Adjusting entries are usually made on the last day of an accounting period (year, quarter, month) so that the financial statements reflect the revenues that have been earned and the expenses that were incurred during the accounting period.
Sometimes an adjusting entry is needed because:
- revenue has been earned, but it has not yet been recorded.
- an expense may have been incurred, but it hasn't yet been recorded.
- a company may have paid for six-months of insurance coverage, but the accounting period is only one month. (This means that five months of insurance expense is prepaid and should not be reported as an expense on the current income statement.)
- a customer paid a company in advance of receiving goods or services. Until the goods or services are delivered, the amount is reported as a liability. After the goods or services are delivered, an entry is needed to reduce the liability and to report the revenues.
A common characteristic of an adjusting entry is that it will involve one income statement account and one balance sheet account. (The purpose of each adjusting entry is to get both the income statement and the balance sheet to be accurate.)