A company records transactions in its accounting systems throughout the year. These transactions come from various sources. At the end of each financial year, it summarizes these transactions in a general ledger and then a trial balance. The next step within this process is preparing financial statements. However, companies must also pass adjusting journal entries before that.
What is an Adjusting Journal Entry?
An adjusting journal entry is a journal entry companies post in the general ledger at the end of each accounting period. As the name suggests, it allows companies to modify figures in the relative account before preparing financial statements. These figures relate to the income statement and balance sheet. For example, companies may use an adjusting journal entry for assets, liabilities, income, or expenses.
An adjusting journal entry helps companies conform to the accrual principle in accounting. This principle requires companies to record a transaction as it occurs. Usually, it impacts revenues and expenses only. However, this transaction may also affect the balance sheet through assets and liabilities. Adjusting journal entries are also crucial in preparing the adjusted trial balance.
How do Adjusting Journal Entries work?
Companies do not use a cash approach to accounting for transactions. Instead, they follow the accrual principle, where they must record transactions as they occur. Regardless of the timing of the cash settlement, these transactions enter the accounting system at the time of occurrence. Companies use this principle throughout the financial period.
The accrual principle also requires companies to post some adjusting journal entries. These entries occur at the end of the accounting period. Usually, they help companies record accrued and prepaid expenses or deferred revenues. Adjusting entries are also crucial in other areas, such as recording estimations and non-cash expenses. Once companies post these entries to the general ledger, they can prepare the financial statements.
What are the types of Adjusting Journal Entry?
Adjusting journal entries may differ from one company to another based on their business. However, these entries may fall into one of three broad categories. These include the following.
Prepayments or deferrals
A prepayment or deferral is an adjusting entry for revenues or expenses that companies have already recorded. However, the associated rewards with these transactions have not occurred at the end of the accounting period. For example, companies pay rent in advance and record it as a prepaid expense. The adjusting entry for this transaction is as follows.
|Cr||Cash or bank|
The same may apply to advances received from customers. The journal entry for this transaction may be as follows.
|Dr||Cash or bank|
Accruals are the opposite of prepayments. In this case, companies record an expense for which a settlement has not occurred. For example, companies record salaries and wages at the end of each month but may pay for it later. The journal entry for this transaction will be as follows.
Companies also use adjusting journal entries for non-cash expenses. For example, companies calculate and record depreciation on fixed assets at the end of each accounting period. The journal entry for this transaction is as follows.
Companies post an adjusting journal entry in the general ledger at the end of each accounting period. It may help record various types of transactions. For example, they may include prepayments, accruals, and non-cash expenses. Adjusting journal entries are a part of the accounting cycle. They are crucial in preparing the trial balance and financial statements.
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