Detailed Definition of Adjusting Journal Entry (AJE)
An Adjusting Journal Entry (AJE) refers to reconciliation entries made at the end of an accounting period to ensure that income and expenses are recognized in the correct period. These entries are vital for conforming to the accrual accounting requirements and for providing a true and fair view of the business’s financial position and performance.
Purpose of Adjusting Journal Entries
- Correct inaccuracies in the recorded amounts.
- Reflect expenses and revenues in the period they occur.
- Ensure compliance with Generally Accepted Accounting Principles (GAAP).
- Preparing accurate financial statements.
Types of Adjusting Journal Entries
- Accrued Revenues: Income earned but not yet recorded.
- Accrued Expenses: Expenses incurred but not yet recorded.
- Deferred Revenues: Income received but not yet earned.
- Deferred Expenses: Prepaid expenses that apply to future periods.
- Depreciation (and amortization): Allocating the cost of tangible and intangible assets over their useful lives.
Examples of Adjusting Journal Entries
Example 1: Accrued Revenue
A company provides consulting services worth $2,000 at the end of the year but has not yet billed the client.
Journal Entry:
Debit Accounts Receivable: $2,000
Credit Consulting Revenue: $2,000
Example 2: Prepaid Expenses
Rent of $1,200 is paid in advance for January next year.
Journal Entry:
Debit Prepaid Rent: $1,200
Credit Cash: $1,200
Example 3: Depreciation
A business records annual depreciation of $5,000 on equipment.
Journal Entry:
Debit Depreciation Expense: $5,000
Credit Accumulated Depreciation: $5,000
Example 4: Accrued Expense
Wages of $3,000 are earned by employees at year end but are not yet paid.
Journal Entry:
Debit Wages Expense: $3,000
Credit Wages Payable: $3,000
Frequently Asked Questions (FAQs)
Q1: What is the primary objective of AJEs?
- The main objective is to align the financial statements with the income and expenses that belong to the current period, ensuring compliance with accrual basis accounting.
Q2: When are AJEs typically made?
- They are usually made at the end of an accounting period such as a month, quarter, or year-end.
Q3: Can AJEs affect both balance sheet and income statement accounts?
- Yes, AJEs can impact both the balance sheet and the income statement accounts by adjusting entries to reflect accrued or deferred revenues and expenses.
Q4: Are AJEs mandatory for cash basis accounting?
- No, AJEs are pertinent to accrual basis accounting and are not common in cash basis accounting.
Related Terms
- Journal: A detailed account that records all financial transactions of a business.
- Ledger Account: A complete record of all the financial transactions of an entity.
- Accrual Basis Accounting: Accounting method that records revenues and expenses when they are incurred, regardless of when cash is exchanged.
- Prepaid Expense: Payment made for goods or services to be received in the future.
- Depreciation: The systematic allocation of the depreciable amount of an asset over its useful life.
Online References
- Investopedia: Adjusting Entries
- Accounting Coach: Adjusting Journal Entries
- Corporate Finance Institute: Adjusting Entries
Suggested Books for Further Studies
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- “Financial Accounting” by Robert Libby, Patricia Libby, and Frank Hodge
- “Accounting Principles” by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso
Accounting Basics: “Adjusting Journal Entry” Fundamentals Quiz
### Which type of adjusting entry is necessary for an expense that has been incurred but not yet paid?
- [x] Accrued Expense
- [ ] Deferred Expense
- [ ] Prepaid Expense
- [ ] Depreciation Expense
> **Explanation:** An accrued expense is one that has been incurred but not yet paid and therefore needs to be recognized in the accounting period in which it occurred.
### Revenues earned but not yet received can be recorded as:
- [x] Accrued Revenues
- [ ] Deferred Revenues
- [ ] Prepaid Revenues
- [ ] Unearned Revenues
> **Explanation:** Accrued revenues refer to earnings that the business has obtained but has not yet received or billed to the client.
### If a company pays insurance premiums in advance, it should record these premiums as:
- [x] Prepaid Expenses
- [ ] Accrued Expenses
- [ ] Deferred Revenues
- [ ] Unearned Revenues
> **Explanation:** Insurance premiums paid in advance are considered prepaid expenses and are recognized as assets until the coverage period occurs.
### At year-end, what adjusting entry should be made for utility expenses incurred but not paid until the next period?
- [x] Debit Utility Expense; Credit Utilities Payable
- [ ] Debit Utilities Payable; Credit Utility Expense
- [ ] Debit Utility Expense; Credit Cash
- [ ] Debit Cash; Credit Utilities Payable
> **Explanation:** Utility expense occurred but not paid should be recorded as an accrued expense by debiting the expense and crediting the payable account.
### What is the purpose of an adjusting journal entry for depreciation?
- [x] Allocate the cost of an asset over its useful life
- [ ] Record the fair value of an asset
- [ ] Transfer ownership of an asset
- [ ] Account for misplacement of resources
> **Explanation:** Depreciation expense is recorded via AJE to allocate the cost of tangible assets over their useful lives as per depreciation schedules.
### What type of account is affected by adjusting entries related to unearned revenues?
- [ ] Accounts Receivable
- [ ] Prepaid Expenses
- [x] Revenue
- [ ] Depreciation
> **Explanation:** Unearned revenues initially recorded as liability upon receipt are recognized as actual revenue through an adjusting journal entry.
### If a service is provided in December but invoice is sent in January next year, what AJE should be done in December?
- [x] Debit Accounts Receivable; Credit Service Revenue
- [ ] Debit Service Revenue; Credit Accounts Receivable
- [ ] Debit Cash; Credit Service Revenue
- [ ] Debit Service Revenue; Credit Cash
> **Explanation:** To recognize earned revenue for services provided in December despite the invoice being sent in January, debit accounts receivable and credit service revenue.
### When a one-year insurance policy is purchased in advance, how is the monthly expense recognized?
- [x] By making an adjustment each month debiting insurance expense and crediting prepaid insurance monthly
- [ ] By recording the full amount as insurance expense at the date of purchase
- [ ] By recording the full amount as prepaid insurance at the date of payment
- [ ] No adjustment is necessary
> **Explanation:** The insurance policy expense is allocated monthly through an adjusting entry to debit insurance expense and credit prepaid insurance.
### What is the common feature of all adjusting journal entries?
- [ ] They involve only cash transactions
- [ ] They only occur at the start of the period
- [x] They involve one income statement account and one balance sheet account
- [ ] They are optional adjustments
> **Explanation:** Adjusting journal entries commonly involve updating one income statement account and one balance sheet account at period end.
### An adjusting journal entry for interest earned but not yet recorded would most likely involve which accounts?
- [ ] Cash and Interest Revenue
- [x] Interest Receivable and Interest Revenue
- [ ] Interest Expense and Interest Revenue
- [ ] Prepaid Interest and Interest Expense
> **Explanation:** For interest earned but not yet recorded, the relevant AJE is to debit interest receivable and credit interest revenue.
Thank you for exploring the topic of Adjusting Journal Entries (AJEs) with us. We hope this detailed breakdown and fun quiz help solidify your understanding of this essential accounting concept. Happy accounting!
