In accrual basis accounting, adjusting journal entries are necessary because the exchange of cash does not always occur at the moment you purchase an item, provide services or incur an expense. Adjusting journal entries are completed at the end of an accounting period, and help to give a more accurate picture of a company’s financial status. These entries include accrued liabilities and assets, and deferred expenses and revenues.
Accrued revenues include items or services that you have delivered or performed but for which you have not yet received payment. When you bill your customer for the work you have completed, you start the process to recognize revenues that you have earned. You will recognize this revenue by recording the adjusting entry for accrued revenues, debiting the receivable account and crediting the revenue account. When you do receive a payment, you would then adjust your journal by debiting cash and crediting the applicable receivable account.
Unearned revenue, or deferred revenue, is the cash you receive for services you have not yet performed, or items you have not yet delivered. Unearned revenue is recognized as a liability until you deliver the item or perform the service. For example, when your customer gives you a deposit for services you will perform over the next year, you would debit cash and credit your unearned revenue account. Each month as you earn the monthly portion of the deposit, you would then prepare an adjusting journal entry by debiting the unearned revenue account and crediting the revenue account.
Accrued expenses or accrued liabilities are expenses that you incur but for which you have not issued payment. Accrued expenses include rent you owe for your office, interest on your business loans and your employees’ earnings that you have not yet paid. To recognize an accrued expense, prepare an adjusting journal entry by debiting the applicable expense account and crediting the matching payable account. When you issue payments, reverse the entry by debiting cash and crediting the expense payable account.
Also called deferred expenses, prepaid expenses include any expense that you pay but incur on a future date. Your insurance premium is an example of a prepaid expense. You pay the annual cost of your policy, but each month you would recognize the monthly portion of your payment. When you prepay an expense, you debit the applicable expense account and credit cash. When you prepare your monthly adjusting entries in your journal, you would then debit the applicable expense account and credit the prepaid expenses account.