This lesson explains what an adjusting journal entry is and how to determine the correct offsetting account. Furthermore there is a logical ordering system in creating adjusting journal entries and a section covers this method of identification and order. Finally I’ll provide some insight with how work papers use adjusting journal information to illustrate the changes in the account balances.
This lesson is instrumental in understanding the next two lessons related to a trial balance and closing the books. In preparation for this lesson please read the following:
Adjusting Journal Entry Fundamentals
It is rare for the books of record to be 100% accurate. Many small businesses have several hundred entries per day from a multitude of sources. This includes the high school kid at the front register to the mechanic entering a purchase order. Invariably they are prone to errors especially related to more complex transactions such as a return at the register. Errors exist in the books of record.
To fix these errors or set accounts to their correct balances accountants use adjusting journal entries.
The method of discovery is called reconciliation which is explained in detail in the advanced bookkeeping section of this website. During reconciliation, a discrepancy may be discovered. Discrepancies include errors, miscalculations, transposition issues, omissions and closing entries.
Obviously, a correcting value is inserted as a debit or credit. Where the bookkeeper has concern relates to identifying the account the offsetting debit or credit is posted. I explain to inexperienced bookkeepers that 9 times out of 10, the offset goes to the most common account that is the offset to the account under normal conditions. Here are some examples:
Payroll Taxes – After reconciling the end of the quarter for FUTA (Federal Unemployment Tax) the amount owed in payroll taxes payable for FUTA is too much. Since FUTA is traditionally sourced from payroll taxes under labor in the income statement, a debit entry is made to accrued payroll taxes, a current liability, with a control ID of FUTA reducing the liability. The offsetting credit is assigned to labor/payroll taxes on the income statement reducing its total dollar value too.
Loan Payment Interest – At the end of the year the bank sends a loan balance document (Form 1099-I) identifying interest paid and principle balance remaining. The interest paid year to date in the capital expenses section of the income statement is off $1.07. The bookkeeper also notices the principle balance under long-term debt for this note is also off $1.07. An adjusting journal entry is made using both interest expense and long-term debt to correct the balances.
Monthly Bank Fee – Each month the bank has a different fee for its services. On the last business day each month a fee is assessed and withdrawn from the bank account. A recurring entry debits bank fees under other costs in the expenses section of the income statement. The credit is to the respective checking account. The bookkeeper opens the entry and simply adjusts the dollar amounts involved to match the actual cost as reported by the bank.
Other adjusting entries include conforming entries or compliance requirements. An example of this includes the writing off of bad debt. The accounts receivable balance (normally a debit value) is credited to reduce its balance to a more realistic collectible balance. The offsetting debit is to bad debt over in the expenses section (usually the capital accounts section) of the income statement.
Here is a short list of some common adjusting journal entries:
C) Partner/Member Capital Accounts
D) Removal of Assets Related to Disposal
E) Unusual Sales of Fixed or Intangibles Assets
F) Contractual Closings or Compliance
G) Tax Payments/Obligations
H) Equity Section Adjustments Including Retained Earnings Adjustments
I) Write Down of Value Related to Assets
Again, anytime an account balance is adjusted for an error of omission, miscalculation or as a closing requirement an adjusting journal entry is used. There is actually a logical method to record this information.
Adjusting Journal Entry Methods and Records
There are four major methods of generating adjusting journal entries. Three of the methods involve the end of reporting periods including monthly, quarterly and yearly. The fourth method and one I encourage bookkeepers to adopt is called ongoing adjustments. Again the underlying reason to create adjusting journal entries is the correction of errors, miscalculations, omissions and as closing entries. Closing entries are generated at the end of accounting periods and are explained in more detail in Lesson 69. Corrections are sourced from reconciliations or contractual/legal compliance.
A coding method is required to identify the entry in the books as an adjusting entry. Use the following coding system for the end of accounting periods:
EOM – End of Month, during interim reporting periods use the acronym EOM and then a two digit sequential numbering system such as EOM-01, EOM-02 and so on. In addition, I like to add initials to the end of the identifier associating the entry to the author as illustrated below:
The creator/author is in parenthesis so future readers know who created this entry.
EOQ – End of Quarter
EOY – End of Year
Ongoing entries are identified as ADJ (Adjusting) along with a four digit sequential numbering system. The first two digits identify the month and the last two the particular entry for that month as follows:
ADJ-0516 (GOV) – Identifies this as an ongoing adjusting journal entry, ‘May’ and as the sixteenth adjusting entry for that month. The initials tie to the creator/author. This is important to understand, this entry may happen on any day in the month of May, this does not indicate the 16th day of May. Again use sequential entries starting with 01, and continuing to 02, then 03 …
As highlighted earlier, reconciliations are the primary driving force of adjusting journal entries. Other sources include:
* Depreciation Schedules – Fixed assets are depreciated each month requiring an entry. Recurring entries are the best tools to use for depreciation and amortization.
* Writing Off Uncollectible Accounts
* Corrections – Often job costs are incorrectly posted to either the wrong job or phase of construction; adjusting entries correct these mistakes.
* Classification Errors – Some errors are driven by lack of information. This often results in a misclassification of one side of the entry. Once the clarifying information is available, the entry can be adjusted.
Post the adjusting journal entry to the appropriate journal related to the subject matter. If unsure, use the general journal to record the entry.
Adjusting journal entries are also copied to work papers related to the respective account. The bookkeeping lessons to date have only touched base with work papers and this subject is covered in more detail in the advanced skills section of bookkeeping. As an example, an adjusting entry for a bank reconciliation is noted to that particular account’s spreadsheet in Excel via the actual identifier used. If ADJ-14 (GOV) is used in the books then note the exact same identifier on the respective spreadsheet. I take it one step further and copy the entry to the worksheet so future readers understand my debit and credit posting.
In the work paper and in the description field of the entry please be descriptive in the explanation. If an error from the original source document or via inputting the source entry, state it clearly. I can’t tell you how many times I simply stated ‘I screwed up’! The key is that it is now getting fixed.
Summary – Adjusting Journal Entries
Adjusting journal entries are used to correct errors, reconcile account balances, post closing entries, enter omissions and clarify information. Bookkeepers use a logical ordering method to indicate the type of entry including:
ADJ – Month/Sequential Number and Clerk’s Initials in Parenthesis; used for ongoing entries throughout the reporting period (month, quarter, year).
EOM – End of Month and Sequential Number
EOQ – End of Quarter and Sequential Number
EOY – End of Year and Sequential Number
In addition, accountants tie the entry to a work paper for that respected account. Finally, a very descriptive explanation is written identifying source documents and corresponding information as basis for the entry. ACT ON KNOWLEDGE.