What Is an Adjusting Journal Entry?

What Is an Adjusting Journal Entry?

Let me explain what an adjusting journal entry is. It's an entry you make in your company's general ledger at the end of an accounting period to record any income or expenses that haven't been recognized yet for that period. If a transaction starts in one period and finishes in another, you need this entry to account for it properly.

These entries can also fix mistakes from earlier in the period. You use them to keep your financial reporting accurate.

Key Takeaways

You use adjusting journal entries to record transactions that have happened but aren't yet in the books under accrual accounting. Record them in the general ledger at period's end to follow the matching and revenue recognition principles. The main types are accruals, deferrals, and estimates. They're for accrual accounting when periods transition, and cash accounting companies don't need them.

Understanding Adjusting Journal Entries

The goal here is to shift cash transactions to accrual accounting. Accrual accounting recognizes revenue when earned, not when cash comes in. For example, if a construction company starts work in one period but invoices six months later, you make an adjusting entry each month to recognize 1/6 of the revenue.

These entries always involve an income statement account like revenue or expense, and a balance sheet account like an asset or liability. They often deal with accumulated depreciation, allowance for doubtful accounts, accrued expenses, accrued income, prepaid expenses, deferred revenue, and unearned revenue.

You might adjust income statement accounts such as interest expense, insurance expense, depreciation expense, and revenue. Do this to match expenses with related revenue in the same period, following the matching principle. These adjustments go into the general ledger and flow to your financial statements.

Types of Adjusting Journal Entries

In short, the most common are accruals, deferrals, and estimates.

Accruals

Accruals cover revenues and expenses you haven't received or paid yet, and they aren't recorded in standard transactions. For instance, rent paid at month's end but space used from the start is an accrued expense.

Deferrals

Deferrals are for revenues and expenses received or paid in advance and recorded, but not yet earned or used. Unearned revenue is money for goods not delivered yet.

Estimates

Estimates record non-cash items like depreciation expense, allowance for doubtful accounts, or inventory obsolescence reserve.

Tip

Remember, not every entry at period's end is adjusting. Recording a purchase on the last day isn't one.

Why Are Adjusting Journal Entries Important?

Many companies deliver goods at different times from payment, like on credit or prepayment. When a period ends with pending situations, adjusting entries reconcile timing differences in payments and expenses. Without them, you'd have unresolved transactions.

Example of an Adjusting Journal Entry

Take a company with a fiscal year ending December 31 that borrows a loan on December 1, with interest paid every three months starting March 1. You still accrue interest for December, January, and February. For year-end statements in January, make an adjusting entry to record December's accrued interest expense on the income statement and interest payable on the balance sheet. Debit interest expense and credit interest payable for that amount.

What Is the Purpose of Adjusting Journal Entries?

You use them to reconcile open transactions that cross periods, like payments or expenses where timing doesn't match delivery.

What Are the Types of Adjusting Journal Entries?

Mainly accruals and deferrals. Accruals are for owed credit items, deferrals for undelivered prepayments.

What Is the Difference Between Cash Accounting and Accrual Accounting?

The key difference is timing: cash accounting recognizes when money changes hands, accrual allows lags like credit purchases.

Who Needs to Make Adjusting Journal Entries?

Companies on accrual accounting with transactions spanning periods must make them.

The Bottom Line

An adjusting journal entry records occurred but unrecorded transactions under accrual accounting, handling unrecognized income or expenses across periods or correcting earlier mistakes.