Adjusting entries are often necessary at the end of an accounting period to make adjustments to the balances in the company's general ledger accounts. These entries, called AJEs (adjusting journal entries), are first recorded in the adjusting journal and they bring accounts such as depreciation, amortization, inventory, liabilities, loan balances and accruals up to date so the financial statements accurately reflect the company's financial condition. AJEs can also be be used to correct errors in posting original transactions. Each AJE involves at least one debit entry and at least one credit entry, along with a written explanation of the purpose of the AJE.
Record depreciation expense and amortization expense for the period. Depreciation schedules track the used portion of fixed assets' useful lives, such as property, plant and equipment. Amortization schedules track the used portion of intangible assets' useful lives, such as start-up costs, patents, loan points and copyrights. Make these AJEs by posting a debit to the depreciation or amortization expense accounts and a credit to the accumulated depreciation account or the accumulated amortization account. Write an explanation below each of these transactions in the adjusting journal, such as, "To record depreciation (or amortization) expense for the year ending 12/31/20XX."
Adjust inventory accounts by crediting the amount used in production during the period to the inventory account and debiting an equal amount to the cost of goods sold account. Write an explanation under the entry in the adjusting journal, such as, "To record inventory used for the year ending 12/31/20XX." There may be many inventory accounts if each item is tracked separately, and this requires an entry to each of the inventory accounts. Just be sure that the total credits to these accounts is equal to the total debits to cost of goods sold.
Bring loan balances up to date by making AJEs to the short term and long term loans payable and loans receivable accounts. Short term loan balances are the amounts payable or receivable within one year. Long term balances are those amounts payable or receivable over periods longer than one year. These balances are usually adjusted at the end of the year so the amounts due during the subsequent year are segregated from the remainder of the loans. Debit the long term loan amounts for the amounts equal to the next fiscal year's payments, and credit these amounts to short term loan accounts. Write an explanation such as, "To adjust short term/long term loan balances (payable or receivable) for the year ending 12/31/20XX."
Accrue amounts owed and receivable at the end of a period that will be paid or received during the next period by recording them with adjusting journal entries. For example, if employees have earned wages during one period, but will not be paid until the subsequent period, record payroll liabilities by crediting wages payable and debiting wage expense. Sales made during the current period which customers will pay for during the next period require a debit to accounts receivable and a credit to sales. Expenses incurred during the current period which the company will pay during the next period require a credit to accrued expenses and a debit to an appropriate expense account. Write an explanation such as, "To accrue wages earned at 12/31/20XX, payable on 1/31/20XX."
Correct errors in posting with AJEs to provide transparency in the accounting for the period. It's possible with some accounting software to simply go back to the original entry and correct the error there, but using AJEs for these corrections acknowledges that an honest error was made, recognized and corrected. Changing original entries after they are made may raise the suspicion that someone is trying to cover up mistakes or even illegal activity.
- Make adjusting journal entries at the end of any period financial statements will be prepared. These may be monthly or quarterly financial statements (interim financial statements) or annual financial statements. Explanations for interim financial statements include the period for which the adjustments are made, such as " . . . for the month ending January 31, 20XX," or " . . . for the quarter ending March 31, 20XX." The explanation should be clear enough so you have no trouble remembering why the entries were made when looking at them later.
- As these adjusting entries are made to the adjusting journal, remember to also post them to the appropriate general ledger accounts. Most accounting software, such as QuickBooks, make these postings to the general ledger automatically when you enter them in the adjusting journal.
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