Adjusting entries are an important and often necessary part of your accounting!
As any small business owner knows, keeping the books by recording all transactions and putting together financial statements can be a complicated procedure. Still, it is crucial that it is done accurately to ensure that you stay on top of income and expense totals such as rent expenses, prepaid expenses or advance payments, prepaid rent, utilities, interest expense, or interest payable wages expense and insurance expense.
The only way to keep your business afloat is by knowing exactly how much money you have coming in and how much is going out.
Balancing the books every month is how you record all of this monetary flow of cash items or cash payments and those that fall under the accrual basis.
How To Compute And Record End-Of-Period Adjusting Entries…
Once you’ve created a trial balance report, then it’s time to make your adjusting entries in your accounting system.
Adjustments will be necessary to account for any money that comes in or goes out ahead of actual services rendered. This is a regular occurrence for any business and requires computing and recording adjustments to keep the books balanced and determine the adjusted trial balance.
Three Basic Categories Of Adjusting Entries…
There are three basic categories of adjustments:
- revenue that has been earned but not recorded
- expenses that have been incurred and not recorded
- depreciation expenses on items that incur regular wear or tear that will affect the viability of the item in question
Each of these needs to be recorded and then computed to reflect actual income and expense account amounts. Adjusting entries account for revenue and expenses that haven’t been recorded in the general ledger and are entered into the general ledger accounts at the end of an accounting period.
Unearned Revenue End Of The Period Adjustments…
For adjustments involving Unearned Revenue, this covers all income received for services not yet rendered. Accrued revenue is when services have been performed, but the customer has not yet been billed. Entries or adjustments would be made in the accounts receivable and accrued revenue accounts.
For instance, if a client pays you for two months of consulting services, you’ll only have earned half of that money at the end of the first month, yet you would already have received the full amount for two months.
Therefore, you need to record an adjustment that reflects the actual amount earned that month. You would then have to reflect the remainder of the income in the “unearned revenue account.”
Review this page on accounting journal entries if you are unfamiliar with the process of recording journal entries.
The process of recording adjusting journal entries is not too difficult.
- Figure what your current account balance is
- Determine what your current balance should be
- Record adjusting entry
Using the example above … you were paid $500 for 2 months of consulting services. It is the end of the reporting period, and you need to record an adjusting entry to show you only “earned” half of that amount…
- Debit Cash $250
- Credit Unearned Revenue $250
In this case, you would need a deferral or a doubtful account for the revenue or expense that has been entered but not used or earned.
Adjusting Entries For Expenses…
In terms of expenses, adjustments can cover several different possible scenarios.
If you purchase $1,000 worth of supplies at the beginning of the accounting period, yet you’ve only used up $600 of them during that time, then your adjustment will need to reflect that $600 as supplies used, reducing the actual account to the proper balance. Similarly, an insurance adjustment reflects the actual amount spent on insurance during the accounting period as opposed to the full amount of the insurance policy.
Another expense adjustment is for salary expenses.
These are amounts owed to employees in salary that weren’t actually paid during the accounting period. This particular adjustment usually occurs when a company pays its employees at the end of a week, but the monthly accounting period ends in the middle of the week. An adjustment has to be made to reflect the overlapping two or three days of the month that won’t be paid until the following week.
To record the accrued salaries…
- Debit Salaries Expense (an income statement account)
- Credit Salaries Payable (a balance-sheet short-term liability account)
Don’t forget after you make the actual payroll deposit in the next reporting period; you will need to…
- Debit Salaries Payable (to zero it back out)
- Credit Cash
Depreciation Adjusting Entries…
A depreciation adjustment is made to reflect the cost of assets such as equipment or buildings that have been used up during the accounting period, whether it is annual, January through December, or even on a monthly basis, say from the beginning of January to the end of January.
Most property is expected to depreciate in value by a certain amount over a stated amount of time. Over this period of time, you build up accumulated depreciation which is recorded via an accrual account, and an accumulated depreciation account which is known as a contra asset account and shows up as a balance sheet account.
An estimate of that depreciation is made at the beginning of the accounting period. Then an adjustment is made at the end of the period to reflect the actual depreciation during that span.
This gives you a basic idea of how to go about computing and recording adjustments throughout the accounting cycle.
It is a vital component of accounting for any business but especially for small businesses that can live and die by the accuracy of their books. It’s very important to make these adjustments accurately so that you have a clear picture and summary of your financial situation at the end of an accounting period.