Accounting adjustments definition
/What are Accounting Adjustments?
An accounting adjustment is a business transaction that has not yet been included in the accounting records of a business as of a specific date. Most transactions are eventually recorded through the recordation of (for example) a supplier invoice, a customer billing, or the receipt of cash. Such transactions are usually entered in a module of the accounting software that is specifically designed for it, and which generates an accounting entry on behalf of the user.
However, if such transactions have not yet been recorded as of the end of an accounting period, or if the entry incorrectly states the impact of the transaction, the accounting staff makes accounting adjustments in the form of adjusting entries. These adjustments are designed to bring the company's reported financial results into compliance with the dictates of the relevant accounting framework, such as Generally Accepted Accounting Principles or International Financial Reporting Standards. The adjustments are primarily used under the accrual basis of accounting.
Accounting adjustments can also apply to prior periods when the company has adopted a change in accounting principle. When there is such a change, it is carried back through earlier accounting periods, so that the financial results for multiple periods will be comparable.
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Types of Accounting Adjustments
An accountant can employ an array of accounting adjustments, of which the most common are as follows:
Accrued revenues. These are revenues earned but not yet received or recorded by the end of the accounting period. An adjusting entry records the revenue and a corresponding receivable to reflect earnings accurately.
Accrued expenses. These are expenses that have been incurred but not yet paid or recorded. The adjustment ensures the expense is recognized in the period it was incurred, along with a liability.
Deferred revenues. These are payments received before the related revenue has been earned. An adjustment transfers the appropriate portion from a liability to revenue as the earnings process progresses.
Prepaid expenses. These are payments made in advance for goods or services to be used in future periods. Adjusting entries allocate the expense to the current period as the benefit is consumed.
Depreciation adjustments. Depreciation spreads the cost of a long-term asset over its useful life. An adjustment records the periodic depreciation expense and reduces the asset’s book value via accumulated depreciation.
Amortization of intangible assets. Amortization is the gradual expense recognition of intangible assets like patents or trademarks. The adjustment reflects the portion of the asset’s cost applicable to the current period.
Inventory adjustments. These adjustments reflect changes in inventory levels due to usage, shrinkage, or obsolescence. They help ensure that cost of goods sold and ending inventory are accurately reported.
Bad debt expense adjustments. This adjustment estimates the portion of receivables that may become uncollectible. It ensures revenues are not overstated by matching bad debts to the period in which the related sales occurred.
Examples of Accounting Adjustments
An example of an accounting adjustment is altering the amount in a reserve account, such as the allowance for doubtful accounts or the inventory obsolescence reserve. For example, the following journal entry increases the amount in the allowance for doubtful accounts by $10,000, to reflect an increased risk of bad debts being incurred. The offset to this entry is a current-period charge of $10,000 to the bad debt expense account.
Another example is to recognize revenue that has not yet been billed. This is common in longer-term contractual arrangements where the seller is not allowed to bill until the end of the contract. The following sample journal entry is used to increase the amount of recognized revenue by $8,000, while parking the offset in an unbilled receivables account. When the customer is eventually billed, the entry is a debit to accounts receivable and a credit to unbilled receivables.
A common example of an accounting adjustment is to recognize expenses for a supplier invoice that has not yet been received. This is a common entry for a business that closes its books within a short period of time, and cannot wait for slower suppliers to issue their invoices. In the following sample journal entry, a business records $20,000 of raw materials inventory that it had received prior to month-end, but for which no invoice had yet been received. Once the dilatory invoice eventually arrives, the actual charge is recorded in accounts payable, while the accrued liability is reversed.
Reversing Entries
Some of these accounting adjustments are intended to be reversing entries - that is, they are to be reversed as of the beginning of the next accounting period. In particular, accrued revenue and accrued expenses should be reversed. Otherwise, inattention by the accounting staff may leave these adjustments on the books in perpetuity, which may cause future financial statements to be incorrect. Reversing entries can be set to automatically reverse in a future period, thereby eliminating this risk.
How Adjusting Entries are Made
Adjusting entries are made with a journal entry. Every journal entry contains a minimum of one debit entry and one credit entry, and may contain many more (which is known as a compound entry). The totals of all debits and credits entered into a journal entry must equal the same amount; otherwise, your accounting software will not accept the entry. Ideally, these journal entries should be set up as templates, which are standardized forms that already have the correct account numbers entered into them. Templates save time and also reduce the number of journal entry errors.
Accounting Adjustment FAQs
What is the difference between an adjusting entry and a correcting entry?
An adjusting entry updates account balances at period-end to recognize accrued, deferred, or estimated amounts under accrual accounting. A correcting entry fixes an error made in a prior entry, such as a wrong amount, account, or classification. Thus, one records needed period-end changes, while the other repairs mistakes.
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Accrual-Type Adjusting Entries