What is an adjusting entry?
Adjusting entries are changes to journal entries you’ve already recorded. Specifically, they make sure that the numbers you have recorded match up to the correct accounting periods.
Journal entries track how money moves—how it enters your business, leaves it, and moves between different accounts.
Here’s an example of an adjusting entry: In August, you bill a customer $5,000 for services you performed. They pay you in July.
In August, you record that money as receivables—income you’re expecting to receive. Then, in July, you record the money as cash deposited in your bank account.
To make an adjusting entry, you don’t literally go back and change a journal entry—there’s no eraser or delete key involved. Instead, you make a new entry amending the old one.
Why make adjusting entries?
When you make an adjusting entry, you’re making sure the activities of your business are recorded accurately in time. If you don’t make adjusting entries, your books will show you paying for expenses before they’re actually incurred, or collecting long after you’ve earned it.
So, your income and expenses won’t match up, and you won’t be able to accurately track revenue. Your financial statements will be inaccurate—which is bad news, since you need financial statements to make informed business decisions and accurately file taxes.
Who needs to make adjusting entries?
If you do your own accounting, and you use the accrual system of accounting, you’ll need to make your own adjusting entries.
If you do your own accounting and you use the cash basis system, you likely won’t need to make adjusting entries.
No matter what type of accounting you use, if you have a bookkeeper, they’ll handling any and all adjusting entries for you.
Spreadsheets vs. accounting software vs. bookkeepers
Adjusting entries will play different roles in your life depending on which type of bookkeeping system you have in place.
If you do your own bookkeeping using spreadsheets, it’s up to you to handle all the adjusting entries for your books. Then, you’ll need to refer to those adjusting entries while generating your financial statements—or else keep extensive notes, so your accountant knows what’s going on when they generate statements for you.
If you use accounting software**, **you’ll also need to make your own adjusting entries. The software streamlines the process a bit, compared to using spreadsheets. And it will likely generate financial statements for you. But you’re still 100% on the line for making sure those adjusting entries are accurate and completed on time.
If you have a bookkeeper, you don’t need to worry about making your own adjusting entries, or referring to them while preparing financial statements. They’ll do both for you.
If you don’t have a bookkeeper yet, check out Bench—we’ll pair you with a dedicated bookkeeping team, and give you access to simple software to track your finances.
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The five types of adjusting entries
If making adjusting entries is beginning to sound intimidating, don’t worry—there are only five types of adjusting entries, and the differences between them are clear cut. Here are descriptions of each type, plus example scenarios and how to make the entries.
1. Accrued revenues
When you generate revenue in one accounting period, but don’t recognize it until a later period, you need to make an accrued revenue adjustment.
Your business makes custom tote bags. In February, you make $1,200 worth for a client, then invoice them. The client pays the invoice on March 7.
You incurred expenses making the bags—cost of materials and labor, workshop rent, utilities—in February. To accurately reflect your income for the month, you need to show the revenue you generated. (Remember: Revenue minus expenses equals income.)
First, you make an adjusting entry, moving the revenue from a “holding account” (accrued receivables) to a revenue account (revenue.) Then, on March 7, when you get paid and deposit the money in the bank, you move the money from revenue to cash.
Example adjusting entry
In your general ledger, the adjustment looks like this. First, during February, when you produce the bags and invoice the client, you record the anticipated income.
For the sake of balancing the books, you record that money coming out of revenue.
|Feb. 27||Accrued receivables||$1,200|
Then, when you get paid in March, you move the money from accrued receivables to cash.
|March 7||Accrued receivables||$1,200|
2. Accrued expenses
Once you’ve wrapped your head around accrued revenue, accrued expense adjustments are fairly straightforward. They account for expenses you generated in one period, but paid for later.
Suppose in February you hire a contract worker to help you out with your tote bags. You agree in advance to pay them $400 for a weekend’s work. However, they don’t invoice you until early March.
Example adjusting entry
In February, you record the money you’ll need to pay the contractor as an accrued expense, debiting your labor expenses account.
|February 21||Accrued expenses||$400|
|February 21||Labor expenses||($400)|
In March, when you pay the invoice, you move the money from accrued expenses to cash, as a withdrawal from your bank account.
|March 1||Accrued expenses||$400|
3. Deferred expenses
If you’re paid in advance by a client, it’s a deferred expense. Even though you’re paid now, you need to make sure the revenue is recorded in the month you perform the service and actually incur the expenses.
Over the years, you’ve become well-respected in the tote bag community. You’re invited to speak at the annual Tote Symposium, in Lodi, California.
The conference showrunners will pay you $2,000 to deliver a talk on the changing face of the tote bag industry. You invoice them in January, after you confirm you’ll be attending. They pay you in March.
Example adjusting entry
First, record the income on the books for January as deferred revenue. You’ll be crediting it from your consulting revenue account for now.
|January 6||Deferred revenue||$2,000|
|January 6||Consulting revenue||$2,000|
Then, in March, when you deliver your talk and get paid, move the money from deferred revenue to consulting revenue.
|March 7||Deferred revenue||$2,000|
4. Deferred expenses
Deferred expenses work a lot like deferred revenue. Except, in this case, you’re paying for something up front—then recording the expense for the period it applies to.
In early January, your thread supplier suddenly retires. It’s a knotty problem, so to speak, but you’re able to find a vendor store that can FedEx the same kind of thread to you, so you can complete your orders.
When you place the order and receive an invoice in January, you record it as a deferred expense.
Then, come February, when you pay the invoice, you move the money from deferred expenses to cash as a withdrawal.
5. Depreciation expenses
When you depreciate an asset, you make a single payment for it, but disperse the expense over multiple accounting periods. This is usually done with large purchases, like equipment, vehicles, or buildings.
The way you record depreciation on the books depends heavily on which depreciation method you use. It’s a pretty complex operation involving large sums. Considering the amount of cash and tax liability on the line, it’s smart to consult with your accountant before recording any depreciation on the books. To get started, though, check out our guide to small business depreciation.
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