written by | April 28, 2022

Adjusting Entries - Types, Significance and Example

One of the basic aspects that need to be considered in the uplifting of the companies in the market is financial stability. The financial stability depends upon the structure of their transaction, expenses, and the overall record of that expenditure, without missing any entries or records. Therefore, an adjusting entry must be recorded when payment is due, pre-paid situation, etc. It is necessary to give considerable regard to the adjusting entries to generalise the total financial expenses and transactions in the financial statements. These adjusting entries record expenses, accrual of income, depreciation allowances, etc.

It plays an important role in maintaining the company's financial stability. It presents it in the market as a well-established and well-managed business. There are certain types of adjusting entries, like the entries that convert assets to expenses, entries that convert liabilities to revenue, entries regarding depreciation, entries regarding acquiring uncollected revenue, etc.

Did you know?

Adjusting entries do not contain any record of the cash amount and thus, do not affect liabilities.

What Is Adjusting Entry?

Adjusting entries are considered as those journal entries that are made in the financial aspects of the business. These entries are made to record and consider expenses made in a financial year. Still, their warrant or tenure is extended beyond the financial year. In simple words, every financial year regards the recording, managing, and updating of the accurate balance of the comprehensive accounting and financial transactions in the year. The basic goal of the adjusting entries is to reflect the total amount properly and accurately in the financial statements. 

Several transactions and expenses are not recorded in the journals during the transaction year, which proves beneficial at the end of the financial year. These adjusting entries in accounting play an important role in finalising and summarising the total records of financial statements. The basic adjusting entries are done for accrual of expenses, accrual of income, depreciation, allowances, etc.

Also Read: Accounting Cycle: Definition and Steps in the Accounting Cycle Process

Why Are Adjusting Entries Important?

Keeping the update and record of the adjusting entries is essential for any business. The company is dependent on these adjusting entries because these are the direct and a Consider reflection of the financial stability and the managed financial structure of that particular company. The adjusting journal entries will provide all of the financial expenses in a transaction that is taken place in the whole financial year, which provides a clear picture of the financial stability. In the absence of the adjusting entry, the company's financial structure will show a mismatch of the financial entries.  There might be several entries missing in the financial statement giving a bad picture of the company's financial stability, which affects the trading and business to a great extent.

Not only for large-scale firms, but adjusting entries is also important for small-scale companies. It plays a vital role in managing the accurate financial statement, understated expenses, and the revenue that appears to be low because of some missing entries, which are not recorded on General Ledger.

Types of Adjusting Entries

There are certain types of adjusting entries recorded in the book of accounts. Some of them are

  1. Accrued revenue: Accrued revenue is termed as that revenue that has not been recorded in the Ledger. The company has provided a certain service to any individual, and the invoice for that service is not yet issued, and the payment is not received. Therefore, the adjusting entry must record an account receivable value and a CR sales revenue.
  2. Accrued expenses: Accrued expenses are those expenses evaluated before they are being paid to any individual. The acquired expenses include the utility expenses as well as the wages that are paid to the employees. For example, the salary of an employee who did the work in January will be paid for that work in February.
  3. Unearned revenues: Unearned revenues are those amounts that are being paid in balance for a particular service or delivery of goods. Therefore, the adjusting journal entry must be prepared for recording and evaluating these revenues that must be matched during payment. 
  4. Pre-paid expenses: The pre-paid expenses are those expenses that need to be paid before the delivery of the service, i.e., renting a commercial space as well as the payment for advertising, insurance, etc. All of these are the category of pre-paid expenses; an adjusting entry must be made for recording these pre-paid expenses.
  5. Depreciation: Depreciation is the decrement in the amount of a certain product, which could be building equipment or the economic life of any asset. Therefore, this depreciation must be recorded and evaluated in the adjusting entry to provide the proper financial structure in the financial statement.

Also Read: Learn About Bookkeeping: Definition, Types & Importance

Example of Adjusting Entries

Adjusting entries in accounting is one of the basic considerations when evaluating and managing the financial statement. To describe the types of addressing entries with examples, consider a company with a certain number of individuals working as an employee. The overall financial statement was created in December at the end of the year. Therefore, the conditions under which the adjusting entries are maintained are

  1. If accrued expense is considered, the salary of certain company employees has not been paid to the employees and is not recorded in the Ledger. Considering the total salary as ₹50,000, the adjusting entry will be made in the following manner:

Sl. No

Ref. Date

Title and Explanation

Debit

Credit

1

December 31st

Salaries expense.

₹10,000

 
   

Salaries payable.

 

₹10,000

   

Adjusting entry for the unpaid salaries.

   
  1. The closing tenure of the company is considered to be December. Let’s assume the company provides service at the beginning of December, for which the payment will be made in the next month after the end of the tenure. Therefore, the accrued revenue will be written and recorded in adjusting entry in the given manner:

Sl. No

Ref. Date

Title and Explanation

Debit

Credit

1

December 31st

Accounts receivable.

₹3,500

 
   

Service revenue.

 

₹3,500

   

Adjusting entry for the accrued service.

   
  1. Considering the payment of the rent of the commercial space acquired by the company to be ₹15,000, which is paid quarterly, as ₹5000 per month. The adjusting journal entry must be recorded in the following manner:

Sl. No

Ref. Date

Title and Explanation

Debit

Credit

1

December 31st

Cost of rent.

₹5,000

 
   

Prepaid amount.

 

₹5,000

   

Adjusting entry to convert prepaid entry into expense.

   
  1. A membership provided by that company, whose total evaluation is ₹2000, is earned at the end of the month. Therefore, this amount is termed the unearned revenue, and the adjusting entry for such revenue can be expressed as:

Sl. no

Ref. Date

Title and Explanation

Debit

Credit

1

December 31st

Unearned revenue.

₹2,000

 
   

Service revenue.

 

₹2,000

   

Adjusting entry for recording the unearned revenue.

   

Conclusion

Adjusting entries are one of the basic aspects of maintaining and regulating the financial stability of a company. The adjusting entry is described as a journal where all of the expenses made or yet to be made are being recorded for the proper management of the financial transaction during the recording and evaluation of the financial year’s financial statement. 

There are various important aspects of adjusting entries, not only for large-scale industries but also for small scale businesses. These adjusting journal entries directly reflect the financial stability of that company, which provides an upper hand in the market. There are several types of adjusting entries, including accrued revenues, accrued expenses, unearned revenues, pre-paid expenses, depreciation, etc. The basic principle of maintaining adjusting entry is to record all expenses and transactions made that are either pre-paid or paid after the services and are not recorded in the general ledger.

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FAQs

Q: What do you mean by ledger in accounting?

Ans:

A ledger in accounting can be the compilation of all the transactions and expenditures undertaken by a company or a business. It is a book that records all the entries of the transaction. The adjusting entries in final accounts play an important aspect in evaluating the overall edger. It helps create the trial balance and prepare the financial statement.

Q: What are the types of adjusting entries?

Ans:

The adjusting entries are categorised into several groups: accrued revenue, accrued expenses, unearned revenue, prepaid expenses, depreciation, etc. Each of these transactions must be recorded in the adjusting accounts to maintain and regulate the financial statement during the closing of the financial year.

Q: What is the importance of adjusting entries in accounting?

Ans:

The adjusting entry plays an important role, not only for the large-scale business but also for the small-scale business. Its basic motto is to maintain the expenditure structure as well as the management of the financial statement of that particular company. With the managed and regulated financial structure, the company will have the upper hand in the market.

Q: What do you mean by adjusting entries?

Ans:

The adjusting journal entries are those records that are being evaluated based on accrued expenses, accrued revenues, unearned revenues, depreciation, etc., to maintain the financial stability of a company. Without adjusting entry, there will be various missing transactions, which would have affected the overall financial structure of the final budget statement.

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