The adjusting entries in accounting
Adjusting entries are made specifically to update the initial recording of accounting data. There are two instances in which adjusting journal entries are required before the release of financial statements:
- Certain expenses or revenues have not been recorded in the accounting records, but in fact, they occurred and must be included in the current period’s income statement and balance sheet.
- Although data has been documented in accounting records, the entire amount must be divided over two or more accounting periods.
The businesses evaluate each account in the trial balance to see whether it is complete and up-to-date for financial statement purposes. If there is any need to make changes to existing records, adjusting entries are made.
Adjusting entries in accounting are required whenever a business entity prepares its financial statements. Furthermore, each adjusting entry shall have one income statement account and one balance sheet account.
Most importantly, adjusting entries ensure that the principles of revenue and cost recognition are followed.
Types of Adjusting Entries
We can classify adjusting entries as either deferrals or accruals. The word defer means to postpone or delay something. Deferrals refer to expenses or revenues that are recorded at a later period than the point when cash was actually exchanged.
Accrual refers to the accumulation or increase of something over a period of time. As a result, the adjusting entry for accruals will raise both a balance sheet and an income statement account.
Let’s see the examples of deferrals and accruals:
Prepaid expenses are those expenses that are paid in cash before being used or consumed.
Before the performance of services, cash is received.
Revenues for services that have been provided but not yet received in cash or recorded.
These are expenses that a business entity has incurred but yet not paid in cash or recorded.
Need for adjusting entries in Accounting
Here we will see the several reasons why adjusting entries are needed.
- Some events are not recorded daily because it is not efficient to do so. Use of supplies and the earning of wages by employees are a few examples in this case.
- During the accounting period, some costs are not recorded since these costs expire over time, rather than as a result of recurring daily transactions. For instance, depreciation expense, rent expense, and insurance expense.
- Some other items may also be not recorded. An example is a bill for utility service which is not received until the next period of accounting.
In all the above cases we require adjusting entries to record the unrecorded data or make changes to previously recorded data and finally prepare the adjusted trial balance. The adjusted trial balance is the basis and final source of complete data before proceeding to final accounts like income statements and balance sheets.