Skip to main content

Adjusting Entries: Definition, Types and Examples




Definition of Adjusting Entries

Adjusting entries refers to a set of journal entries recorded at the end of the accounting period to have an updated and accurate balances of all the accounts. Adjusting entries are mere application of the accrual basis of accounting.

Sounds bookish? Let’s make it easier for you.

It’s so common in business that you pay or receive or buy something who’s benefit is either yet to be consumed in full or something is paid today for tomorrows use.

For example, if you are paying an insurance premium of 65,000 Rs on 1st October and insurance covers for a period of 12 months from 1st October,2018 to 30th September,2019.

definition of adjusting entries

Now, if you closely look at the above example, an expense of 65,000 towards insurance premium is incurred in the accounting period 1st April,2018 to 31st March,2019 but the entire expense is not attributable to the financial year 2018-2019.

The reason is the premium covers till 30th September,2019 and only the portion of expenses till 31st March 2019 is attributable to F.Y 18-19. The remaining portion is treated as ‘Pre-paid’ expenses’ as on 31st March,2019.

For you to bring this impact in the books of accounts, you need to record an adjusting entry at the end of the accounting period so that expenses are rightly reflected in the financial statements.

Like the above examples, there are many situations in which expenses may have been incurred but not yet recorded in the journals. And also some of the income may also have been earned but not entered in the books.

Thus, adjusting entries help you keep your accounts updated before they are summarized into the financial statements. Adjusting entries are made for accrual of income, accrual of expenses, deferrals (income method or liability method), prepayments (asset method or expense method), depreciation, and allowances.

Importance of Adjusting Entries

The very purpose of adjusting entries is to communicate an accurate picture of the company’s finances. The management can have a complete look into the financial statements knowing that everything that occurred during the month is reported even if the financial part of the transaction would have warranted to have occurred at a later stage. A statement of finance prepared without considering adjusting entries would misrepresent the financial health of the company.

Types of Adjusting Entries

The following entries are the most common types of adjusting entries recorded in books of accounts.

  • Accrued Revenues

If you perform a service for a customer in one month but don't bill the customer until the next month, you would make an adjusting entry showing the revenue in the month you performed the service and would also debit accounts receivable and credit service revenue.

  • Accrued Expenses

One fine example of accrued expenses is wages paid to employees. When a business entity owes wages to employees at the end of an accounting period, they make an adjusting journal entry by debiting wages expense and crediting wages payable.

  • Unearned Revenues

Unearned revenues refer to payments received for goods to be delivered in the future or services to be performed. In this case, the company would make an adjusting entry debiting unearned revenue and crediting revenue account.

  • Prepaid Expenses

These are the assets that are paid for and which gradually get used up during the accounting period. It’s similar to the example of pre-paid insurance premium we discussed above.

  • Deprecation

Depreciation is the process of allocating the cost of an asset, such as a building or a piece of equipment, over the serviceable or economic life of the asset. Due to various reasons, the asset value depreciates by some amount and adjusting entry is made to account the depreciation expenses.

Examples of Adjusting Entries

As learnt, that to arrive at a correct figure of profits and loss as well as true figures in the balance sheet, certain accounts require some adjustments. Entries for making such adjustments are called as adjusting entries. Following are some of the examples of adjusting entries.

Example 1: Depreciation on Machinery Rs. 1,00,000 /- @ 10% per annum. The adjustment entry as on March. 31, 2019 will be as follows:

Date

Particulars

L.F

Debit ( Rs. )

Credit ( Rs. )

31.12.2013

Depreciation A/c.          DR.
Machinery A/c
[ Depreciation charged on machinery ]

 

               10,000

 

 

 

10,000

Example 2: Max Ltd, which owed 65,000 /- KES to the company has been adjudged insolvent since they are unable to pay. The adjusting entry to provide the effect to the above transaction is :

Date

Particulars

L.F

Debit ( KES )

Credit ( KES )

31.03.2018

Bad debts.  A/c.           DR.
To ABC Ltd A/c
[ Loss on account of bad debts provided in the books of accounts ]

 

               65,000

 

 

 

65,000

Example 3: Puspak Publications received subscriptions amounting to. 40,000 TAK during the financial year ending 30th June 2019. Out of this, 7,500 TAK represent subscriptions relating to the next financial year.

The adjusting entry to provide the effect to the above transaction is :

Date

Particulars

L.F

Debit ( TAK )

Credit ( TAK )

31.12.2018

 Subscription A/c      DR.
To Subscription received in advance
[ Subscriptions received in advance ]

 

               7,500

 

 

 

 

7,500

Example 4: The Accounts Receivable of RST Ltd. was 1,50,000 /- Dirhams as on 31st December 2018. It was estimated that 8,000 /- of the amount due may turn out to be uncollectable during the forthcoming year.

For the creation of the provision, the following adjusting journal will be recorded:

Date

Particulars

L.F

Debit ( AED )

Credit ( AED)

31.03.2018

 Profit and loss A/c    DR.
To provision for bad & doubtful debts
[ Provided for bad and doubtful debts based on the estimate from management]

 

               8,000

 

 

 

 

8,000

Comments

Post a Comment

Popular posts from this blog

What are the Key Reports a Business Owner Must Track and Which is the Best Tool for it?

As a business owner, you must be already keeping a track of the overall financial health of the business. While you may hire an accountant for end-to-end tasks that will keep your books of accounts updated, it is imperative that as a business owner, you also go beyond the basic understanding of key financial reports to take your business to the next level. The three primary key aspects which would help you as a business owner to get a holistic view of your company’s books of accounts in sync with your business transactions are; Cash Stock and Taxation Cash What is the ultimate goal of any business? To have regular cash flow, right? So, where do we get these crucial insights about cash flow management in order to stay updated with your company’s finances from? Let’s take a look at how these cash flow reports will help you build your business and trigger long term, growth. Cash Flow Cash flow is the amount of money going in and out of your business. Healthy cash flow can help lead your b...
Post a Comment
Read more

Break Even Point: Definition, Formula, Example and Analysis

What is the Break-Even Point? A simple financial tool which helps you determine at what stage your company, or a new service or a product, will be profitable. To put simply, break-even point analysis will tell you the number of products or services a company should sell to cover its costs, particularly fixed costs. Break-even is a situation where you are neither making money nor losing money, but all your costs have been covered. Break-even analysis is useful in studying the relation between the variable cost, fixed cost and revenue. Generally, a company with low fixed costs will have a low break-even point of sale. For example, a company has a fixed cost of Rs.0 (zero) will automatically have broken even upon the first sale of its product. The purpose of the break-even analysis formula is to calculate the amount of sales that equates revenues to expenses and the amount of excess revenues, also known as profits, after the fixed and variable costs are met. The main thing to understand i...
Post a Comment
Read more

6 Tips for Efficient Cash Flow Management

By definition, cash flow refers to the amount of money flowing in and out of the business. The larger the time gap between cash outflow (payments to your supplier, employees, duties etc.) and cash inflow (receipts from your customers), the higher the risk it possesses to the business. These situations persist in every business and to smoothly manage such situations, you need cash flow management. In simple words, cash flow management largely implies managing frequency of payments and a whole lot of activities to encourage your customers to pay as fast as possible. Cash flow management involves a process of preparing cash flow statement, monitoring, analysing and optimizing such that business has enough cash cushion to run their business. In this article’ Tips to Efficient Cash Flow Management’, we are sharing you some of the best ways to manage optimum cash flow in your business. Here are 6 quick tips to manage your cash flow efficiently. Faster realisation of accounts receivables Acco...
Post a Comment
Read more