Introduction to Adjustment Entries
In accounting adjustment entries are made in the journal at the end of the accounting period. These types of entries are made in accrual based accounting based on the revenue recognition principle. Adjusting entries are made for income or expenses occurred in a previous time period at the time of preparing the financial statements or on the balance day.
Two Scenarios for adjustment entry:
In this scenario the income or expenses accrued but not recorded in the accounts. For example, if the payment for a machinery that is acquired in this month is paid the next month, an adjustment entry is made in this months account about the expenses next month.
In this scenario the income or expense is recorded but need to be deferred at a later time. For example, if the EMI payment is made for year in the month of January itself, a deferred entry must be made for every month by dividing the total amount by 12.
In a case of payments received before the goods are delivered also requires an adjustment entry. First the cash received is recorded then a deferral adjustment entry is made on the day the goods are invoiced.
Importance of adjustment entries:
So at the end of financial year the neat and clean balance sheet has to be presented to the stock holders. Not only to know the cash flow for the financial period, but also to calculate the profit and loss precisely adjustment entries are must. Even though adjustment entries are known as balance day entries, it can be done at the right time to avoid income and expense confusion.