Adjusting Entries

Definition: Journal entries made at the end of the accounting period to measure the period’s income accurately and bring the related asset and liability accounts to correct balances before the financial statements are prepared.

Adjustments for Accruals

Adjustments may be needed for accruals when revenues have been earned, or expenses have been incurred before cash is exchanged. Because cash has not been exchanged, it is possible that the revenue or expense has not been recorded, so an adjusting entry is needed to record the revenue or expense.

Two types of adjustments are made for accruals:

  1. Accrue, or record, unrecorded revenues. Revenues are recorded in the current period by debiting a receivable and crediting revenue.
  2. Accrue, or record, unrecorded expenses. Record the expenses in the current period by debiting an expense and crediting a liability.

Adjustments for Deferrals

A deferral is created when cash is exchanged before the related revenue or expense is recognized. Examples include receiving cash from customers before providing services or purchasing supplies that are not used immediately.

Two types of adjustments are made for deferrals:

1. Divide unearned revenues between periods. When payment is received in advance from a customer for goods or services, cash is debited. The liability account titled Unearned Revenue is credited because the customer is owed the goods or services. Once the customer receives the goods or services, an adjusting entry is prepared in which the Unearned Revenue account is debited to reduce it and a Revenue account is credited.

Unearned revenue

A liability created when a business collects cash from customers in advance of providing goods or services; also called deferred revenue.

2. Divide prepaid expenses, supplies, buildings, equipment, and other assets between periods. These items are recorded as assets when they are purchased because the item that was paid for has not yet been used up. Therefore, an asset account is debited and cash is credited to record the purchase. Once part, or all, of the item is used up, an adjusting entry is prepared in which an expense account is debited and the related asset is credited to reduce it.

Prepaid expenses

Amounts that are assets of a business because they represent items that have been paid for but will be used later; also called deferred expenses.