The 5 types of adjusting entries
Now that we’ve covered the basics, let’s take a look at the five most common types of adjusting entries, and how each might apply to a company’s financial record.
Prepaid expenses are things you’ve paid for upfront but haven’t yet used in full, and are considered company assets. Common examples of prepaid expenses include insurance policies, rent, and necessary supplies or materials.
Because prepayments are considered assets, the initial journal entry of your purchase would debit the asset, and credit the amount paid. Often, prepaid expenses require an adjusting entry at the end of a financial year, and an additional one when the asset’s value has been fully incurred.
Let’s say your company purchased 12 months of rent upfront for $20,000 in October 2021. In December, you would make an adjusting entry reflecting the use of three months' rent like so:
February 5, 2021
|Rent expense: $5,000||Prepaid rent: $5,000|
On September 30, 2022 (when the 12 months have expired), you would create another adjusting entry reflecting the rest of your prepaid rent (nine months or $15,000).
Depreciation adjusting entries are used to spread out the cost of a fixed asset over time. Often, depreciation is recorded at the end of every year, until the estimated lifetime of the asset is complete.
For example, if your company purchased a delivery van at the beginning of 2021 for $40,000, and you expect to sell it for $5,000 after 10 years of use, you would want to spread out the remaining $35,000 over the next 10 years ($3,500 each year) using straight-line depreciation.
To account for depreciation, you debit the depreciation expense and credit the accumulated depreciation.
December 31, 2021
|Depreciation expense - Delivery van: $3,500||Accumulated depreciation: $3,500|
Each year you will use your depreciation adjusting entries to update your balance sheet on the remaining value of the asset as well.
An accrued expense basically means that you owe somebody something. Whether your employees are waiting on a commission check, or you owe a client money for materials, these expenses need to be reflected in an adjusting entry.
For example, if you take out a loan from the bank on July 1 for $10,000 with 4% interest, you will need to make an adjusting entry at the end of the year reflecting the accrued expense of your interest so far.
December 31, 2021
|Accrued expense - loan interest x 6 months: $200||Accounts Payable: $200|
Accrued revenue (or accrued income) adjusting entries reflect money that is owed to you. Let’s say your company makes a contract to provide three months of services to a client in January, at $500 per month. If the client agrees to pay you after the three months are up, you will make an adjusting entry reflecting your accrued revenue like so:
January 1, 2021
|Accounts receivable: $1,500||Accrued revenue: $1,500|
This category of adjusting entries is also known as unearned income, deferred revenue, or deferred income. Essentially, it refers to money you’ve been prepaid by a client before you’ve done the work or provided services. In the accrual system, this unearned income is seen as a liability and should be credited.
For instance, if a client pays you $500 for a machine rental upfront in August, but you won’t be delivering the machine until the following month, your adjusting journal entry would look like this:
August 1, 2021
|Cash: $500||Unearned income: $500|
Depending on your source, accounting professionals may recognize only four categories of adjusting entries, or up to seven. Additional types might include bad debts (or doubtful accounts), and other allowances.