An important part of the monthly closing cycle for your small business's general ledger is reviewing the trial balance and posting adjusting entries to recognize accruals, prepaid expenses and correct errors. Adjusting entries can be used to fix entries posted incorrectly, expenses posted to the wrong account and balance sheet adjustments. When you understand the core fundamentals of adjusting entries, you can ensure that your monthly reporting is accurate.
Determine what expenses you have incurred during the period that have not yet been paid. Create a list of these outstanding expenses and the corresponding amount that is owed.
Build a journal entry to recognize the expense. Debit the expense account for the amount of the outstanding balance. For example, if you have a $600 order for advertising that has been completed but on which you have not yet issued payment, debit the advertising expense account for $600.
Credit an accrual account for the same amount posted to the expense account. In this case, credit $600 to an advertising accrual account.
Reverse an accrual in the accounting period that the expense posts by crediting the expense account for the amount of the payment. Debit the accrual account for the same amount to offset the accrual balance.
Reduce an accrual when you pay a portion of the expense. Debit the accrual account by the amount that you paid and credit the expense account. For example, if you have a $1,200 accrual for support fees and you pay $700, debit the subscriptions and fees accrual $700 and credit the subscriptions and fees expense account $700. This transaction leaves a balance of $500 outstanding in the accrual for later adjustment.
Identify any expenses that are prepaid, or paid in advance of actually incurring the expense. An example of this is insurance, if you pay a six-month premium in advance. Five months of the premium are prepaid, while the current month is an expense.
Create a journal entry to adjust the expense account. Debit the prepaid account, in this case prepaid insurance, for five months of the premium. For example, a six-month premium of $450 would equal $75 per month, or $375 for five months.
Credit the expense account, in this case insurance expense, for the same amount. This transaction credits five months to the balance sheet, leaving one month on the income statement.
Other Adjusting Entries
Review the trial balance report for the general ledger. Check the trial balances for each account to be sure that they are accurate. If the trial balance does not match, you identify an error, or a ledger account needs to be adjusted, create an adjusting entry to record the transaction.
Reverse entries that posted backward. Identify the account that was credited in the original entry and list it as the debit account for the new entry. Debit the account for the same amount as it was credited in the first entry. Credit the account that received the debit, in the same amount as the original debit.
Adjust any entries that have transposed numbers or posted incorrectly. Calculate the difference between the value of the original entry and what should post, then adjust it accordingly. For example, if the entry should have credited an account for $250 but accidentally posted at $240, adjust it with an additional credit of $10. Post the transaction to the same accounts as the original entry.
- Always double-check the trial balance after posting journal entries to confirm that the entries posted correctly.