Adjusting Entries

Definition

Adjusting entries are journal entries made at the end of an accounting period to record any unrecognized income or expenses for the period. These entries are necessary to ensure that the financial statements accurately reflect the company's financial position.

Adjusting entries are made after the trial balance is prepared but before the financial statements are issued. They are used to update the accounts to reflect the actual activity that occurred during the period.

Example

For example, let's say a company has a prepaid insurance policy that covers the next six months. At the end of the first month, the company has used one month of the policy but has not yet recorded the expense. To accurately reflect the company's financial position, an adjusting entry must be made to record the expense.

The adjusting entry would be a debit to the insurance expense account and a credit to the prepaid insurance account. The debit would be for the amount of the insurance expense for the month and the credit would be for the amount of the prepaid insurance that was used up.

Why it Matters

Adjusting entries are important because they ensure that the financial statements accurately reflect the company's financial position. Without adjusting entries, the financial statements would be incomplete and inaccurate.

Adjusting entries also help to ensure that the company's taxes are calculated correctly. Without adjusting entries, the company's taxable income would be understated, resulting in a lower tax liability than is actually due.

Adjusting entries are also important for internal decision making. Without adjusting entries, the company's financial statements would not provide an accurate picture of the company's financial position, making it difficult for management to make informed decisions.

In summary, adjusting entries are an important part of the accounting process. They ensure that the financial statements accurately reflect the company's financial position and are necessary for accurate tax calculations and internal decision making.