Adjusting Entries: Definitions, Purpose, Types, and Examples

Learning Objective: Prepare the adjusting entries

What are adjusting entries?

Adjusting entries, also known as end-of-period adjustments, are journal entries made at the end of an accounting period to ensure that the accounts accurately reflect the revenues and expenses of the current period.

Purpose of Adjusting Entries

According to the accrual concept of accounting, revenue should be recognized in the period when it is earned, and expenses should be recognized in the period when they are incurred. Some business transactions impact revenues and expenses across multiple accounting periods. For instance:

• A service company might receive fees from clients spanning several periods.
• Prepayments may occur for expenses that cover multiple periods.

Adjusting entries allocates the appropriate portion of revenue and expenses to the relevant accounting period. They ensure that financial statements adhere to the accrual concept of accounting.

These entries assign revenue earned and expenses incurred to the correct accounting period.

When Adjusting Entries Are Made?

Typically, adjusting entries are made at the end of an accounting period. However, they can also be made at the end of a quarter, month, or even daily, depending on the company’s accounting procedures and business nature.

For the examples in this article, we’ll assume that adjusting entries are made at the end of each month.

Types and Examples of Adjusting Entries

Adjusting entries fall into four main types:

1. Accrued Revenues: These recognize revenue earned but not yet received. For instance, interest income accrued on investments.
2. Accrued Expenses: These account for expenses incurred but not yet paid. Examples include salaries owed to employees.
3. Prepaid Expenses: These adjust for expenses paid in advance. For instance, prepaid insurance.
4. Unearned Revenues: These address revenue received in advance. An example is unearned rent revenue.

Common Accounts Involved:

Balance Sheet Accounts

• Accumulated depreciation
• Allowance for doubtful accounts
• Accrued expenses
• Accrued income
• Prepaid expenses
• Deferred revenue
• Unearned revenue

Income Statement Accounts

• Interest expense
• Insurance expense
• Depreciation expense
• Revenue

Matching Principle

Adjusting entries follow the matching principle, ensuring that expenses are matched with related revenues in the same accounting period.

Let’s illustrate with an examples

On December 31, the following data were accumulated for preparing the adjusting entries for Kagitingan Realty:

• The supplies account balance on December 31 is PHP 1,375. The supplies on hand on December 31 are PHP 280
• The unearned rent account balance on December 31 is PHP 9,000 representing the receipt of an advance payment on December 1 of four months’ rent from tenants
• Wages accrued but not paid on December 31 are PHP 3,220
• Fees earned but unbilled on December 31 are PHP 18,750
• Depreciation of office equipment is PHP 2,900

Instructions

1. Journalize the adjusting entries required on December 31.

Requirement 1. Journalize the adjusting entries required on December 31

Case Problem (20 Points)

Instruction. Study carefully the subject topic. Identify and analyze the business transaction stated below and prepare the necessary requirements.

 

On February 29, the following data were accumulated for preparing the adjusting entries for Valientes Repair Shop: 

1. Valientes acquired office equipment on February 15, 2023, for his repair shop business. The cost of the equipment is PHP25,000. It was estimated to have a useful life of five years. It is estimated that after five years, the office equipment can be sold at a scrap value of PHP1,000. The company uses the straight-line method of depreciation.
2. On February 15, 2023, Valientes entered into a contract with Kagitingan to maintain the computers of Kagitingan for two months starting on February 15, 2023, up to April 15, 2023. On the same date, Kagitingan paid the total contract amount of PHP40,000 in full.
3. On February 19, 2023, Valientes purchased PHP5,000 worth of office supplies on account. By the end of the month, PHP2,000 worth of these supplies are still unused.
4. On February 29, 2023, Valientes received the electric bill for February amounting to PHP3,800. Valientes will pay this bill in March 2023.
5. On February 28, 2023, Valientes repaired the computer of Pedro for PHP15,000. Pedro was on an out-of-town trip so he could not pay Valientes. He told Valientes that he would pay for their services on March 1, 2023.

Requirement:

1. Journalize the adjusting entries required on February 29, 2016.