An adjusting entry is a journal entry made at the end of an accounting period to record accruals that have occurred during that time period. Adjusting entries are common to ACCRUAL BASIS accounting, but they are not found in cash basis accounting. An accrual is an ASSET (other than cash), LIABILITY, equity account, revenue or expense that has accrued within a particular accounting period. In the case of a long-term note receivable, interest income will be earned each accounting period, although the interest income may not be received until the maturation of the note. Interest income will accrue over the life of the note, and it must be recorded as it is earned, not when it is received. In the case of a note payable, interest expense will accrue over time. As interest expense accrues, it must be recorded. The recognition and recording of such accruals is normally done at the end of the accounting period with adjusting entries.
As with most accounting entries, an adjusting entry is a double entry with one account being debited and another account credited. One of the entries will always be an INCOME STATEMENT account (either a revenue account or expense account), and the other entry will be a BALANCE SHEET account (either an asset, liability, or equity account). Because adjusting entries are necessary for the proper application of accrual-basis accounting, cash is never one of the accounts in an adjusting entry.
Frequently a trial balance is performed before the adjusting entries are made. The trial balance, consisting of a debit and a credit column, is a listing of all the ledger accounts with their net debit or net credit balances. The total of all the ledger accounts with debit balances should be equal to the total of all the accounts with credit balances. If the total debits are unequal to the total credits, an accounting error has been made. If there is equality, the trial balance signals the “green light” to proceed to the next step in the accounting cycle, the adjusting entries.
A trial balance constructed after the adjusting entries have been made is called an adjusted trial balance. As such, the adjusted trial balance includes all of the firm’s revenue and expense transactions for that accounting period—that is, the cash transactions and the accruals. If the total debits are equal to the total credits, the adjusting trial balance again signals a “green light” to proceed to the next phase of the accounting cycle.
See also DEBIT, CREDIT.