Adjustment Accounts and Its Journal Entries

There are 2 types of adjustment entries in accounting (bookkeeping), they are: Deferral and Accrual Adjustment.

 

Deferral Adjustments

Deferral adjustments are used for updating accounts involving previously recorded transactions. These accounts are Unearned Revenues (Liability) and Prepaid Expenses (Asset):

 

[1]. Unearned Revenues: These are revenues that have been received but not earned by the business. This is a liability account because the money has not been earned by the business and could be returned to the customer for one reason or another.

Example:

These revenues can take the form of monthly magazine subscription dues that are paid on an annual basis. The magazine company received $1,200 from customers for subscription dues on January 1, 2008. The entry would be recorded as:

January 01’ 2008:

[Debit]. Cash = $1,200
[Credit]. Unearned Subscription Revenue = $1,200

As each month passes, the magazine company sends out the monthly issues and earns the revenue for that month. The adjustment to Unearned Subscription Revenue would be recorded as:

January 31’ 2008:

[Debit]. Unearned Subscription Revenue = $100
[Credit]. Subscription Revenue = $100
(Note: $1,200 / 12 = $100 per month)

These entries will continue until all magazines have been issued for the year, or the subscription money is returned to the customers as a refund. The Unearned Subscription Revenue account in the General Ledger will eventually have a balance of $0.

 

[2]. Prepaid Expenses: These are expenses that have been paid by the business but not used. This is an asset account because until the company uses these expenses, it might have the option of receiving its money back for one reason or another.

Example:

These expenses can take the form of monthly rent paid in advance for the entire year. On January 1, 2008, the company paid $12,000 in rent for the next 12 months. The entry would be recorded as:

January 01’ 2008:

[Debit]. Prepaid Rent = $12,000
[Credit]. Cash = $12,000

As each month passes, the business uses a portion of the prepaid rent and therefore records the expense during that month. The adjustment to Prepaid Rent would be recorded as:

January 31’ 2008:

[Debit]. Rent Expense = $1,000
[Credit]. Prepaid Rent = $1,000
(Note: 12,000 / 12 = 1,000)

These entries will continue until every month has passed, or the prepaid rent is returned as a refund. The Prepaid Rent account in the General Ledger will eventually have a balance of $0

 

Accrued Adjustments

Accrual Adjustments are used for including transactions not previously recorded. These accounts are Accrued Revenues (Asset) and Accrued Expenses (Liability).

[1]. Accrued Revenues: These are revenues that have been earned by the business but not yet received. These revenues are Accounts Receivable. The business has performed a service or sold a product, but the service or product has not been paid for.

Example:

On January 1, 2008, the body shop removed dents from a customer’s truck for $1,000. The customer picked up the truck and asked the body shop to bill him/her for the work performed. The entry would be recorded as:

January 01’ 2008:

[Debit]. Accounts Receivable = $1,000
[Credit]. Service Revenue = $1,000

Eventually, when the customer pays off his/her account, the Accounts Receivable relating to this transaction will be $0. The adjustment entry for the payment of the Accounts Receivable is:

February 15’ 2008:

[Debit]. Cash = $1,000
[Credit]. Accounts Receivable =$1,000

 

[2]. Accrued Expenses: These are expenses that have been incurred by the business but not yet paid. These expenses are Accounts Payable.

Example:

The business has used electricity for the month of January 2006, but it has not been billed. However, the business knows this will need to be paid. The entry would be recorded as:

January 31’ 2008:

[Debit]. Utilities Expense = $100
[Credit]. Accounts Payable = $100

Eventually, when the business is billed and pays for the electricity, the Accounts Payable relating to this entry will be $0. The adjustment entry for the payment of the Accounts Payable is:

February 15’ 2008:

[Debit]. Accounts Payable = $100
[Credit]. Cash = $100

Author: Lie Dharma Putra

Putra is a CPA. His last position, in the corporate world, was a controller for a corporation in Costa Mesa, CA. After spending 15 years as a nine-to-five employee, he decided to serve more companies, families and even individuals, as a trusted business advisor. He blogs about accounting, finance and tax, during his spare time, and helps accounting students (around the globe) to understand the subject matter easier , faster. Follow him on twitter @LieDharmaPutra or add him to your circle at Google Plus Lie+

9 thoughts on “Adjustment Accounts and Its Journal Entries”

  1. Good website for basic and advance accounting. I want to know the journal and reversing entry for deferred tax asset.

  2. the illustration is understandable and enjoyable. could you please do me an example on trading account?

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