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
Examples of accounting adjustments are as follows:
Altering the amount in a reserve account, such as the allowance for doubtful accounts or the inventory obsolescence reserve.
Recognizing revenue that has not yet been billed.
Deferring the recognition of revenue that has been billed but has not yet been earned.
Recognizing expenses for supplier invoices that have not yet been received.
Deferring the recognition of expenses that have been billed to the company, but for which the company has not yet expended the asset.
Recognizing prepaid expenses as expenses.
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.
Accounting Adjustment Best Practices
It can be time-consuming to formulate and record an accounting adjustment, and there is also a risk that the adjustment will be incorrect. Given these concerns, it makes sense to minimize the use of accounting adjustments. This can be accomplished by establishing a threshold level below which no adjustments will be made. Any proposed transactions below this threshold level are ignored, because they will have an immaterial impact on the resulting financial statements. This best practice can also reduce the amount of time required to close the books at the end of a reporting period and produce financial statements.
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.
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Accrual-Type Adjusting Entries