Adjusting Entries in Accrual Accounting: A Definitive Guide For Businesses

In accrual accounting, you record transactions as they are incurred, regardless of when cash changes hands. This means some transactions begin in one accounting period and are completed in another. To recognize these transactions properly, you need to record a special type of journal entry called an adjusting entry. Below, we discuss the definition, importance, and types of adjusting entries.

What Are Adjusting Entries?

Adjusting entries are entries you record in your general journal at the end of an accounting period to recognize revenue earned or expenses incurred from a transaction that began in a previous accounting period. Typically, this occurs during the following scenarios:

• Accrued Revenues: You render a service or sell a product and send an invoice or bill to the customer. You provide value in the present but will only receive payment in the future.
• Accrued Expenses: You are billed for a service or product that you recently used. You receive value in the present but pay later.
• Deferred Revenues: A customer pays for a product or service in advance. You receive payment in the present but provide value later.
• Deferred Expenses: Also known as prepaid expenses, deferred expenses are expenses incurred for future access to a product or service. They occur when you pay for a product or service in advance.

Why Are Adjusting Entries Important?

Adjusting entries ensure that your revenue and expenses are recorded in the period they are actually earned or incurred. Without them, your financial statements would misrepresent your financial position, overstating or understating income and expenses for a given period. Accurate adjusting entries lead to reliable income statements and balance sheets, which in turn support better business decisions and tax compliance.

Types of Adjusting Entries

Deferred Expenses (Prepaid Expenses)

Deferred expenses, also known as prepaid expenses, are expenses incurred for future access to a product or service. They occur when you pay for a product or service in advance. Examples of deferred expenses include prepaid rent, insurance, reservations, and annual subscription payments.

Below, we illustrate the concept with a concrete example. Last January, you paid EpicBooks $1,800 upfront for a full year of access to expert bookkeeping services. Your initial entry credits assets to acknowledge the loss of cash and debits expenses to acknowledge the prepaid expense.

Initial Entry

Account	Debit	Credit
Prepaid Expense (Asset)	$1,800
Cash (Asset)		$1,800

Each month, you acknowledge that the service has been rendered by moving $150 from the prepaid expense account balance to your bookkeeping expense account balance. This debits bookkeeping expenses and credits prepaid expenses.

Monthly Adjusting Entry

Account	Debit	Credit
Bookkeeping Expense (Expense)	$150
Prepaid Expense (Asset)		$150

You will add a new adjusting entry per month until the full $1,800 has moved from the prepaid expense account to the bookkeeping expense account.

Deferred Revenues

Deferred revenues occur when a customer pays for a product or service in advance. You receive payment in the present but provide value later. From the perspective of EpicBooks in the example above, your $1,800 upfront payment would be recorded as deferred revenue (a liability) until the service is rendered. As each month of service is delivered, EpicBooks records an adjusting entry that moves a portion of the deferred revenue into earned revenue. You will add new adjusting entries per payment the client makes.

Accrued Expenses

When you accrue expenses, you acquire a product or service and pay for it at a later date. For example, a vendor bills you $500 for graphic design services rendered in December, but you only pay your bill in January. The initial entry records the expense and the liability in December.

Initial Entry (December)

Account	Debit	Credit
Graphic Design (Expense)	$500
Accounts Payable (Liability)		$500

When you pay your bill, you create an adjusting entry for the decrease in cash and the elimination of your accounts payable liability.

Adjusting Entry (January)

Account	Debit	Credit
Accounts Payable (Liability)	$500
Cash (Asset)		$500

Accrued Revenues

Accrued revenue is the reverse of accrued expenses: you rendered a service or sold a product to a customer, but they have yet to pay. You record the revenue and an accounts receivable asset in the period the value was provided, then create an adjusting entry to recognize the cash and eliminate the receivable once payment arrives.

Depreciation

You can use adjusting entries to update account balances with changes in value that are less straightforward to calculate. Typically, bookkeepers use adjusting entries to account for depreciation expenses. Below, we provide an example.

You bought office furniture worth $4,000. It is projected to depreciate by $250 per year. To record depreciation expenses, debit $250 to depreciation expenses and credit the same amount to accumulated depreciation, which is considered a contra asset.

Annual Depreciation Adjusting Entry

Account	Debit	Credit
Depreciation Expense (Expense)	$250
Accumulated Depreciation (Contra Asset)		$250

Adjusting Entries vs Closing Entries

Adjusting entries are journal entries recorded at the end of a transaction period to update previous entries as changes in value take effect. Meanwhile, closing entries transfer balances from temporary accounts (which reflect balances over a specific accounting period) to permanent accounts (which reflect long-term financial status). Closing entries reset temporary account balances to accurately reflect financial health for the upcoming accounting period.

Leave Your Adjusting Entries to EpicBooks

Books often keep business owners too busy. Leave the manual load of financial management to the experts at EpicBooks to free your schedule for higher-impact business activities. At EpicBooks, we provide journal entry, reporting, fixed asset tracking, account reconciliation, transaction recording, and other bookkeeping services. We tackle your business journals so you can tackle your business journey.

Read the EpicBooks services page for more information.