A numerical mistake within your accounting journals could lead to a landslide of problems by the end of an accounting period. Like one rock dislodging from a mountainside, one calculation error could cause further damage down the line of the fiscal period, resulting in a full-blown landslide of your business’s financial statements.
Therefore, your journal entries and accounting ledgers‘ periodic adjustment is required to ensure all transactions are accurately recorded. Adjusting journal entries throughout an accounting period will save you time, money, and a massive headache. So let’s take a look at how to account for these entry updates properly.
Why Adjust Journal Entries?
The accounting and bookkeeping process requires precise record-keeping to function correctly. All journal entries and records are needed to track the evolution of your business accounts. If not, mistakes and incorrect entries will rear their ugly head within your financial statements. These documents will then require amendments to reflect your company’s overall financial position accurately.
Depending on your business, and how often you choose to update your accounts (whether on a daily, weekly, or monthly basis), you will need to factor in ongoing adjustments. These adjustments made to original journal entries will update accounts for events that have occurred up to that specific point in time. For example, they will reflect the activity that has occurred over the lapsing of time from the date of the original entry until the date that the adjusting entry is recorded.
What are 3 Types of Adjusting Entries?
There are three general types of entry adjustments, those being:
The accrual accounting method is the process of recording a business’s transactions when an event occurs, rather than when a cash payment is received and/or issued. Accrual entries are most commonly used to reflect the existence of liabilities that will require future payment by the business.
For example, a business owner will need to anticipate future expenses and thus will journal accrual entities to reflect these future expenses. Most companies and corporations elect to use the accrual method of accounting in their books of record.
Adjusting entries to reflect accrued revenue is one of the primary forms of updating your business’s books. Suppose your business provides a service to one of your customers, completing the job over two different accounting periods, yet billing them and receiving payment after the second period once the work has been completed. That being said, you will want to reflect the portion of the revenue you earned in the first period when you close your accounting books of record for the first period.
Consequently, you will accrue into income the portion of the revenue attributed to the work completed in the 1st period, even though you will not send out a bill for all of the work until the remaining work is completed in the second period. The business owner would record this accrual of income at the end of the first period by debiting accounts receivable and crediting service revenue for the amount the services were valued, which was completed in the first period.
Accrued expenses work the same way as accrued revenue, just the other way around. Suppose your business must pay a utility expense for the amount of electricity you used within a month. Your accounting books and records should reflect this utility expense at the month-end period rather than when you receive the utility bill in the next month.
Inevitably, the actual amount of electricity that you used will be slightly different than what you estimated, which will ultimately require an adjusting entry to reflect this reconciliation of original estimate to the final determination of the expense. Here is an accrued expenses adjustment example.
Deferral adjustments can refer to both revenues and expenses. This occurs when a business receives payment or pays in advance of the service or product being supplied. The parties need to reflect this prepayment on their respective books being made in advance of the service or product being provided.
Deferred revenue, also known as unearned revenue, is the payment your business receives in advance of a job anticipated to be completed in the future. Suppose your business accepts an upfront deposit or advanced payment before starting and finishing a project to reserve a future contract. In that case, you will receive the cash deposit today and record this revenue as deferred revenue in your balance sheet accounts.
The deferral of expenses is when a company pays an expense currently, although the paid item is not fully consumed in the period in which it is paid. For example, you buy business supplies today that you use periodically over the following year.
Rent could be considered a deferred expense if you are required to pay it prior to the time it covers the premises’ use. Typically, you must pay your rent at the first of the month, yet you have not used the rented space at the time of payment. Deferred expenses can be found on the asset side of a balance sheet.
Estimates are used to reflect an item’s anticipated cost in the books and records before the final value is determined. Adjusting entries are subsequently required to reconcile the difference between the initial estimated cost and the final cost. As noted above, a business owner will often estimate his utility expense to reflect this in his books and records before he receives the utility bill.
Depreciation refers to allocating some amount of the cost of a fixed asset over the course of said asset’s expected useful life.
Suppose you purchase a large piece of equipment to make a product for your business. This newly acquired asset will start creating revenue for your company right away and continue to do so for years to come. Under the matching principle, you will spread the payment of this fixed asset in line with the revenue it generates for each accounting period.
For adjusting entries like this, you will need to debit the depreciation expense account, located on the income statement, while crediting the same amount to the accumulated depreciation account.
Making Adjustments for your Small Business
The type of business you run will dictate the type of adjustment that will need to be made in your accounting books. Expenditures and revenue are typically analyzed and reviewed at the end of each accounting period to ensure proper reporting and up-to-date recording. With the proper adjusting journal entries, you can stop the landslide before it starts.
As a small business owner, you will want to ensure that all of your original journal entries are up-to-date and reflect accruals, deferrals, and final numbers. If you require quality accounting software to help make journal adjustments easy, then QuickBooks accounting software has you covered.