His bill for January is $2,000, but since he won’t be billing until February 1, he will have to make an adjusting entry to accrue the $2,000 in revenue he earned for the month of January. Depreciation expense and accumulated depreciation will need to be posted in order to properly expense the useful life of any fixed asset. An accrued expense is an expense that has been incurred before it has been paid. For example, Tim owns a small supermarket, and pays his employers bi-weekly. In March, Tim’s pay dates for his employees were March 13 and March 27. As important as it is to recognize revenue properly, it’s equally important to account for all of the expenses that you have incurred during the month. This is particularly important when accruing payroll expenses as well as any expenses you have incurred during the month that you have not yet been invoiced for.

This would also include cash received for services not rendered yet or cash paid for expenses not incurred yet. The methodology states that the expenses are matched with the revenues in the period in which they are incurred and not when the cash exchanges hands. The Inventory Loss account could either be a sub-account https://www.bookstime.com/ of cost of goods sold, or you could list it as an operating expense. We prefer to see it as an operating expense so it doesn’t skew your gross profit margin. The Reserve for Inventory Loss account is a contra asset account, and it shows up under your Inventory asset account on your balance sheet as a negative number.

What are Adjusting Journal Entries (AJE)?

You mowed a customer’s lawn in one accounting period, but you will not bill the customer until the following accounting period. Having adjusting entries doesn’t necessarily mean there is something wrong with your bookkeeping practices. Keep in mind, this calculation and entry will not match what your accountant calculates for depreciation for tax purposes. But this entry will let you see your true expenses for management purposes.

With cash accounting, this occurs only when money is received for goods or services. Accrual accounting instead allows for a lag between payment and product (e.g., with purchases made on credit). Accruals are revenues and expenses that have not been received or paid, respectively, and have not yet been recorded through a standard accounting transaction. For instance, an accrued expense may be rent that is paid at the end of the month, even though a firm is able to occupy the space at the beginning of the month that has not yet been paid. To prevent inadvertent omission of some adjusting entries, it is helpful to review the ones from the previous accounting period since such transactions often recur. It also helps to talk to various people in the company who might know about unbilled revenue or other items that might require adjustments. The preceding discussion of adjustments has been presented in great detail because it is imperative to grasp the underlying income measurement principles.

5.1 Accrued Expenses

Without adjusting entries to the journal, there would remain unresolved transactions that are yet to close. Assume that the Lawndale Company currently owes $900 for those utilities. The following adjustment is needed before financial statements are created. It is an adjusting entry because no physical event took place; this liability simply grew over time and has not yet been paid. Adjusting entries are slightly different, as you’ll need to consider accumulated depreciation (i.e., the accumulated depreciation of assets over the company’s lifetime). Essentially, from the point at which the asset is purchased, it depreciates by the same amount each month. For that month, a depreciation adjusting entry is made, debiting depreciation expense and crediting accumulated depreciation.

This will be discussed later when we prepare adjusting journal entries. In the case of unearned revenue, a liability account is credited when the cash is received.