Definition of Adjusting Entries
Adjusting entries are usually made on the last day of an accounting period (year, quarter, month) so that a company's financial statements comply with the accrual method of accounting. In other words, the adjusting entries are needed so that a company's:
- Income statement reports the revenues that have been earned during the accounting period
- Balance sheet reports the receivables that it has a right to receive as of the end of the accounting period
- Income statement reports the expenses and losses that were incurred during the accounting period
- Balance sheet reports the liabilities it has incurred as of the end of the accounting period
Examples of Adjusting Entries
Here are a few examples of the need for adjusting entries:
- A company shipped goods on credit, but the company's sales invoice was not processed as of the end of the accounting period
- A company received some goods from a vendor but the vendor's invoice had not been processed by the company as of the end of the accounting period
- A company that prepares monthly income statements paid for 6 months of insurance coverage in the first month of the insurance coverage. (This means that 5/6 of the payment is a prepaid asset and only 1/6 of the payment should be reported as an expense on each of the monthly income statements.)
- A company's customer paid in advance for services to be provided over several accounting periods. Until the services are provided, the unearned amount is reported as a liability. After the services are provided, an entry is needed to reduce the liability and to report the revenues.
Note that a common characteristic of every adjusting entry will involve at least one income statement account and at least one balance sheet account.
