Adjusting Entries-Definition, Example, Classification, Features and Importance

What are Adjusting Entries?

In preparing the final account at the end of any financial period, only the income and expenditure account of the corresponding accounting period will be included in the final account to determine the correct result. As a consequence, no income-expenditure account can be shown before or after the specified account period.

All revenue transactions during an accounting period will be treated as income-expenditure for that period, but if for any reason they are incomplete or omitted, or any income-expenditure for the period before or after that period is executed this year, a reconciliation journal must be paid for them. The reconciliation journal given on these topics is called the adjusting entries.

In a nutshell, adjustment entries are those journal entries that are used to update the relevant ledger account surplus in order to reflect the correct balance at the end of an accounting period.

Example of Adjusting Entries

The examples of Adjusting Entries are as follows:

  1. Prepaid House Rent $1200 (2 years)
  2. Accrued Salaries $500
  3. Interest on Investment earned $800 but not yet received.

Adjusting Entries for these transactions are as follows:

SL NOParticularsRef.Debit
(Amount)
Credit
(Amount)
1House Rent Exp A/C———–Dr.$600
Prepaid House Rent A/C—–Cr.$600
2Salaries Exp A/C—————-Dr.$500
Accrued Salaries a/C———-Cr.$500
3Interset on Investment Receivable A/C—Dr.$800
Interest Income A/C—————————–Cr.$800

Features of Adjustment Entries

Adjusting entries are given at the end of a certain accounting period. Adjustments are usually given at the end of the financial year before the final accounts or financial statements are prepared.

The following are the features of the adjustment entries:

  • It is given for accruals and advances income-expenditure.
  • Adjustment entries are given for exclusions and estimated inter-transactions.
  • Adjustment entries are provided as amended entries or unwritten cash transactions.
  • It always affects the income statement and the balance sheet.

Necessity or Importance or Benefits of Adjusting Entries

The necessity or importance or benefits of adjusting entries are enormous. Adjusting Entries plays an important role in determining the correct outcome of the organization.

Adjusting entries ensure that the principles of revenue recognition and expense recognition are accurately followed.

Below are the necessity or importance or benefits of adjusting entries:

  • The adjusting entries implement the concept of accruals.
  • Adjusting entries help to determine the accurate gains and losses of the organization.
  • It presents the correct financial status.
  • It helps to know the actual income and expenditure amount of the business organization.
  • It assists to evaluate the closing stocks accurately.
  • Proper assessment of assets and liabilities can be made.
  • Any time an organization prepares financial statements, it must make the adjusting entries.

Classification of Adjusting Entries

There are two types of adjusting entries which are as follows:

  1. Accruals
  2. Deferrals

1.Accruals:

Accruals mean when a service has been incurred, but no money has been paid or recorded for that service or when a service has been performed, but no money has been received or recorded for that service i.e. arrears.

There are two types of accruals which are as follows:

1.1. Accrued Revenues:

Accrued revenues mean when revenue is performed but the money for that revenue is still in arrears, that is, it has not been received.

In this case, since the service has been performed, the revenue will increase, again, since the money has not been received yet, a kind of asset will also increase.

This asset will be shown in the balance sheet as a current asset and the corresponding revenue account of the ledger will have to be increased.

Example: Interest on investment $600 has been earned but not yet received. Adjusting entry for this transaction is as follows:

Interest Receivable on Investment A/C—-Dr.

Interest on investment A/C——————-Cr.

1.2. Accrued Expenses:

Accrued expenses mean when an expense is incurred but the money for that expense is still in arrears, that is, it has not been paid.

In this case, since the expense has been incurred, the expense will increase, again, since the money has not been paid yet, a kind of liability will also increase.

This liability will be shown in the balance sheet as a current liability and the corresponding expenditure account of the ledger will have to be increased.

Example: Office rent is due $6,000. Adjusting entry for this transaction is as follows:

Office Rent Expense—Dr.

Office rent Payable—-Cr.

2. Deferrals:

Deferrals mean when cash is paid before receiving a service or when cash is received before providing a service.

There are two types of deferrals which are as follows:

2.1. Prepaid Expenses:

Prepaid expenses mean when expenses paid in cash before they are incurred. An increase to an expense account and a decrease to an asset account result from an adjusting entry for prepaid expenses.

Example: Prepaid Insurance $2400 for 2 years. An Adjusting entry for this transaction is as follows:

Insurance Expense—Dr.

Prepaid Insurance—Cr.

2.2. Unearned Revenues:

Unearned Revenues mean when services received in cash before they are performed. A decrease in a liability account and an increase in a revenue account result from an adjusting entry for unearned revenues.

Example: Received $5000 as a consultancy fee expected to be completed in the next 2 years. An Adjusting entry for this transaction is as follows:

Unearned Service Revenue—Dr.

Service Revenue—————–Cr.

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