Adjusting entries are most commonly used in accordance with the matching principle to match revenue and expenses in the period in which they occur. Year end (fiscal) or reporting period adjustments to the financial statements are recorded with adjusting entries. The purpose of adjusting entries is to ensure both the balance sheet and the income statement faithfully represent the account balances for the accounting period. Navigating Law Firm Bookkeeping: Exploring Industry-Specific Insights Some cash expenditures are made to obtain benefits for more than one accounting period. Examples of such expenditures include advance payment of rent or insurance, purchase of office supplies, purchase of an office equipment or any other fixed asset. These are recorded by debiting an appropriate asset (such as prepaid rent, prepaid insurance, office supplies, office equipment etc.) and crediting cash account.

Unearned revenue is a liability created to record the goods or services owed to customers. When the goods or services are actually delivered at a later time, the revenue is recognized and the liability account can be removed. Prepaid expenses include goods or services that a company has paid for but not utilized yet. However, the company cannot take full benefit of it until the end of that six-month period. At the end of the accounting period, only expenses that are incurred in the current period are booked while the remaining is recorded under prepaid expenses.

What are examples of adjusting entries?

As one can see on each year’s balance sheet, the asset continues to be reported at its $150,000 cost. However, it is also reduced each year by the ever-growing accumulated depreciation. The asset cost minus accumulated depreciation is known as the book value (or “net book value”) of the asset.

This is posted to the Supplies T-account on the credit side (right side). You will notice there is already a debit balance in this account from the purchase of supplies on January 30. The $100 is deducted from $500 to get a final debit balance of $400.

When to Make Accounting Adjustments

In the second illustration, it was explicitly stated that financial statements were to be prepared at the end of March, and that necessitated an end of March adjustment. If your business is a corporation, and your corporation has declared a dividend payable to shareholders, the declared dividend needs to be recorded on the books. Assuming the dividend will not be paid until after year-end, an adjusting entry needs to be made in the general journal.

Under cash basis accounting process, it will be treated as income of 2003. Similarly under this system the expenditure of 2002 if paid in 2003, will be treated as an expenditure of 2003. For all these financial statements the accountant classifies the life of a business into several small periods. https://www.digitalconnectmag.com/a-deep-dive-into-law-firm-bookkeeping/ In a periodic inventory system, an adjusting entry is used to determine the cost of goods sold expense. This entry is not necessary for a company using perpetual inventory. A third classification of adjusting entry occurs where the exact amount of an expense cannot easily be determined.