what is an adjusting entry?
Adjusting entries means making changes to entries you’ve already written in your journal. They make sure that the numbers you’ve written down match up with the proper accounting periods.
Journal entries track how money flows through your business—entering, exiting, and moving between accounts.
An example of an adjusting entry is as follows: You bill a customer $5,000 for services rendered in August. You will be paid in September.
You record that money in accounts receivable as anticipated income for August. The money is then recorded as cash deposited in your bank account in September.
You don’t need to literally go back and change a journal entry to make an adjusting entry—no, there’s an eraser or delete key involved. Instead, you create a new entry while editing the old one.
Returning to the first example, let’s say your customer called you after getting the bill and asked for a 5% discount. If the discount was given, you could change the journal entry to reduce accounts receivable and revenue by $250 (5% of $5,000).
Making adjusting entries is one way to follow the matching principle, which says that expenses must be recorded in the exact same accounting period as the revenue they are tied to.
In the accounting cycle, adjustments are made before a trial balance and financial statements are made.
why do you need to make adjusting entries?
Making an adjusting entry makes sure that your company’s activities are recorded correctly and on time. If no adjusting entries are made, your books will show you paying for expenses before they are incurred or collecting unearned revenue before you can use it.
As a result, your income and expenses will not match, and you will be unable to track revenue accurately. Your financial statements will be inaccurate, which is terrible news because financial statements are required to make informed business decisions and file taxes correctly.
Also, when depreciating assets, journal entries must be adjusted. This is important for reporting tax deductions and keeping your books balanced.
further read: cost-effective accounting solutions for startups how to streamline payroll and keep finances in check
who is responsible for adjusting entries?
If you do your own accounting and use the accrual system, you must create your own adjusting entries.
You won’t need to adjust entries if you do your accounting and use the cash basis system.
If you have a bookkeeper, they will handle all adjusting entries for you, regardless of the type of account you use.
accounting software vs. spreadsheets vs. bookkeepers
Adjusting entries will play a different role in your life depending on the type of bookkeeping system you use.
If you do your own Bookkeeping with spreadsheets, you are responsible for all adjusting entries. Then, when generating your financial statements, you’ll need to refer to those adjusting entries—or keep detailed notes so your accountant knows what’s happening.
You’ll also need to adjust your entries if you use accounting software. When compared to spreadsheets, software such as Quickbooks speeds up the process slightly. It will also generate financial statements for you. However, you are still entirely responsible for ensuring that those adjusting entries are accurate and completed on time.
You don’t have to worry about making your own adjusting entries or referring to them when preparing financial statements if you have a bookkeeper. They’ll take care of both.
If you don’t yet have a bookkeeper, check out—Countick. We’ll pair you with a dedicated bookkeeping team and provide you with access to simple financial software.
helpful resource: 3 ways an accounting firm maximizes business financials
the five different types of adjusting entries
If making adjusting entries seems daunting, Don’t worry—there are only five different kinds of adjusting entries, and the distinctions between them are clear. Here are descriptions of each type, as well as examples of scenarios and how to enter them.
1. accrued revenues
You must make an accrued revenue adjustment when revenue is generated in one accounting period but not recognized until a later period.
scenario idea
Your company creates personalized tote bags. Then, in a few months, you can buy a new car. On March 8, the client paid the invoice.
In February, you incurred expenses while making the bags (materials and labor, workshop rent, and utilities). You must show the revenue you generated to reflect your monthly income accurately. (Keep in mind that revenue minus expenses equals income.)
To start, you make an adjusting entry by transferring revenue from a “holding account” (accrued receivables) to a revenue account (revenue).
When you get paid on March 8 and put the money in the bank, you change it from revenue to cash.
example of an adjusting entry
The adjustment appears in your general ledger as follows. The first step is to make a list of all the people who will be affected by your decision.
You record the money coming out of revenue to balance the books.
| Date | Account | Debit | Credit |
| Feb 28 | Accrued receivables | $1,300 | |
| Feb 28 | RevenueReR | $1,300 |
The money is then transferred from accrued receivables to cash when you are paid in March.
| Date | Account | Debit | Credit |
| March 8 | Accrued receivables | $1,300 | |
| March 8 | Cash | $1,300 |
2. accrued expenses
Once you’ve mastered accrued revenue, accrued expense adjustments are relatively simple. They account for expenses incurred during one period but paid for later.
scenario example:
Assume you hire a contract worker to assist you with your tote bags in February. You agree to pay them $400 in advance for a weekend’s work. They do not, however, bill you until early March.
example of an adjusting entry
In February, you record the money you’ll need to pay the contractor as an accrued expense, debiting your labor expenses account.
| Month | Account | Debit | Credit |
| February 21 | Accrued expenses | $400 | |
| February 21 | Labor expenses | $400 |
When you pay the invoice in March, you transfer the money from accrued expenses to cash as a withdrawal from your bank account.
| Month | Account | Debit | Credit |
| March 1 | Accrued expenses | $400 | |
| March 1 | Cash | $400 |
3. revenues deferred
When a client makes an advance payment to you, deferred revenue occurs. Even if you’ve already been paid, you must ensure the income is recorded in the month you do the work and pay for the expenses.
case in point
You’ve earned a good reputation in the tote bag community over the years. You’ve been invited to speak at the annual Tote Symposium, which will be held in California.
The organizers of the conference will pay you $2,000 to give a talk about the changing face of the tote bag industry. They will pay you in January after you confirm your attendance. You’ll be giving a talk at the conference in March.
example of an adjusting entry
First, deferred revenue should be recorded on the books for January. For now, you’ll credit it to your deferred revenue account.
| Date | Account | Debit | Credit |
| January 6 | Cash Cash | $2,000 | |
| January 6 | Deferred revenue | $2,000 |
Then, when you deliver your talk and earn the fee in March, transfer the money from deferred revenue to consulting revenue.
| Date | Account | Debit | Credit |
| March 7 | Deferred revenue | $ 2,000 | |
| March 7 | Consulting revenue | $ 2,000 |
4. prepaid expenses
Prepaid expenses function similarly to deferred revenue. Except in this case, you’re paying for something upfront and then recording the expense for the period it applies to.
case in point
You rent a new space for your tote manufacturing company and decide to pay a year’s rent in advance in December.
You deduct it from an expense account in December as a prepaid rent expense.
| Account | Debit | Credit |
| Prepaid rent | $12,000 | |
| Cash | $12,000 |
Then, you’ll want to record your monthly rent expense in January. You will convert the portion of the prepaid rent for January from an asset to an expense.
| Account | Debit | Credit |
| Rent expense | $1,000 | |
| Prepaid rent | $1,000 |
5. depreciation costs
When you depreciate an asset, you pay for it once but spread the expense over multiple accounting periods. This is typically done when making large purchases such as equipment, vehicles, or buildings.
The total accumulated depreciation amount on your balance sheet changes at the end of an accounting period in which an asset is depreciated. And each time you pay depreciation, it appears on your income statement as an expense.
The way you record depreciation on the books is heavily influenced by the depreciation method you employ. It’s a fairly complicated operation involving large sums of money. Given the amount of money and tax liability at stake, it’s a good idea to consult your accountant before recording any depreciation on the books.
