What are adjusting entries in accounting?
It’s easy to see when adjusting entries are made. They’re necessary when you want to make changes in journal entries. They are especially important if we’re talking about already recorded numbers in specific accounting periods.
In other words, adjusting entries are irreplaceable in order to correctly reflect the way your business spends and gets the money. It is quite easy to understand the way they work, but we’ll get to specific examples, as you keep reading the article.
How they work
Here is a clear example of how adjusting entries actually work. Let’s imagine that your company bills a client for $1,000 for your services in June. However, they’ll pay you only in July. At this point, you already recorded this amount as your income you’re expecting to get quite soon.
Nevertheless, a client unexpectedly asks for a discount. If you decide to grant this discount, you’ll eventually have less income. Therefore, you’ll have to return to your journal entries and change them. This is when adjusting entries come into play, as you need to correct the final amount you get next month.
If you imagine that you can simply cross out the old information replacing it with new details, it doesn’t work like this. Instead, you just create a new entry correcting the old one. This will help you keep the numbers accurate and concise. Besides, you’ll record the expenses in the same accounting period as necessary.
Below, you see a picture demonstrating to you how adjusting entries look.
In the “Notes” section, you can write all the adjustments you consider necessary.
Why adjusting entries are so important for any business
As you already understand, making adjusting entries is extremely important. They allow you to see how money moves in your business. At the same time, you can make all the records when they’re required. You can also correct them if something changes (e.g. expenses are increased for some reason).
Here is a reasonable question you may ask: What happens if I don’t make adjusting entries at all? The answer is quite simple, but let’s look at this question in detail:
- You won’t be able to match up your income and expenses.
- Tracking your revenue in an accurate way will be a huge problem.
- The worst thing is that your financial statements will be wrong.
- All those problems will lead your business to inaccurately filed taxes and inappropriate business decisions.
Therefore, you have to make adjusting entries if you do care about the future of your business. Sure, making them on your own can be a problem. Just keep reading to learn your options.
Who should work with adjusting entries
You can try to keep the records on your own. It all depends on what accounting system you’re using. If you prefer to use the accrual system, you’ll need to make adjusting entries anyway.
However, if your choice falls on the cash basis system, you can forget about this step. Although it’s still recommended to make adjusting entries, especially if you hire a bookkeeper or an accountant who knows what to do.
What types of adjusting entries exist
Let’s describe all the types of adjusting entries you can come across. There are only five of them, and it’s easy to figure out what is the main difference between them all.
- Accrued revenues: You’ve already earned revenue, but you can’t recognize it until the sales invoice is processed.
- Accrued expenses: Some expenses have been incurred, but you’ll need to pay for them later.
- Deferred revenues: A certain amount of money was received in advance without you having the work done yet.
- Deferred expenses: A certain amount of money was paid in advance.
- Depreciation expenses: It’s applied if an asset was purchased in a certain period, but its cost must be allocated.
As you can see, all the types are quite straightforward and easy to remember. Once you’ve figured out what the first type means, it becomes easier with others. Here, we also present them as a picture for you to remember the information easier.
Make sure to remember all of them, as they’re necessary to keep your business thriving. Working without adjusting entries is a bad idea, as you won’t be able to track your own finances accurately. If you don’t feel like you can handle this part yourself, you should hire a professional to help you instead.