Adjustment Entries, Meaning, Types, Importance, Examples
To ensure that revenues and expenses are reported when they are incurred, adjustment entries correct previously recorded journal entries. Continue Reading to learn more!
Izhar Ahmad28 Nov, 2023
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Adjustment entries are recorded in a business's general ledger at the end of an accounting period to make sure the matching and revenue recognition rules are followed.
At the end of a pay period, it can be essential to submit extra entries, such as modifying journal entries, after reviewing financial information. These entries are very important for keeping track of costs and earnings, particularly when payments are not received right away or are not paid at the moment of sale.Start your Commerce career with PW Online Course. Enroll now to build a successful future in Commerce.
Adjustment Entries Meaning
Adjustment entries cover a number of journal entries made at the end of an accounting period to ensure that all accounts reflect updated and correct amounts. These records are basically the application of the accrual basis of accounting. The main goal of adjustment entries is to move cash transactions into the accrual accounting method. Accrual accounting is based on the revenue recognition principle, which aims to identify income in the time it is made rather than when cash is received. A journal entry adjusting binds an income statement account (either revenue or cost) with a balance sheet account (either asset or debt).Types of Adjustment entries
The following are the types of Adjustment entries:Accrued Expenses:
Accrued expenses, also known as accrued liabilities, are costs incurred during a pay period but paid at a later date. This situation often arises with recurring bills such as utilities or payroll. For instance, if your employees work throughout a month but receive their paychecks on the first day of the subsequent month, you need to make an adjustment for accrued expenses to reflect the amount in the appropriate prior month.Accrued Revenues:
Accrued revenue occurs when you earn income from providing products or services to customers but receive payment at a later time. To ensure accurate recording of revenue in the correct accounting period, adjustments are made. This is particularly relevant in service-oriented industries and instances of interest accrual.Deferred Expenses:
Deferred or prepaid expenses involve payments made in advance for services or products. Unlike accrued expenses, this adjustment is made in the future month when the service is delivered. Common examples include advance payments for advertising, rent, and insurance.Deferred Revenues:
Deferred revenue occurs when payment is received for a service or product that is yet to be provided. This is typical in subscription models or when retail stores sell gift cards. For example, although payment is received when a gift card is purchased, the adjustment is made when the customer redeems the card.Depreciation Expenses:
Depreciation expenses involve a one-time payment to account for the loss in value of equipment. The calculation is done by subtracting the original value from the current value and spreading this amount over the months the equipment has been used. Depreciation methods and recording practices may vary based on cash flow and liability considerations.Provisions:
Provisions are amounts set aside to anticipate future costs for a business. The allowance for doubtful accounts is a common provision, especially when offering credit to customers where missed payments are anticipated.Looking for the Best Commerce Coaching?
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Adjustment entries Examples
Example 1: Accrued Salaries Expense Suppose at the end of the accounting period, the company has incurred but not yet paid Rs. 20,000 in salaries.| Date | Particulars | L.F | Debit (Rs.) | Credit (Rs.) |
| 31.12.2019 | Salaries Expense A/c DR. | 20,000 | ||
| Accrued Liabilities A/c | 20,000 | |||
| [Recognition of accrued salaries expense] |
| Date | Particulars | L.F | Debit (Rs.) | Credit (Rs.) |
| 31.12.2019 | Rent Expense A/c DR. | 7,500 | ||
| Prepaid Rent A/c | 7,500 | |||
| [Recognition of rent expense for three months] |
| Date | Particulars | L.F | Debit (Rs.) | Credit (Rs.) |
| 31.12.2019 | Unearned Revenue A/c DR. | 15,000 | ||
| Service Revenue A/c | 15,000 | |||
| [Recognition of revenue for services provided] |
| Date | Particulars | L.F | Debit (Rs.) | Credit (Rs.) |
| 31.12.2019 | Bad Debt Expense A/c | 25,000 | ||
| Allowance for Doubtful | 25,000 | |||
| [Recognition of estimated bad debts] |
Importance of Adjustment entries
- Adjustment entries ensure that financial statements accurately reflect the company's financial position and performance by accounting for all relevant transactions in the correct accounting period.
- Adjustment entries facilitate the application of accrual accounting principles, allowing the recognition of revenues and expenses when they are earned or incurred, rather than when cash is received or paid.
- They enable the application of the matching principle, ensuring that expenses are matched with the revenues they generate in the same accounting period, providing a more realistic portrayal of profit and loss.
- Adjustment entries help in presenting timely and relevant financial information, as they account for transactions that occurred but were not recorded during the regular course of business operations.
- They help an organization to stick to accounting standards and regulatory requirements, making the financial statements more transparent and reliable.
- Adjustment entries better portray a true representation of a company’s financial health thus enabling management, investors, and other stakeholders to make informed decisions.
- Without making adjustment entries, financial statements can give a false impression on how well the company performed as some revenues are misplaced or omitted.
Adjustment Entries FAQs
What is the adjusting entry for?
Adjustment entries ensure accurate financial reporting by updating accounts for transactions occurring at the end of an accounting period.
What are the 7 adjustment entries?
Common adjustment entries include accrued expenses, accrued revenues, deferred expenses, deferred revenues, depreciation, provisions, and amortization.
What are closing journal entries?
Closing journal entries are made to transfer temporary account balances to permanent accounts at the end of an accounting period.
What is a reversing journal entry?
A reversing journal entry is a type of entry made at the beginning of an accounting period to reverse the effects of certain adjustment entries made in the previous period.
What is in trial balance?
A trial balance contains a list of all accounts and their balances to ensure that debits equal credits before preparing financial statements.
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