Definition, Purpose, Types

Adjusting Journal Entry: Definition, Purpose, Types
What Is an Adjusting Journal Entry?

An adjusting journal entry is an entry in a company’s general ledger that occurs at
the end of an accounting period to record any unrecognized income or expenses for
the period. When a transaction is started in one accounting period and ended in a
later period, an adjusting journal entry is required to properly account for the
transaction.
Adjusting journal entries can also refer to financial reporting that corrects a mistake
made previously in the accounting period.
Key Takeaways
 Adjusting journal entries are used to record transactions that have occurred
but have not yet been appropriately recorded in accordance with the accrual
method of accounting.
 Adjusting journal entries are recorded in a company’s general ledger at the
end of an accounting period to abide by the matching and revenue
recognition principles.
 The most common types of adjusting journal entries are accruals, deferrals,
and estimates.
 It is used for accrual accounting purposes when one accounting period
transitions to the next.
 Companies that use cash accounting do not need to make adjusting journal
entries.
Understanding Adjusting Journal Entries

The purpose of adjusting entries is to convert cash transactions into the accrual
accounting method. Accrual accounting is based on the revenue recognition
principle that seeks to recognize revenue in the period when it was earned, rather
than the period when cash is received.
As an example, assume a construction company begins construction in one period

but does not invoice the customer until the work is complete in six months. The
construction company will need to do an adjusting journal entry at the end of each
of the months to recognize revenue for 1/6 of the amount that will be invoiced at
the six-month point.
An adjusting journal entry involves an income statement account (revenue or

expense) along with a balance sheet account (asset or liability). It typically relates
to the balance sheet accounts for accumulated depreciation, allowance for doubtful
accounts, accrued expenses, accrued income, prepaid expenses, deferred revenue,
and unearned revenue.
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. The adjustments made in journal entries are carried
over to the general ledger that flows through to the financial statements.
Types of Adjusting Journal Entries
In summary, adjusting journal entries are most commonly accruals, deferrals, and
estimates.
Accruals
Accruals are revenues and expenses that have not been received or paid,
respectively, and have not yet been recorded through a standard accounting
transaction. For instance, an accrued expense may be rent that is paid at the end of
the month, even though a firm is able to occupy the space at the beginning of the
month that has not yet been paid.
Deferrals
Deferrals refer to revenues and expenses that have been received or paid in
advance, respectively, and have been recorded, but have not yet been earned or
used. Unearned revenue, for instance, accounts for money received for goods not
yet delivered.
Estimates
Estimates are adjusting entries that record non-cash items, such as depreciation
expense, allowance for doubtful accounts, or the inventory obsolescence reserve.
Not all journal entries recorded at the end of an accounting period are adjusting
entries. For example, an entry to record a purchase of equipment on the last day of
an accounting period is not an adjusting entry.
Why Are Adjusting Journal Entries Important?
Because many companies operate where actual delivery of goods may be made at a
different time than payment (either beforehand in the case of credit or afterward in
the case of prepayment), there are times when one accounting period will end with
such a situation still pending. In such a case, the adjusting journal entries are used
to reconcile these differences in the timing of payments as well as expenses.
Without adjusting entries to the journal, there would remain unresolved transactions
that are yet to close.
Example of an Adjusting Journal Entry
For example, a company that has a fiscal year ending Dec. 31 takes out a loan from
the bank on Dec. 1. The terms of the loan indicate that interest payments are to be
made every three months. In this case, the company’s first interest payment is to
be made on March 1. However, the company still needs to accrue interest expenses
for the months of December, January, and February.
Since the firm is set to release its year-end financial statements in January, an
adjusting entry is needed to reflect the accrued interest expense for December. To
accurately report the company’s operations and profitability, the accrued interest
expense must be recorded on the December income statement, and the liability for
the interest payable must be reported on the December balance sheet. The
adjusting entry will debit interest expense and credit interest payable for the
amount of interest from Dec. 1 to Dec. 31.
What Is the Purpose of Adjusting Journal Entries?
Adjusting journal entries are used to reconcile transactions that have not yet closed,
but that straddle accounting periods. These can be either payments or expenses
whereby the payment does not occur at the same time as delivery.
What Are the Types of Adjusting Journal Entries?
The main two types are accruals and deferrals. Accruals refer to payments or
expenses on credit that are still owed, while deferrals refer to prepayments where
the products have not yet been delivered.
What Is the Difference Between Cash Accounting and Accrual Accounting?
The primary distinction between cash and accrual accounting is in the timing of
when expenses and revenues are recognized. With cash accounting, this occurs only
when money is received for goods or services. Accrual accounting instead allows for
a lag between payment and product (e.g., with purchases made on credit).
Who Needs to Make Adjusting Journal Entries?
Companies that use accrual accounting and find themselves in a position where one
accounting period transitions to the next must see if any open transactions exist. If
so, adjusting journal entries must be made accordingly.
The Bottom Line
An adjusting journal entry is an entry in a company’s general ledger that records
transactions that have occurred but have not yet been appropriately recorded in
accordance with the accrual method of accounting. The entry records any
unrecognized income or expenses for the accounting period, such as when a
transaction starts in one accounting period and ends in a later period.
Adjusting journal entries can also refer to financial reporting that corrects a mistake
made earlier in the accounting period.

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Definition, Purpose, Types

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Adjusting Journal Entry: Definition, Purpose, Types

What Is an Adjusting Journal Entry?

Understanding Adjusting Journal Entries

As an example, assume a construction company begins construction in one period

An adjusting journal entry involves an income statement account (revenue or

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