What are Adjusting Entries?

#Businesses are divided into accounting periods. And in each financial period, the financial statements have to be accurately created. Further, it is crucial to create adjusting entries at the end of each accounting period. Adjusting entries ensures that revenue and expenses are recognized when they occur by updating previously recorded journal entries. In this blog, let’s learn more about the adjusting entry in detail.

What are Adjusting Entries?

Adjusting entries is a significant step of the accounting cycle in every accounting period. It refers to the changes made in the already recorded journal entries. Adjusting entries record any unrecognised income or expenses at the end of the accounting period. So, when a transaction begins and ends with a particular accounting period, it is vital to properly account for each transaction. Plus, it results in accounting accuracy and remains up-to-date.

Adjusting entries also means financial reporting that rectifies an error in the previous fiscal year. The major objective of the adjusting journal entries is to change cash transactions to an accrual accounting method. So, what is accrual accounting? It depends on the revenue recognition principle that identifies revenue earned in that specific period rather than the period where cash was received.

Adjusting Entries example

Adjusting journal entries can be understood better with an example. Take, for example, a landscaping business, assume that the company started the work and didn’t invoice the customer for over 6 months till the completion of work. At the end of each month, the construction company must make an adjusting journal entry to acknowledge revenue equivalent to 1/6 of the total amount to be invoiced after the six-month period.

Adjusting entries consists of the income statement account (profit or expense) together with a balance sheet account(asset or liability). Generally, it pertains to balance sheet accounts such as accumulated depreciation, allowance for doubtful accounts, accrued expenses, accrued income, prepaid expenses, deferred revenue, and unearned revenue.

Some of the income statement accounts that need to be adjusted include interest expense, insurance expense, depreciation expense,?and revenue. All the entries are made on the basis of the matching principle to match expenses to the relevant revenue in the same fiscal year. So as the adjustments are made in the journal entries, it is later carried over to the General Ledger which then flows to the financial statements.

Also Read :?The Role of Journal Entries in Accounting

Significance of Adjusting Entries

Before tallying at the end of the accounting period, it is vital to understand the purpose of adjusting entries. The major importance is that it is hugely helpful in tracking all the receivables and payables. Further, it helps in identifying all the profit or loss in every financial year.

If the financial statement is taken without adjusting journal entries, then the financial health of the business is affected. The net income and owner’s equity will be exaggerated, while expenses and liabilities will be understated. To avoid such scenarios, using adjusting journal entries and accrual basis is pivotal.

Finally, an adjusting entry is crucial for depreciating assets as it will be useful for reporting tax deductions and balancing the book at the end of an accounting period.

Click here to read more about Types & Automation for Adjusting entries.