Introduction to Adjusting Journal Entries and Prepaid Expenses Video Tutorial & Practice

Continuing with our example of Bob and his company, Bob’s Donut Shoppe, Inc., we need to adjust his unadjusted trial balance at the end of the accounting cycle. Accumulated Depreciation appears in the asset section of the balance sheet, so it is not closed out at the end of the month. In this case, assume that the equipment depreciates at a rate of $100 per month, which is determined by dividing its cost of $6,000 by 60 months (five years). It has lost $100 of its initial value, so it is now worth only $5,900.

• At the end of your accounting period, you need to make an adjusting entry in your general journal to bring your accounts receivable balance up-to-date.
• This type of revenue is common in service-related businesses, as services can be performed several months before a customer is invoiced.
• In a periodic inventory system, an adjusting entry is used to determine the cost of goods sold expense.
• The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.
• The revenue recognition principle is the basis of making adjusting entries that pertain to unearned and accrued revenues under accrual-basis accounting.
• Deferred revenue indicate when a company receives payment in advance of work that has not yet been completed.

Revenue and expense accounts are affected on the income statement, and the balance sheet is adjusted based on whether the entry is an asset or liability. The use of adjusting journal entries is a key part of the period closing processing, as noted in the accounting cycle, where a preliminary trial balance is converted into a final trial balance. It is usually not possible to create financial statements that are fully in compliance with accounting standards without the use of adjusting entries. Thus, adjusting entries are created at the end of a reporting period, such as at the end of a month, quarter, or year. Income statement accounts that may need to be adjusted include interest expense, insurance expense, depreciation expense, and revenue. The entries are made in accordance with the matching principle to match expenses to the related revenue in the same accounting period.

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No matter what type of accounting you use, if you have a bookkeeper, they’ll handle any and all adjusting entries for you. Here’s an example with Paul’s Guitar Shop, Inc.,where an unadjusted trial balance needs to be adjusted for the following events. Advisory services provided by Carbon Collective Investment LLC (“Carbon Collective”), an SEC-registered investment adviser. During the month you will use some of these taxes, but you will wait until the end of the month to account for what has expired. A business license is a right to do business in a particular jurisdiction and is considered a tax. The word “expense” implies that the rent will expire, or be used up, within the month.

The adjusted entries are important to track, as they generally help to even out revenues and expenses on a month-to-month basis, and avoid inconsistent and unpredictable swings in spending and earning. This allows you to easily identify and get reports for adjusting journal entries. A third classification of adjusting entry occurs where the exact amount of an expense cannot easily be determined. The depreciation of fixed assets, for example, is an expense which has to be estimated.

Overview: What are adjusting entries?

The same adjusting entry above will be made at the end of the month for 12 months to bring the Prepaid Insurance amount down by $100 each month. Here is an example of the Prepaid Insurance account balance at the end of October. The $100 balance in the Supplies Expense account will appear on the income statement at the end of the month. The remaining $900 in the Supplies account will appear on the balance sheet. This amount is still an asset to the company since it has not been used yet. Let’s assume you used $100 of the $1,000 of supplies you purchased on 6/1.

You don’t have to compute depreciation for your books the same way you compute it for tax purposes, but to make your life simpler, you should. Generally, one-half of FICA is withheld from employees; the other half comes from your coffers as an expense of the business. The amounts are a little different in 2012 because of the payroll tax break. This is posted to the Unearned Revenue T-account on the debit side (left side).

What Is the Difference Between Cash Accounting and Accrual Accounting?

The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes Adjusting Journal Entries only and all users thereof should be guided accordingly. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Be sure to write off this account in your accounts receivable ledger, so that it agrees with your general ledger. With few exceptions, most businesses undergo a variety of changes that require adjustment entries. We’ll show you how to rectify everything from bad debts to depreciation to keep your books organized.