With few exceptions, most businesses undergo a variety of changes that require adjustment entries. We'll show you how to rectify everything from bad debts to depreciation to keep your books organized.
Certain end-of-period adjustments must be made when you close your books. Adjusting entries are made at the end of an accounting period to account for items that don't get recorded in your daily transactions. In a traditional accounting system, adjusting entries are made in a general journal.
Some adjusting entries are straightforward. Others require judgment and some accounting knowledge. You will have to decide if you are going to tackle some or all adjusting entries, or if you want your accountant to do them. If your accountant prepares adjusting entries, he or she should give you a copy of these entries so that you can enter them in your general ledger.
The following might require adjusting journal entries:
- Accrue wages earned by employees but not yet paid to them
- Accrue employer share of FICA taxes due
- Accrue property taxes
- Record interest expense paid on a mortgage or loan and update the loan balance
- Record prepaid insurance
- Adjust your books for inventory on hand at period end
- Accrue interest income earned but not yet received
- Record depreciation expense
- Adjust for bad debts
- Accrue dividends payable if a corporation
- Accrue income taxes payable if a corporation
- Account for the sale of fixed assets
- Set up accounts receivable balance if your day-to-day books are maintained on a cash basis
- Set up accounts payable balance if your day-to-day books are maintained on a cash basis
After all adjusting entries are made, do the following to complete your books for the accounting period:
- Foot the general journal.
- Post the general journal totals to the general ledger.
- Foot the general ledger accounts to arrive at the final, adjusted balance for each account.
- Prepare an adjusted trial balance using the general ledger balances.
- Prepare financial statements using the adjusted trial balance.
Accommodating accruing wages payable
If you have employees, chances are you owe them a certain amount of wages at the end of an accounting period. If so, an adjusting entry is required in your general journal.
On December 31, 2013, you owe your employees one week of salary that will be paid on January 7, 2014. The gross wages for that week are $1,512.00. Make the following general journal entry:
|To accrue wages owed but unpaid on 12/31/2013.|
Accommodating accruing employer FICA taxes
One component of the payroll taxes you deposit with the government is FICA tax (made up of Social Security and Medicare taxes).
Generally, one-half of FICA is withheld from employees; the other half comes from your coffers as an expense of the business. The amounts are a little different in 2012 because of the payroll tax break. If you have payroll taxes due at the end of an accounting period that will be paid next period, you should accrue the employer share of FICA that is due at the period end by creating an adjusting entry in your general journal.
Example: On January 4, 2014, you deposit payroll taxes due as of December 31, 2013. The deposit includes FICA taxes of $420.50. One-half of that ($210.25) is the employer share that has not yet been recorded on the books. Make the following general journal entry:
|Payroll taxes expense||210.25|
|Payroll taxes payable||210.25|
|To accrue employer share of FICA owed but unpaid on 12/31/2013|
Accruing real property taxes and other related charges
Example: Do you pay property taxes on buildings or land? Your tax payment may not be due for several months, but in reality, you incur one-twelfth of your annual property tax bill every month. At the end of the accounting period, you should make an adjusting entry in your general journal to set up property taxes payable for the amount of taxes incurred but not yet paid.
Estimated property taxes of $5,200 were assessed on July 1, 2013, for the 12-month period to end on June 30, 2014. The first payment of the first half-year tax is due on March 1, 2014. As of December 31, 2013, no payments have been made on this assessment although the half-year estimate is owed, even though not due until March 1. You need to accrue six months of property taxes ($2,600) as of December 31, 2013. Make the following general journal entry:
|Property tax expense||2,600|
|Property tax payable||2,600|
|To accrue six months' property tax owed but unpaid on 12/31/2013|
Adjusting interest and loan balances
If you've been making monthly payments on a loan, you will probably need to make an adjusting entry in your general journal at year-end so the correct amount of interest expense is on your books, and the loan balance as of year-end is correctly shown on your books.
Example: Your monthly mortgage payment is $1,200. Of course, each monthly payment is part interest, part principal. If you record the correct amount of interest and principal in your cash disbursements journal every month, no adjusting entry would be necessary. An example of such a cash disbursements journal entry:
Chances are you do not correctly record both interest and principal every month. Do you simply put the entire debit amount to the mortgage payable account every month? Or do you put the entire debit amount to the interest expense account?
Either way, you will need an adjusting entry so your period-end books show the proper amount of interest expense and mortgage payable. You should have an amortization schedule, or a statement from your lender, showing you the amount of interest paid for the year and the year-end loan balance. (If you don't have one, your accountant can prepare one for you.)
As mentioned in the previous example, your monthly mortgage payment is $1,200, and you make the following entry in your cash disbursements journal every month:
Because you haven't recorded interest expenses every month, you refer to the statement from your lender. It shows that you paid a total of $7,560.49 in interest for the year. You make the following adjusting entry in your general journal:
|To adjust for mortgage interest paid in 2011.|
Or, assume that you've been making the following cash disbursements journal entry every month:
Because you have been charging the entire payment to interest every month, you need to refer to the statement from your lender. You find that a total of $6,839.51 was paid in principal for the year. Make the following adjusting entry:
|To adjust for mortgage balance at Dec. 31, 2011|
Recording depreciation expense and adjusting for bad debts
At the end of an accounting period, you must make an adjusting entry in your general journal to record depreciation expenses for the period. The IRS has very specific rules regarding the amount of an asset that you can depreciate each year. You don't have to compute depreciation for your books the same way you compute it for tax purposes, but to make your life simpler, you should. Consult your accountant about how to compute depreciation.
More than likely, your accountant will make this adjusting entry for you, or your accountant may be able to provide you with a schedule showing the amount of depreciation for each asset for each year.
Example: Your business has equipment and a building. Using a depreciation schedule provided by your accountant, you determine that current period depreciation is $3,400 on the equipment, and $2,550 on the building. You need to make the following adjusting entry to record depreciation expense and update your accumulated depreciation accounts:
|Accumulated depreciation equipment||3,400|
|Accum. depreciation building||2,550|
|To record depreciation for the period ended 12/31/10|
Adjusting for bad debts
Do you extend credit to your customers? If so, do you have any accounts receivable at year-end that you know are uncollectable? If so, the end of the year is a good time to make an adjusting entry in your general journal to write off any worthless accounts.
Example: You extend credit to your regular customers, and normally do not experience any trouble collecting from them. Considering you rarely have trouble collecting from your customers, you have not set up a reserve for bad debts. However, as you review your accounts receivable at year-end, you notice that a particular customer, now insolvent, still owes you $750. You are certain that you will never be paid. Write off this account by making the following adjusting entry:
|Bad debt expense||750|
|To record bad debts for the year ended 12/31/2010|
If you extend credit to numerous customers, and your experience is that a certain number of your sales on account will be uncollectable, you should probably set up a reserve for bad debts. That way, your books and financial statements will more accurately reflect your true financial picture. At the end of every year, you should evaluate your accounts receivable and adjust your allowance for bad debts accordingly. Your accountant may be able to help you do this.
Example: After years of extending credit to your customers, and experience tells you that a small amount of your sales on account will never be collected. On December 31, 2013, you evaluate your accounts receivable. You estimate that $1,000 of your receivables will not be collectible.
On December 31, 2002, you estimated that $800 of your receivables at that time were uncollectable and your reserve for bad debts account in the general ledger currently reflects that $800 balance. You need to make the following adjusting entry to record this $200 increase in estimated bad debts:
|Bad debt expense||200|
|Allowance for bad debts||200|
|To adjust allowance for uncollectable accounts at 12/31/2013|
For what to do if you've written off a bad debt, but the customer later pays some or all of what he owes, see bad debt recoveries.
Accruing dividends and income taxes payable, and adjusting for the sale of fixed assets
If your business is a corporation, and your corporation has declared a dividend payable to shareholders, the declared dividend needs to be recorded on the books. Assuming the dividend will not be paid until after year-end, an adjusting entry needs to be made in the general journal.
Your corporation declares a dividend of $1.00 a share on December 31, 2013. There are 10,000 shares of common stock outstanding. The dividend will be paid on January 15, 2014. Make the following adjusting entry:
|To record dividends payable as of 12/31/2013|
Accruing income taxes payable
If your business is a corporation, it is a separate entity required to pay income taxes. After your accountant computes the income tax liability of the corporation, an adjusting entry should be made in the general journal to reflect the income tax expense for the year.
Example: Your corporation has made four estimated income tax payments of $3,000 each for its calendar-year 2013 tax liability. These payments were each recorded during the year in your cash disbursements journal as follows:
|Reserve for income. tax||3,000|
Because the four payments were made during the year, there is a debit balance of $12,000 ($3,000 x 4) in the reserve for income tax account on December 31, 2013.
Now, consider your corporate income tax return for the year ended December 31, 2013, has been completed, and it shows a tax liability for the year of $13,450. Because you've already paid in $12,000, you owe another $1,450 to the IRS. Make the following adjusting entry to reflect the income tax expense for the year and the amount of tax owed to the IRS at year-end:
|Income tax expense||13,450|
|Reserve for income tax||12,000|
|Income taxes payable||1,450|
|To record income taxes for the year ended 12/31/2013|
Adjusting for sales of fixed assets
Did you sell any fixed assets during the year? If so, you probably need to make an adjusting entry in your general journal to properly account for the sale. You may need to have your accountant help you with this type of transaction.
Example: On March 4, 2014, you sold a truck outright for $5,000. At the time of the sale, you made the following entry in your sales and cash receipts journal:
|Gain on sale of asset||5,000|
The truck had a cost of $24,000. As of December 31, 2013, you had taken $20,500 of depreciation on the truck. The adjusted basis of the truck is $3,500 ($24,000 cost minus $20,500 depreciated). Therefore, you have a gain of $1,500 on the sale ($5,000 received minus $3,500 basis). Make the following adjusting entry to take the truck off your books and reflect the correct amount of gain (or loss) on the sale:
|Gain on sale of asset||3,500|
|Accumulated depreciation truck||20,500|
|To adjust for sale of truck on 3/4/2014|
Adjustments relating to year-end accounts receivable and year-end accounts payable
If you prepare your financial statements using the accrual method, but maintain your books on a daily basis using the cash method, you normally do not make entries to your accounts receivable general ledger account during the accounting period. At the end of your accounting period, you need to make an adjusting entry in your general journal to bring your accounts receivable balance up-to-date.
Example: You keep your books on the cash basis, but your financial reporting and tax return are done on the accrual basis. You add up your accounts receivable ledgers and find that your total receivables are $16,500 on December 31, 2013. Your accounts receivable balance on December 31, 2012, which is currently shown in your general ledger, was $13,950. You need to make the following adjusting entries to update your year-end accounts receivable balance:
|To clear out 1/1/2012 accounts receivable balance|
|Reserve for income tax||16,500|
|To set up 12/31/2013 accounts receivable balance|
Adjusting year-end accounts payable
If you prepare your financial statements using the accrual method, but maintain your books on a daily basis using the cash method, you do not make entries to your accounts payable general ledger account during the accounting period. At the end of your accounting period, you need to make an adjusting entry in your general journal to bring your accounts payable balance up-to-date.
Example: You still keep your books on the cash basis, but your financial reporting and tax return are done on an accrual basis. You add up your accounts payable ledgers to that your total payables on December 31, 2013, are $2,650, consisting of merchandise purchases of $2,100, equipment repairs of $330 and an electric bill for $220.
Your accounts payable balance on December 31, 2012, which is currently shown in your general ledger, was $1,500. You look at the adjusting entries for last year and see that at the end of 2012 you owed $1,000 for merchandise purchases, $180 for advertising and $320 for a utility bill. You need to make the following adjusting entries to update your year-end accounts payable balance:
|To clear out 1/1/2012 accounts payable balance|
|Repairs and maintenance||330|
|To set up 12/31/2013 accounts payable|
As you can see from the discussions above, a variety of changes may require adjustment entries.