Adjusting Journal Entries (AJE): What They Are and How They Work

An adjusting journal entry updates account balances at the end of an accounting period. Also known as an adjusting entry or AJE, it ensures that companies record revenues, expenses, assets, and liabilities in the correct period. As a result, financial statements accurately reflect the company’s financial position. Common adjustments include accrued expenses, prepaid expenses, and depreciation.

In traditional accounting, a journal entry records a business transaction. The total amount in the Debit column equals the total amount in the Credit column. Each amount goes to an account on the chart of accounts.

Adjusting journal entries follow this same double-entry accounting principle. They generally correct or update account balances, record previously unrecorded transactions, or reclassify amounts between accounts.

Usage

Accountants and others who prefer traditional accounting record business transactions in a general journal.

If you are not an accountant, you might use the general journal to transfer amounts between income or expense accounts. You can also move amounts from one class to another.

Your accountant may review your books and ask you to adjust various accounts, such as adding depreciation for a fixed asset. You record these adjustments through journal entries.

If you are a bookkeeper and are unfamiliar with how a general journal works, you should do some research. This is a very common accounting function.

For a closer look at how journals, ledgers, and other accounting records work together, see The Complete Guide to Manual Bookkeeping.

Additional Details

AJEs Serve These Functions:

• Adjusting balances. They adjust account balances, which means they change the amounts that go to financial statements. Understanding beginning and ending balances also helps you review these adjustments between accounting periods.
• Reclassifications. These AJEs move balances from one account to another.

Accountants Put Some AJEs to Special Uses:

• Recurring entries. These entries are the same each month. They always have the same amounts and go to the same accounts.
• Reversing entries. AJEs may not be permanent. You may wish to reverse them at the beginning of the next period. These are reversing entries.

Example

Payday is not the same day as the end of the month. So, what about the wages employees earned between the last payday and the end of the month?

We debit Wages Expense and credit Accrued Wages Liability. This makes our financial statements correct but throws us off for the next month. What to do? Reverse that monster and just go ahead and make your regular payroll entry. We take care of the problem in the next month’s accrual.

This is an example of an accrued expense. The company has incurred the expense because employees have performed the work. However, the next payday has not arrived. The adjusting entry recognizes the expense when employees earn it and records the corresponding liability.

Reversing the entry at the beginning of the next accounting period prevents double-counting accrued wages when you record regular payroll.

Accruals and deferrals are important parts of accrual-basis accounting. The Financial Accounting Standards Board’s discussion of accrual accounting explains how accountants recognize revenues, expenses, assets, and liabilities. Under this approach, economic activity matters more than when cash changes hands.

How Debits and Credits Affect Account Totals

Credits do not necessarily mean increase and debits do not necessarily mean decrease. It all depends on what account type we are talking about.

A credit increases income, liability, equity, and accumulated depreciation accounts. Credits decrease expense and asset accounts.

A debit increases expense and asset accounts. Debits decrease sales, income, liability, equity, and accumulated depreciation accounts.

Understanding the rules of debits and credits is essential when preparing an adjusting journal entry. Every entry must have equal total debits and credits. However, the type of adjustment determines which accounts you use.

Example of Adjusting Journal Entries

If you wanted to increase your rent account balance by $12,000.00, you would debit the account by $12,000.00. You must also make an offsetting entry (because the cash had to come from somewhere). So, you would credit a bank account $12,000.00.

This is an example of a standard journal entry rather than an adjusting journal entry. An adjusting entry generally updates existing records or recognizes activity that the books don’t yet reflect.

Here Are Some Typical Adjusting Journal Entries (or AJEs for Short)

• Depreciation: The amounts come from a depreciation schedule. In the General Journal, we enter a debit to Depreciation Expense and a credit to Accumulated Depreciation. For more information about depreciation methods and business property, see IRS Publication 946.
• Amortized Intangible Assets: You handle amortization much like depreciation through AJEs. Over the applicable amortization period, you recognize the expense and adjust the asset or accumulated amortization account.
• Inventory: The adjustment equals the difference between ending inventory and the amount on your books. Debit or credit Inventory as needed and balance your entry by debiting or crediting Cost of Goods Sold.
• Payroll Tax Liabilities: These affect the appropriate liability accounts and payroll tax expense accounts. Base adjustments on actual payroll tax obligations and supporting payroll records.
• Loan Balances: At least once a year, compare the loan balances on your books to the lender’s records and supporting loan statements. Investigate and correct any differences. Loan payments generally include both principal and interest, so assign each amount to the appropriate account.
• Accruals: These can be a whole lot of different things. You adjust assets and liabilities against Revenues and Expenses. For example, employees may have earned wages you haven’t paid. You may also owe interest or have earned revenue you haven’t yet billed.

Adjusting journal entries help keep financial records accurate and ensure that financial statements reflect the company’s actual financial activity for the period. If your business maintains its own accounting records, you should understand when and how to make these adjustments. They’re an important part of the month-end and year-end closing process.

A well-maintained general ledger makes it easier to track account activity, review adjustments, and maintain accurate financial records.