unearned revenue is liability for the company to perform certain services or deliver goods. For example, airlines owe you a flight if you buy a ticket. After the flight liability is recorded as earned revenue

Accruals

Accrued revenues are earned (that is, service is performed or goods are delivered) but [payment] not yet recorded or received. For example, professional fee for consultation. When the revenue is recognized, it is recorded as Accounts Receivable.

Accrued expenses could be interest, taxes, rent, and salaries. One company's accrued expenses are accrued revenues for another. Allowance for doubtful accounts is also accrued expenses.

Example

Assume a magazine publishing company Tellchix-Uread charges an annual subscription fee of $12. The cash is paid up-front at the beginning of the subscription. The revenue, 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.

See also

• US Generally Accepted Accounting Principles
• Accrual & Deferral
• Accounting methods

External links

Further reading:

• Adjusting Entries Explanation with examples.