Lesson 72 - Beginner accounting course

72. Common Types of Adjusting Entries

Adjusting entries are necessary to align financial records with the accrual accounting principle. They ensure that revenues and expenses are recorded in the correct period, providing accurate financial statements.

1. What Are Adjusting Entries?

Adjusting entries are journal entries made at the end of an accounting period to update balances before preparing financial statements. These entries correct revenues, expenses, assets, and liabilities to match the period in which they occur.

Key Characteristics:

• Do not involve cash transactions

• Ensure compliance with the matching principle (expenses are matched with revenues)

• Follow the revenue recognition principle (revenue is recorded when earned)

2. Common Types of Adjusting Entries

Adjusting entries fall into four main categories:

Each type ensures financial statements are accurate and complete.

3. Detailed Examples of Adjusting Entries

1. Accrued Revenues (Revenue earned but not yet received)

Example:

A consulting firm provides services worth $5,000 in December but won’t receive payment until January.

This ensures revenue is recorded in December, when it was earned.

2. Accrued Expenses (Expense incurred but not yet paid)

Example:

A company’s employees earned $3,000 in December, but payday is in January.

This ensures the expense is recognized in December.

3. Deferred Revenues (Unearned Revenue) (Cash received in advance for future services)

Example:

A magazine company receives $12,000 in December for a one-year subscription but recognizes $1,000 per month.

Initial Entry (when cash is received):

Adjusting Entry (recognizing revenue for one month): 

This ensures revenue is recognized over time.

4. Deferred Expenses (Prepaid Expenses) (Cash paid in advance for future expenses)

Example:

A company prepays $6,000 for six months of rent in December.

Initial Entry (when rent is paid):

Adjusting Entry (recognizing one month of rent expense): 

This ensures expenses are recognized gradually. 

4. Additional Adjusting Entries

a) Depreciation Adjustment

Depreciation spreads the cost of an asset over its useful life.

Example:

A company buys machinery for $10,000 with a useful life of 5 years. The monthly depreciation is $166.67.

This ensures asset values are updated properly.

b) Supplies Adjustment

If a company buys supplies but doesn’t use them immediately, they must adjust the account.

Example:

A business buys $1,000 of office supplies in December. At the end of the month, $700 remains.

Adjusting Entry:

This ensures only the used portion is expensed.

5. Consequences of Not Making Adjusting Entries

If adjusting entries are not made, financial statements may be inaccurate and misleading:

These errors can lead to regulatory penalties, investor distrust, and poor business decisions.

6. Key Takeaways

• Adjusting entries align financial records with the accrual basis of accounting.

• They ensure revenues and expenses match the correct period, preventing financial misstatements.

• Adjusting entries never involve cash transactions.

• Common types include:

  • Accrued revenues and expenses

  • Deferred revenues and expenses

  • Depreciation adjustments

  • Supplies adjustments

By making adjusting entries, businesses improve accuracy and maintain financial integrity.