Lesson 12: Adjusting Entries
12.1 Introduction
If you recall during our discussion of the accounting cycle, adjusting entries are booked before
financial statement are prepared. The purpose of accounting entries is to bridge the gap between
the activity that was recorded and the activity that was actually incurred. Furthermore, adjusting
entries ensure that all assets and liabilities are recorded using the accrual method of accounting.
To illustrate, we will divide our discussion between common asset adjustments and common
liability adjustments.
12.2 Asset Adjusting Entries


Cash- As outlined in our discussion earlier, cash is usually reconciled through a bank
reconciliation. Common adjusting entries would include, but are not limited to, the
deposits in transit, outstanding checks, and miscellaneous charges. The purpose is to
ensure that the cash amount recorded on the balance sheet appropriately reflects cash on
hand.
Prepaids- Whether it is prepaid salaries, insurance, or rent, prepaid assets represent a
common asset that requires adjusting entries. For example, companies may prepay rent
for multiple years at a time. At the balance sheet date, let’s assume, 12/31, the prepaid
asset on the balance sheet must reflect the amount remaining. To illustrate, let’s assume
on 6/30/2012 you prepay $24,000 rent for a period of 2 years.
At 6/30/2012 you would book the following entry:
Account
Prepaid Rent
Cash
Debit
24,000
Credit
24,000
However, at the balance sheet date of 12/31/2012, you have to properly reflect the
amount of prepaid rent you have left. Thus, you have to adjust the prepaid rent for the
expense incurred over 6 months. $24,000 is for 2 years’ worth of rent, thus 1 years’
worth of rent would be $12,000. As we only used 6 months’ worth, you would need an
adjusting entry for $6,000:
Account
Rent Expense
Prepaid Rent
Debit
6,000
Credit
6,000
Thus, your ending prepaid rent balance would be property reflected at $18,000.
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
Interest Receivable-When you loan out money, you expect to accrue and earn
interest. However, payment terms may vary and you have to properly reflect the amount
of interest you have accrued. To illustrate, let’s assume your company gave a loan of
$5,000 on 6/30/2012 with an annual interest rate of 10% payable on 6/30/2013.
Assuming a 12/31/2012 year end, you would need to reflect the 6 months’ worth of
interest you have earned. Thus, $5,000 * 10% = $500 annual interest. Divide by 2, you
would have earned $250 of interest over 6 months. To reflect this, you would book the
following entry:
Account
Interest Receivable
Interest Income

Debit
250
Credit
250
Equipment- As we discussed earlier, equipment would be depreciated over its useful
life. As you are familiar with this calculation, we will discuss application only. At the end
of an accounting cycle, you would ensure that the accumulated depreciation reflects total
depreciation accumulated up to 12/31.
12.3 Liability Adjusting Entries

Interest Payable- Often times companies may take out loans and incur interest. It is
important to properly reflect the amount of interest that has been incurred through the
end of the year. The theory is the same as receiving interest, but will just involve different
accounts. For example, let’s assume on 11/1/2012, your company borrows $1,000 from
the bank with the first payment of interest on 5/1/2013. The interest rate is 5%.
To find the amount of interest you incurred for 2012, the first step is to find the annual
interest. At 5%, your annual interest would be $50 (1,000*.05). However, keep in mind,
for 2012, interest was only outstanding for 2 months. Thus you must take 2 months
worth of $50 and record that as your adjusting entry; (50 * (2/12))= 8.33. Thus the
adjusting entry will be as follows:
Account
Interest Expense
Interest Payable
Debit
8.33
Credit
8.33
As your first payment is not until 5/1/2013, your books will properly reflect the amount
you owe up until 12/31.

Accounts Payable- There are situations where a company gets a service done, let’s say
cleaning, but doesn’t receive the invoice until the following year. This still requires the
company to book a liability to reflect the services received. For example, let’s say on 12/1
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your company solicits cleaning services for $200, however, the invoice doesn’t arrive
until 1/7/2014. On your 12/31 books, you must reflect this liability as follows:
Account
Cleaning/Maintenance Expense
Accounts Payable

Credit
200
Salaries Payable- Company’s usually will have a payment structure of weekly,
biweekly, or monthly to remit salary to employees. Naturally, as employees aren’t
physically paid every day, there will be a lag. For purposes of our example, let’s say a
company has a policy to pay their employees every Friday. We’ll assume monthly
payments total $62,000 for all employees. For the month of December 2013, the last
payment falls on Friday 12/27, leaving 4 days of payments that will fall in the next cycle.
These 4 days will need to be reflected in the books. The first step is to find the amount of
payment per day. As December has 31 days and total payments for the month is
$62,000, we can see salary accrued per day is $2,000. Multiply that by 4 days, you will
see $8,000 worth of salary have still yet to be paid. Thus, you must book the following
entry:
Account
Salary Expense
Salary Payable

Debit
200
Debit
8,000
Credit
8,000
Unearned Revenue- Unearned Revenue represents when a company is paid for goods
or services, but have yet to deliver goods or perform services. To illustrate, let’s assume a
customer approaches you to provide him with accounting services. He pays half the fee
upfront of $5,000 at the end of the year; however, you won’t be performing the services
until the following January. At the end of the year, you have to record reflect the cash
received:
Account
Cash
Unearned Revenue
Debit
5,000
Credit
5,000
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Keep in mind that you could have performed a part of the services. However, the concept
still holds true and you would reflect the amount that you have not performed. Come
January, when you have performed the services, you would reverse the Unearned
Revenue:
Account
Unearned Revenue
Service Revenue
Debit
5,000
Credit
5,000
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