What Are Adjusting Journal Entries?
Adjusting journal entries are transactions recorded at the end of an accounting period to account for unrecognized income or expenses and to correct initial recording errors. These entries align financial records with the accrual basis of accounting, ensuring that revenues and expenses are recorded in the correct accounting period. Here are some key points about adjusting journal entries:
– Align Financial Records: Adjusting entries ensure that financial records accurately reflect the company’s financial position according to accrual accounting.
– Correct Accounting Period: They ensure that revenues and expenses are recorded in the correct period.
– Accurate Financial Statements: These entries are essential for maintaining accurate financial statements.
Types of Adjusting Journal Entries
There are several types of adjusting journal entries, each serving a specific purpose:
Accruals
- Accrued Expenses: These are expenses incurred but not yet paid. For example, if a company has used utilities but has not yet received the bill, an adjusting entry would be made to record this expense.
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Accrued Revenues: These are revenues earned but not yet received. For instance, if a company has provided services but has not yet invoiced the client, an adjusting entry would be made to record this revenue.
Deferrals
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Prepaid Expenses: These are expenses paid in advance but not yet used. For example, if a company pays annual insurance premiums in January, an adjusting entry would be made each month to reflect the portion of the premium used.
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Unearned Revenues: These are revenues received in advance but not yet earned. If a company receives payment for services that will be provided over several months, an adjusting entry would be made each month to recognize the portion of revenue earned.
Estimates
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Depreciation: This involves estimating the decrease in value of assets over time.
- Bad Debt: This involves estimating the amount of accounts receivable that may not be collected.
- Other Estimated Expenses: Other estimated expenses such as warranty costs or litigation expenses can also be adjusted.
Steps to Make Adjusting Journal Entries
Identify Transactions Needing Adjustment
The first step is to identify transactions that need adjustment. This includes reviewing accounts for accrued revenues, accrued expenses, prepaid expenses, and depreciation. For example, you might check if there are any unpaid salaries or if there are any revenues earned but not yet invoiced.
Determine the Correct Adjustment Amounts
Once you have identified the transactions needing adjustment, you need to determine the accurate amounts for each transaction. This involves using the matching principle to ensure that revenues and expenses are recorded in the correct period. For instance, calculating the amount of depreciation for an asset or determining how much of a prepaid expense has been used.
Record the Adjusting Entries
After determining the adjustment amounts, you need to record these entries in your journal. Each entry affects at least one income statement account and one balance sheet account. For example:
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Debit: Salaries Expense (Income Statement)
Credit: Salaries Payable (Balance Sheet)
This entry records an accrued expense for salaries incurred but not yet paid.
Post to the General Ledger
Once recorded in the journal, these entries need to be posted to the general ledger to update account balances. This step ensures that all accounts reflect the adjustments made.
Review and Finalize
Finally, it is crucial to review all adjusting entries to ensure accuracy and compliance with accounting standards. This step confirms that all necessary adjustments have been made before closing the accounting period.
Impact on Financial Statements
Adjusting journal entries significantly impact both the income statement and the balance sheet. By ensuring that revenues and expenses are recognized in the correct accounting period, these entries reflect the true financial position of the company. For instance:
– Accrued expenses increase expenses on the income statement and increase liabilities on the balance sheet.
– Accrued revenues increase revenues on the income statement and increase assets on the balance sheet.
Automation in Adjusting Journal Entries
Automation can play a significant role in streamlining the process of making adjusting journal entries. Financial close automation tools can reduce human error and improve efficiency by automatically identifying transactions needing adjustment and calculating accurate amounts. These tools also help in recording and posting these entries accurately.