Adjusting Entries: Definition, Types & Examples

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  • 0:00 What Are Adjusting Entries?
  • 0:29 Prepaid Expenses
  • 2:28 Accrued Expenses
  • 3:38 Unearned Revenue
  • 4:16 Accrued Revenue
  • 5:02 Lesson Summary
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Lesson Transcript
Instructor: Tina Van Rikxoord
Adjusting entries are a very important part of the accounting cycle because they ensure that you are reporting the company's financial situation accurately. In this lesson, you will learn which accounts need adjusting and how those adjustments are made.

What Are Adjusting Entries?

Adjusting entries are journal entries made at the end of an accounting cycle to update certain revenue and expense accounts and to make sure you comply with the matching principle. The matching principle states that expenses have to be matched to the accounting period in which the revenue paying for them is earned.

There are four main types of accounts that need to be adjusted:

  1. Prepaid expenses
  2. Accrued expenses
  3. Unearned revenues
  4. Accrued revenues

Prepaid Expenses

Prepaid expenses are expenses that have been paid in advance, like paying your rent for six months all at one time. The thing is, you can't actually record the whole six months of rent as an 'expense' right away because the money really hasn't been spent yet. For instance, what if something happens three months into your lease which prevents you from renting the office, and the landlord has to return some of your money? Right now, that prepaid rent is actually an asset.

According to the matching principle, you have to match the cost of the rent for each month to money earned in that month. So, when you first make a prepaid expense payment, you record the entire amount as an asset. At the end of each successive accounting period, you can record the used-up portion of the prepaid expense as an expense. Prepaid expenses that need an adjusting entry usually include things like rent, insurance and office supplies.

For example, your first month's rent is due on March 1. Your office rent is $500 per month, and you decide to pay for an extra six months all at once - April to September. On March 1, you give the landlord $3,500 in cash and record the transactions in your journal like this:

First, you record a regular journal entry for the $500 payment as a debit for rent expense and a credit to cash.

Rent Expense Journal Entry

You also record a regular journal entry for the $3,000 that you paid in advance as a debit to prepaid rent and a credit to cash like this:

Prepaid Rent Journal Entry

In April, you'd make an adjusting entry to account for the used-up of part of the prepaid rent by recording a $500 rent expense as a debit and crediting $500 as prepaid rent. You now have a balance of $2,500 in your prepaid rent account.

Rent from Prepaid rent

Finally, in May, June, July, August, and September, you'd make more adjusting entries to record the rent expense payments in the same was as you did in April. The balance in the prepaid rent account will be $500 less each month, so after recording the September payment, the balance in the prepaid rent account would be zero.

Rent for six months

Accrued Expenses

Accrued expenses are expenses that build up over the accounting period, but you don't pay for them until after you use them, like utilities. Think about your own utility bill: all month long, you accrue charges for the utilities you're using, like heat, light, and water. You don't know how much your bill will be until after you receive one from the utility company, so you can't even pay for the energy you used until the end of the month. This makes it a payable, or a liability, which is the amount you owe. Unlike prepaid expenses, which need multiple adjusting entries, accrued expenses require only one adjusting entry for the amount of the expense. Accrued expenses include things like utilities, employee wages, employee salaries, interest, and taxes.

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