Adjusting Entries

At the end of an accounting period, an adjusting journal entry (often called an "adjustment" entry) is made/submitted to the general ledger to record any unrealised revenue or expenses during the period. This type of entry ensures that transactions spanning multiple periods are correctly accounted for.

Why adjusting entries matter

Adjusting entries is crucial for accurate and timely recording of business transactions. They help you keep track of payables and receivables and accurately determine profit and loss at the end of the fiscal year.

Without adjusting entries, financial statements can be misleading, inflating the owner’s equity and net income while understating expenses and liabilities.

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Types of adjusting journal entries

  1. Accruals include revenues and expenses that have been incurred but have not been recorded. For example, rent is due at the end of the month for a space occupied throughout the month.
  2. Deferrals: These are revenues and expenses received or paid in advance but have yet to be earned or incurred. An example is unearned revenue for goods yet to be delivered.
  3. Estimates: These entries account for non-cash items such as depreciation, allowances for doubtful accounts, or inventory obsolescence reserves.

Detailed example of an adjusting entry

Depreciation is an adjustment for long-term assets, spreading their cost over their useful life. Consider a company that purchases a delivery truck for $30,000 and expects to use it for five years. Instead of expensing the entire $30,000 in the year of purchase, the cost is allocated over the truck's 5-year lifespan.

Depreciation (per year) = Cost of the asset / Estimated Useful Life

Calculation: $30,000 / 5 years = $6,000 per year

In this example, the business will record a $6,000 depreciation expense each year for five years, ensuring the expense reflects the truck’s usage over time.

Key points

  • The three main types of adjusting journal entries are accruals, deferrals, and estimates. 
  • Adjusting journal entries ensures compliance with the matching and revenue recognition principles. 
  • These entries are essential for accrual accounting rather than for businesses using cash accounting. 

How do you avoid tax and accounting mistakes for early-stage founders?

Fun fact

Did you know? The concept of adjusting entries dates back to the 15th century, pioneered by Luca Pacioli, the father of accounting, who emphasised the need for accurate and timely financial records.

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