Adjust the definition of a journal entry
What is an adjustment journal entry?
An adjustment journal entry is an entry in a company’s general ledger that occurs at the end of a posting period to record any unrecorded income or expense for the period. When a transaction is started in one posting period and ended in a later period, an adjustment journal entry is required to properly post the transaction.
Adjustment journal entries can also refer to financial reports that correct an error that was made earlier in the posting period.
Key points to remember
- Adjusting journal entries are used to record transactions that have taken place but have not yet been properly posted in accordance with the accrual method of accounting.
- Adjustment journal entries are posted to a company’s general ledger at the end of an accounting period in order to adhere to the principles of revenue matching and posting.
- The most common types of adjustment journal entries are accruals, postings, and estimates.
- It is used for accrual accounting purposes when one accounting period moves to the next.
- Businesses that use cash accounting do not need to make adjusting journal entries.
Understanding Adjustment Journal Entries
The purpose of adjusting postings is to convert transactions to cash on an accrual basis. Accrual accounting is based on the principle of revenue recognition which seeks to recognize revenue in the period in which it was earned, rather than in the period in which cash is received.
As an example, suppose a construction company starts construction in one period, but does not invoice the customer until the work is completed in six months. The construction company will have to make an adjusting accounting entry at the end of each month to recognize income for 1/6 of the amount that will be invoiced at the six month point.
An adjustment journal entry involves an income statement (income or expense) as well as a balance sheet account (asset or liability). It generally relates to balance sheet accounts for accumulated amortization, allowance for doubtful accounts, accrued liabilities, income receivable, prepaid expenses, deferred income and unearned income.
Income statements that may need to be adjusted include interest expense, insurance expense, depreciation expense, and income. Postings are made in accordance with the matching principle to match expenses with corresponding revenues during the same accounting period. Adjustments made in journal entries are carried over to the general ledger which is reflected in the financial statements.
Types of adjustment journal entries
In summary, adjustment journal entries are most often accruals, postings, and estimates.
Accrued expenses are income and expenses that have not been received or paid, respectively, and that have not yet been recorded through a standard accounting transaction. For example, an accrued liability might be rent paid at the end of the month, even though a business is able to occupy space at the beginning of the month that has not yet been paid.
Deferrals refer to income and expenses that have been received or prepaid, respectively, and that have been recorded, but not yet earned or used. Unearned income, for example, represents money received for goods not yet delivered.
Estimates are adjusting postings that record non-monetary items, such as depreciation, bad debt or inventory obsolescence reserve.
Not all journal entries posted at the end of a posting period are accrual entries. For example, an entry to record an equipment purchase on the last day of an accounting period is not an adjustment entry.
Why is adjusting journal entries important?
Since many companies operate where the actual delivery of the goods can be made at a different time from payment (either before in the case of a loan or after in the case of a prepayment), it sometimes happens that a accounting period ends with such a situation. still waiting. In such a case, the adjustment journal entries are used to reconcile these differences in the payment schedule as well as the expenses. Without adjusting the journal entries, there would be unresolved transactions that still need to be closed.
Example of an adjustment journal entry
For example, a business with a fiscal year ending December 31 takes out a loan from the bank on December 1. The terms of the loan state that interest payments are to be made every three months. In this case, the company’s first interest payment must be made on March 1. However, the company still has to accumulate interest charges for the months of December, January and February.
Since the company is due to release its year-end financials in January, an adjusting entry is required to reflect the accrued interest expense for December. To accurately report on the operations and profitability of the business, accrued interest expense should be recorded in the December income statement and the liability for interest payable should be reported in the December balance sheet. The adjustment entry will debit interest expense and credit interest due with the amount of interest from December 1 to December 31.
What is the purpose of adjusting journal entries?
Adjustment postings are used to reconcile transactions that are not yet closed, but that overlap posting periods. These may be payments or expenses for which payment does not occur at the same time as delivery.
What are the types of adjustment journal entries?
The two main types are accruals and deferrals. Allowances refer to payments or credit expenses that are still due, while deferrals refer to advance payments when products have not yet been delivered.
What is the difference between cash and accrual accounting?
The main distinction between cash and accrual accounting is when expenses and income are recognized. With cash accounting, this only happens when money is received for goods or services. Rather, accrual accounting allows for a mismatch between payment and income (for example, with purchases made on credit).
Who should make adjustment postings?
Businesses that use accrual accounting and find themselves in a situation where one accounting period moves to the next should see if there are any open transactions. If so, adjustment journal entries should be made accordingly.