What Are Adjusting Entries? Benefits, Types & Examples in 2023

Adjusting entries are a fundamental component of the accounting cycle that helps ensure that financial statements accurately reflect the financial position and performance of a specific period. So, every business is required to create adjusting entries to ensure accurate financial information.

Without adjusting entries, financial statements may not accurately represent the financial health of the business, which could lead to poor business decisions and mislead stakeholders. Overall, adjusting entries are a crucial aspect of the accounting process that helps businesses maintain accurate financial records and make informed decisions.

Keep on reading to know more about adjusting entries, their benefits, adjusting entries examples, and types.

What Are Adjusting Entries?

An adjusting entry is a type of accounting entry created at the end of accounting periods to correct the account balances of specific accounts so that the financial statements accurately reflect the company’s financial position and performance. As some transactions take place over time and are not recorded during routine business operations, these adjustments are required.

Recognizing unearned revenue, accruing salaries and wages, recognizing depreciation expenses, and adjusting prepaid expenses are a few examples of adjusting entries. Making adjustments to the financial statements is crucial for ensuring that they accurately reflect the company’s financial position and performance, which is necessary for making wise business decisions.

What Is the Purpose of Adjusting Journal Entries?

To ensure that a company’s financial statements accurately reflect the financial position and performance of the business for a specific period, adjusting journal entries are used. Such adjusting entries are made to correct any inaccuracies, omissions, or oversights that may have occurred during the normal bookkeeping process at the end of an accounting period.

Accounting adjustments are necessary because the accrual accounting method used by most companies requires that revenue and expenses be recognized in the period in which they are earned or incurred, regardless of when cash is actually received or paid.

As a result, certain transactions may not be recorded in the appropriate accounting period or may be recorded incorrectly. Hence, adjusting entries are crucial to correct these errors and ensure that financial statements reflect the true financial position of the company.

Why Are Adjusting Journal Entries Important in Financial Reporting?

The accuracy of a company’s financial statements is ensured by adjusting accounting journal entries, which is crucial in financial reporting. Companies primarily communicate their financial position and performance to stakeholders, including investors, creditors, and regulators, through financial statements.

It is essential that these statements completely and truthfully depict the company’s financial situation and operating results.

Additionally, in order to maintain consistency and comparability among financial statements, adjusting journal entries are required by IFRS and generally accepted accounting principles (GAAP). Due to these requirements, businesses must use accrual accounting, which means that regardless of when cash is actually received or paid, revenue and expenses are recognized in the period in which they are earned or incurred.

To adhere to these requirements and guarantee that financial statements are prepared in accordance with GAAP or IFRS, adjusting entries are required. Adjusting entries can also be made using accounting software; this can help you streamline your accounting process.

What Are the Benefits of Adjusting Entries?

While many companies don’t implement adjusting entries in their accounts, they’re very beneficial for the company’s financial accounts. 

1. Ensuring accurate financial statements – Adjusting entries are necessary to ensure that the financial statements accurately reflect the financial position and performance of the business for the period. Without adjusting entries, the financial statements may be incomplete or incorrect, which could mislead stakeholders and result in poor business decisions.
2. Complying with accounting standards – Adjusting entries are required under generally accepted accounting principles (GAAP) to comply with accounting standards. Failure to comply with accounting standards could result in legal and regulatory issues, financial penalties, and reputational damage.
3. Providing a clear picture of the business – Adjusting entries can help provide a more complete picture by recognizing accounts receivable or accounts payable that were not previously recorded. This can help stakeholders better understand the financial performance and position of the business.
4. Facilitating better decision-making – Accurate and complete financial statements can help stakeholders make better-informed business decisions. Adjusting entries can help provide more accurate and complete financial statements, which can help stakeholders make better decisions regarding investments, financing, and operations.
5. Improving financial analysis – Adjusting entries can help improve the accuracy and reliability of the financial analysis. Accurate and complete financial statements can help analysts identify trends, assess the financial health of the business, and make informed recommendations.

When to Make Adjustments in Accounting?

Adjustments are crucial because incomplete or wrong records of some transactions during the period could have led to inaccurate financial statements. Adjustments in accounting make sure that assets and liabilities are reported at the right values, and that revenue and expenses are recorded in the appropriate period. Below are some scenarios where you are required to create adjustment entries.

1. Accrued revenues and expenses – Accrued revenue and accrued expense are transactions that have been incurred or earned but have not yet been recorded in the accounting system. Therefore, to recognize these transactions and ensure that revenue and expenses are recorded in the correct period, adjusting entries are created.
2. Deferred revenue and expense – These transactions have been recorded but have not yet been earned or used up. Adjusting entries are created to recognize these transactions and ensure that revenue and expenses are recorded in the correct period.
3. Depreciation of fixed assets – Over time, fixed assets, such as structures, machinery, and vehicles, starts depreciating in value as a result of use. Depreciation expense is recorded by adjusting such entries, which also lowers the asset’s value on the balance sheet account.
4. Inventory valuation – For items that are damaged, out-of-date, or unsold at the conclusion of the period may require adjustment to the inventory. To accurately reflect the inventory’s true worth on the balance sheet, adjusting entries are made.
5. Accrued interest and taxes – To ensure that interest expense and taxes are recognized in the right time period, they may need to be accumulated and reported at the end of the period.

How to Make Adjusting Entries?

Before making any adjusting entries in your balance sheet, you need to determine certain criteria. Follow the steps below to ensure you make the right entry in your books.

1. Determine whether a change is required

   Examine the accounts and transactions to find any inaccuracies, omissions, or mistakes that should be fixed. You might need to record earnings that have been made but not yet received or expenses that have been incurred but not yet paid, for instance.

2. Identify the type of adjustment

   Accruals, deferrals, depreciation, and amortization are a few examples of adjusting entries. Depending on the transaction or account, decide which type of adjustment is required.

3. Calculate the adjustment’s size

   Determine the adjustment’s dollar amount based on the transaction or account. This could entail determining the amount of revenue or expense that needs to be recognized or estimating the value of an asset or liability.

4. Prepare the adjusting entry

   Use a journal entry to note the adjustment in the overall journal. Date, accounts impacted, adjustment amount, and a succinct justification should all be included in the entry.

5. Post the adjusting entry

   Once the adjusting entry has been prepared, post it to the relevant ledger accounts. By doing this, the account balances will be updated, and the financial statements will accurately reflect the adjustment.

6. Review and reconcile the accounts

   Execute Reconciliation process to ensure they are accurate and complete after making the necessary adjusting entries. This will make it easier to find and fix any unfixed inconsistencies or errors.

   It’s crucial to keep in mind that adjusting entries are frequently created at the end of an accounting period, such as the end of a month, quarter, or year. To ensure that the financial statements accurately reflect the financial position and performance of the company for the period, these entries are required.

7 Types of Adjusting Journal Entries With Examples

There are various types of adjusting journal entries that a company needs to make. Every entry is made with a different scenario and expense/income. Hence, based on these different types of journal entries, an expense and income statement account is created.

So, check out different types and adjusting entries examples.

1. Accrued expenses

These are expenses that have been incurred but not yet paid or recorded. An adjusting entry for accrued expenses involves debiting an expense account and crediting a liability account. Examples of accrued expenses include salaries, interest, and taxes.

For example, at the end of the month, December 30, a company may have incurred $2,000 in salaries expense that has not been paid. The adjusting entry would be –

2. Accrued revenues

These are revenues that have been earned but not yet received or recorded. An adjusting entry for accrued revenues requires debiting an asset account and crediting a revenue account. Examples of accrued revenues include interest, rent, and fees.

For example, at the end of the month, a company may have earned $1,000 in interest income on November 28th that has not been received. The adjusting entry would be.

3. Deferred expenses

These are expenses that have been paid but not yet used or recorded. Adjusting entry for deferred expenses involves debiting an expense account and crediting an asset account. Examples of deferred expenses include prepaid rent, insurance, and supplies.

For example, a company may have paid $12,000 for insurance coverage for the next year on December 25th. The adjusting entry would be.

4. Deferred revenues

These are revenues that have been received but not yet earned or recorded. An adjusting entry for deferred revenues would involve debiting a liability account and crediting a revenue account. Examples of deferred revenues include rent received in advance, subscription fees, and customer deposits.

For example, on January 29h, a company may have received $5,000 in advance for services to be provided next month. The adjusting entry would be.

5. Prepaid expenses

These are expenses that have been paid in advance and need to be recognized over time as they are used up or consumed. Adjusting entry for prepaid expenses involves debiting an expense account and crediting an asset account. Examples of prepaid expenses include prepaid rent, insurance, and supplies.

For example, a company may have paid $6,000 on 30th March for rent for the next six months. The adjusting entry would be.

6. Depreciation expenses

These are expenses that reflect the gradual loss of value of an asset over time. An adjusting entry for depreciation expenses would involve debiting an expense account and crediting an accumulated depreciation account. Examples of assets that may be depreciated include buildings, equipment, and vehicles.

For example, XCF Company purchased equipment for $20,000 on July 1st with a useful life of five years and a salvage value of $2,000. The adjusting entry would be.

7. Provisions

These are expenses that a company is likely to incur in the future and need to be recognized now. Examples of provisions include bad debt provisions, warranty provisions, and restructuring provisions.

For example, a company may need to create a bad debt provision of $5,000 for outstanding invoices that are unlikely to be paid. The adjusting entry would be.

Conclusion

Adjusting entries are an important aspect of the accounting process that helps ensure the accuracy of financial statements. Adjusting entries also helps comply with accounting standards, provide a complete picture of the business, facilitate better decision-making, and improve financial analysis.

By making adjustments, businesses can ensure that their financial statements accurately reflect their financial position and performance, which is crucial for making informed business decisions and building stakeholder trust.