Adjusting Entries

Adjusting entries are journal entries recorded at the end of an accounting period to adjust income and expense accounts so that they comply with the accrual concept of accounting. Their main purpose is to match incomes and expenses to appropriate accounting periods.

The transactions which are recorded using adjusting entries are not spontaneous but are spread over a period of time. Not all journal entries recorded at the end of an accounting period are adjusting entries. For example, an entry to record a purchase on the last day of a period is not an adjusting entry. An adjusting entry always involves either income or expense account.

Types

There are following types of adjusting entries:

• Accruals:
  These include revenues not yet received nor recorded and expenses not yet paid nor recorded. For example, interest expense on loan accrued in the current period but not yet paid.
• Prepayments:
  These are revenues received in advance and recorded as liabilities, to be recorded as revenue and expenses paid in advance and recorded as assets, to be recorded as expense. For example, adjustments to unearned revenue, prepaid insurance, office supplies, prepaid rent, etc.
• Non-cash:
  These adjusting entries record non-cash items such as depreciation expense, allowance for doubtful debts etc.

Example

This example is a continuation of the accounting cycle problem we have been working on. In the previous step we prepared an unadjusted trial balance. Here we will pass adjusting entries.

Relevant information for the preparation of adjusting entries of Company A
Office supplies having original cost $4,320 were unused till the end of the period. Office supplies having original cost of $22,800 are shown on unadjusted trial balance.
Prepaid rent of $36,000 was paid for the months January, February and March.
The equipment costing $80,000 has useful life of 5 years and its estimated salvage value is $14,000. Depreciation is provided using the straight line depreciation method.
The interest rate on $20,000 note payable is 9%. Accrue the interest for one month.
$3,000 worth of service has been provided to the customer who paid advance amount of $4,000.

The adjusting entries of Company A are:

Date	Account	Debit	Credit
Jan 31	Supplies Expense	18,480
	Office Supplies		18,480
	Supplies Expense = $22,800 − $4,320 = $18,480
Jan 31	Rent Expense	12,000
	Prepaid Rent		12,000
	Rent Expense = $36,000 ÷ 3 = $12,000
Jan 31	Depreciation Expense	1,100
	Accumulated Depreciation		1,100
	Depreciation Expense = ($80,000 − $14,000) ÷ (5 × 12) = $1,100
Jan 31	Interest Expense	150
	Interest Payable		150
	Interest Expense = $20,000 × (9% ÷ 12) = $150
Jan 31	Unearned Revenue	3,000
	Service Revenue		3,000