Adjusting Journal
In accounting/accountancy, adjusting journal are journal entries usually made at the end of an accounting period to allocate income and expenditure to the period in which they actually occurred.
• The only way of changing account balances is to make journal entries.
• Account balances cannot be changed without journal entries.
• If current account balances do not represent correct amounts, journal entries are needed to change current balances to the correct balances.
Types of Adjusting Journal
The two major types of adjusting entries are:
Accruals: for revenues and expenses that are matched to dates before the transaction has been recorded.
Deferrals: for revenues and expenses that are matched to dates after the transaction has been recorded.
Why Needed?
• Current account balances may not represent correct balances due to following reasons:
a. Company made mistakes in preparing journal entries in the past.
b. Accounting records are not updated to reflect new transactions or amount changes in previous transactions.
• Adjusting journal entries are usually prepared at the end of an accounting period to update account balances to reflect correct balances as of the balance sheet date (the date at the end of an accounting period).
• The timing differences in recognizing revenues and expenses between accrual basis and cash basis accounting are frequently corrected by adjusting journal entries.
Steps for Adjusting Journal
Step 1: Identify the original journal entries that have been made during the period.
Step 2: Identify the correct account balances.
Step 3: Analyze the differences between correct and current balances and prepare journal entries to adjust such differences.
Example
On December 1, 2009 Company A signed an insurance contract and paid $3,000 cash as insurance premium for three months. Company recorded $3,000 as prepaid insurance on December 1, 2009. Prepare adjusting journal entries at December 31, 2009.
Step 1 Identify the original journal entries that have been made during the period.
Debit Credit
Prepaid insurance 3,000
Cash 3,000
Step 2 Identify the correct account balances.
On December 31, 2009, $1,000 insurance premium should be recognized as an expense for December.
Insurance expense 1,000 (Debit Balance)
Prepaid insurance 2,000 (Debit Balance)
Insurance expense for 2009 = $3,000 x 1/3 = $1,000
Step 3 Analyze the differences between correct and current balances and prepare journal entries to adjust such differences.
Accounts Correct Current Correct - Current
Insurance expense 1,000 0 1,000
Prepaid insurance 2,000 3,000 (1,000)
To adjust these differences, following adjusting journal entry is needed.
Debit Credit
Insurance expense 1,000
Prepaid insurance 1,000
Credit side of prepaid insurance (an asset account) represents a decrease.
