Adjusting Journal Entry

Definition

An adjusting journal entry is a general ledger entry made at the end of an accounting period to record revenue or expenses that have been earned or incurred but not yet recorded. These entries align recorded transactions with the accrual accounting principles of revenue recognition and matching.

How they work

• Adjusting entries convert cash-basis records (cash received or paid) into accrual-basis results (revenue earned and expenses incurred).
• Each adjusting entry affects one income statement account (revenue or expense) and one balance sheet account (asset or liability).
• Common balance sheet accounts involved include prepaid expenses, accrued expenses, unearned revenue, accrued income, accumulated depreciation, and allowance for doubtful accounts.
• Adjustments ensure financial statements reflect the correct period’s performance and financial position.

Common types and examples

• Accruals: Record revenues earned or expenses incurred that haven’t been billed or paid.
• Example: Accrued wages: debit Wage Expense, credit Wages Payable.
• Deferrals (prepayments and unearned revenue): Adjust previously recorded cash receipts or payments to recognize the portion earned or used.
• Example: Prepaid insurance consumed: debit Insurance Expense, credit Prepaid Insurance.
• Example: Unearned revenue earned: debit Unearned Revenue, credit Service Revenue.
• Estimates: Non-cash adjustments based on management judgment.
• Example: Depreciation: debit Depreciation Expense, credit Accumulated Depreciation.
• Example: Allowance for doubtful accounts: debit Bad Debt Expense, credit Allowance for Doubtful Accounts.

Tip: Not every transaction recorded on the last day of a period is an adjusting entry (e.g., purchasing equipment is a normal transaction, not an adjustment).

Example: Accrued interest

A company takes a loan on December 1; interest is payable quarterly starting March 1. To report December interest expense in year‑end financials:
– Calculate interest for Dec. 1–31.
– Record: Debit Interest Expense; Credit Interest Payable (for the accrued amount).
This ensures the December income statement includes the interest expense and the balance sheet shows the liability.

Who needs to make adjusting entries

Any entity using accrual accounting that has transactions crossing accounting periods must evaluate and record adjustments before preparing period-end financial statements. Companies using cash accounting typically do not make adjusting entries.

Difference between cash and accrual accounting (brief)

• Cash accounting: Recognizes revenue and expenses only when cash is received or paid.
• Accrual accounting: Recognizes revenue when earned and expenses when incurred, creating a need for adjusting entries when timing differs.

Quick checklist for preparing adjusting entries

1. Review unrecorded revenues and expenses that relate to the period.
2. Identify prepaid items and unearned balances that need recognition.
3. Estimate non-cash items (depreciation, allowances) as required.
4. Record entries in the general ledger and ensure they flow to financial statements.
5. Document calculations and supporting schedules.

Key takeaways

• Adjusting entries ensure financial statements reflect transactions in the correct period under accrual accounting.
• They always involve one income statement account and one balance sheet account.
• Main categories: accruals, deferrals, and estimates.
• Proper adjustments are essential for accurate profitability reporting and compliance with accounting principles.