Accounting – Importance and Preparation of Adjusting Entries
Adjusting entries are basically journal entries that you make at the end of accounting period to convert your business’s accounting records to the accrual basis of accounting. They ensure that your business’s balance sheet and income statement are up-to-date under the accrual basis of accounting (Also see Cash vs Accrual Accounting Methods).
The accrual basis of accounting requires you to match the expenses with the related revenue in the same accounting period. This means that you should report the expenses and revenues as they occur not when the cash is paid. However, sometimes you might delay in processing all financial transactions pertaining a specific accounting period at the end of that period. In this case, you will need adjusting journal entries. Besides, you will need adjusting entries if you have processed a bill during an accounting period but that amount represents an expense for a future accounting period.
Always remember that you should process or if you have engaged an accounting service in Singapore, your accountant will process the adjusting entries before issuing your business financial statements.
Guide to recording the adjusting entries
To record the adjusting entries effectively, follow these steps
- Identify the two accounts involved. In most cases, these accounts are the balance sheet account and the income statement account.
- Calculate the amount for adjusting entries
- Enter the adjusting figure in both accounts and the general journal
- You should designate the account that will be credited and one that will be debited
Types of adjusting entries
Adjusting entries can be classified as follows:
If you have earned revenue and other related receivables but the sales invoices haven’t been processed, you will need accrual type of adjusting entries to ensure that this accrued revenue is reported accurately in your business financial statements.
Sometimes, you might incur expenses and other related payables but you haven’t obtain the vendor’s invoices. For you to report such expenses in your company financial statements, you will need an accrual expense entry. For example, if your business incurred an expense on December 27th but expects to receive an invoice on January 2nd, you need to post the double entry accounting shown below.
Debit Insruance expense S$300
Credit Accrued expenses S$300
Accrual method of accounting requires you to defer all the revenue earned in advance to a liability account until the date they are supposed to be earned. For example, if you are paid $5,000 on December 9th for services that you will deliver later, you must determine how much of the $5,000 has been earned as of 31st December. The fraction of $5,000 that hasn’t been earned must be reported as a liability in your business balance sheet as of 31st December.
From the above example, if you earned $3,000 out of the $5,000, the remaining $2,000 should be the deferred revenue. You will need an adjusting account as shown below.
Debit Service income S$2,000
Credit Deferred revenue S$2,000
Adjusting entries are crucial in the financial reporting process. Understanding what they are and how to prepare them is a significant step in ensuring that your business financial statements are accurate.