How to adjust entries in accounting

Adjusting accounting entries often fly under the radar, but they’re essential for keeping financial records in check. When a company closes its books at the end of a given period, accountants and financial teams are busy ensuring that the financial statements reflect the business’ performance. These adjustments are crucial for aligning records with the accrual basis of accounting, ensuring revenue and expenses are recognised in the right periods.

What are adjusting entries?

Adjusting entries are journal entries made at the end of an accounting period to correct or update account balances. They demonstrate that revenue and expenses are recorded in the period in which they occur, and not necessarily when money changes hands. This means that financial statements are accurate and adhere to the matching principle.

Why make adjusting entries?

Journal entry accounting is necessary for several reasons:

• Accurate financial reporting: they ensure that financial statements accurately reflect the financial position of a business at a given time.
• Accrual accounting: they align the timing of revenue and expenses with when they were incurred, rather than when cash transactions occur.
• Compliance: adjusting entries help businesses comply with accounting standards such as GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards).

Who makes adjusting entries?

Adjusting entries are typically made by the accountants or financial managers responsible for preparing accurate financial statements. In some organisations, this may also involve the CFO or the accounting team overseeing the financial processes.

Types of adjustment entries 

There are several types of adjusting entries, each with its own method of calculation and purpose. Below are some common examples:

Accrued expenses 

Accrued expenses are expenses that have been incurred but not yet paid. For example, if a company uses electricity in December but does not receive the bill until January, the accrued expense adjustment would be made to recognise the cost in December’s financial statements.

Example: A business owes £500 for electricity used in December but hasn’t received the bill yet. The adjusting entry would be a debit to the electricity expense account and a credit to accrued expenses (liability account).

Accrued revenues 

Accrued revenues are revenues that have been earned but not yet received. For example, if a company provides consulting services in December but won’t receive payment until January, the revenue should still be recognised in December.

Example: A business earned £1,000 in consulting fees in December but will not receive the payment until January. The adjusting entry would be a debit to accounts receivable and a credit to revenue. 

Deferred expenses

Also known as prepaid expenses, deferred expenses are costs that have been paid but have not yet been incurred. An example is paying for a one-year insurance policy in advance.

Example: A business pays £1,200 for a one-year insurance policy on January 1. Each month, £100 is recognised as an expense, and the rest remains a prepaid asset.

Deferred revenues

Deferred revenues are amounts received for goods or services not yet provided. For example, if a business receives payment in advance for a subscription service, it must defer the revenue until the service is delivered.

Example: A customer pays £500 in advance for a six-month magazine subscription. The adjusting entry each month would involve recognising £83.33 in revenue and reducing the deferred revenue balance.

Depreciation and amortisation

Depreciation is the allocation of the cost of a tangible asset over its useful life. Amortisation works similarly but applies to intangible assets, such as patents or goodwill.

Example: A company purchases a machine for £10,000 with a five-year useful life. Each year, £2,000 is recognised as depreciation.

How to make adjusting entries

Making adjusting entries is a straightforward process, but it requires attention to detail. Below is a simple three-step process to make these entries:

Step 1: Review the unadjusted trial balance

Before making adjusting entries, review the unadjusted trial balance to identify accounts that need to be updated. This step ensures that all transactions across the given period are accounted for correctly.

Step 2: Identify necessary adjustments

Look for transactions where revenues or expenses should be recorded but haven’t been. Common areas requiring adjustment include accrued expenses, prepaid expenses, and unearned revenues.

Step 3: Record adjusting entries

For each identified adjustment, create a journal entry to reflect the correct amounts. Confirm that the entries balance, with debits equalling credits.

When to make accounting adjustments 

Adjusting entries should be made at the end of each accounting period, before the preparation of financial statements. For example, if a business follows a monthly accounting cycle, adjusting entries should be recorded at the end of each month to prepare for the next period.

Automate adjusting journal entries in accounting

Manual adjusting entries can be time-consuming and prone to human error. Automating the process can save time, reduce mistakes, and increase accuracy. Teams can leverage software that helps streamline this process by automatically generating adjusting entries based on predefined rules.

Aurum’s journal entry automation

Aurum’s journal entry automation solution enables businesses to automate the creation of adjusting entries, ensuring that financial statements are always accurate and up to date. By automating this process, businesses can improve their operational efficiency and focus on more strategic tasks.

Adjusting entry FAQs

What is an adjusting entry in accounting?

An adjusting entry is a journal entry made at the end of an accounting period to update the balances of accounts to confirm that financial statements are accurate.

What are the five adjustment entries?

The five main types of adjustment entries are:

1. Accrued expenses
2. Accrued revenues
3. Deferred expenses
4. Deferred revenues
5. Depreciation and amortisation

How to record an adjusting entry?

Adjusting entries are recorded by making journal entries that reflect the correct balances for accrued expenses, prepaid expenses, unearned revenues, and other necessary adjustments.

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