Three entries nobody sends an invoice for, made on the last day of the month, that turn a record of transactions into a set of accounts.
By 30 September every transaction is recorded, and the books are still wrong. Three things happened during the month that no document announced: a month of the insurance was used up, a month of the van's life was used up, and the power was consumed but never billed. Adjusting entries record all three.
They come in two flavours, and the words are worth getting right because the whole close is organised around them. A deferral is cash that moved before the value did — the insurance, the customer's deposit. An accrual is value that moved before the cash — the unbilled power.
Depreciation sits beside them as the third kind of adjustment, an allocation: cash moved long ago, and the cost is spread over the periods the asset serves.
One month of the insurance policy has been used: $600.
| Account | Debit | Credit |
|---|---|---|
| 6300Insurance expense | 600.00 | |
| 1400Prepaid insurance | 600.00 | |
| Balanced | 600.00 | 600.00 |
$7,200 over twelve months. The asset is reduced by what has been consumed and the expense takes it — nobody paid anybody anything on 30 September.
One month of the van's life has been used: $500.
| Account | Debit | Credit |
|---|---|---|
| 6400Depreciation expense | 500.00 | |
| 1590Accumulated depreciation — vehicles | 500.00 | |
| Balanced | 500.00 | 500.00 |
$24,000 over 48 months. The credit does not touch the van's cost — it goes to accumulated depreciation, a contra account, so the balance sheet can show both what was paid and what has been used up.
September's power was used but the utility has not billed yet: $450.
| Account | Debit | Credit |
|---|---|---|
| 6500Utilities expense | 450.00 | |
| 2200Accrued liabilities | 450.00 | |
| Balanced | 450.00 | 450.00 |
The cost belongs to September regardless of when the invoice arrives. With no bill there is no payable, so it is accrued — and reversed or replaced when the real bill lands in October.
September's three adjustments. No cash moves in any of them.
$600 is not a judgment call — it is $7,200 ÷ 12, and the schedule that produces it is the evidence for the entry. The same for the van: $24,000 over 48 months. A schedule has one non-negotiable property, which is that it sums back to the amount it is spreading, to the cent. A schedule that misses by three cents is a journal that will not post in its final month.
The van's schedule rests on three choices, and each is a policy someone has to own: a useful life of 48 months, a salvage value of zero, and the straight-line method with a full month charged in the month it went into service. Change any of them and the monthly charge changes; the van does not. After September its net book value is $23,500.
It is worth being precise about what the van's $500 a month is. It is not an estimate of how much value the van lost in September, and a schedule is not a valuation. GAAP says so in as many words.
Your turn
The van cost $24,000 and will serve 48 months, with nothing left at the end. The insurance cost $7,200 and covers 12 months. Each needs a schedule before it can become an adjusting entry — and each schedule has to sum back to what was paid, to the cent.
| Row | AItem | BMethod | CCost | DPeriods | ESalvage |
|---|---|---|---|---|---|
| 1 | |||||
| 2 | |||||
| 3 | |||||
| 4 | |||||
| 5 |
| Period | Charge | Remaining |
|---|---|---|
| 1 | 500.00 | 23,500.00 |
| 2 | 500.00 | 23,000.00 |
| 3 | 500.00 | 22,500.00 |
| 4 | 500.00 | 22,000.00 |
44 more rows — copy the schedule to see them all.
| Period | Charge | Remaining |
|---|---|---|
| 1 | 600.00 | 6,600.00 |
| 2 | 600.00 | 6,000.00 |
| 3 | 600.00 | 5,400.00 |
| 4 | 600.00 | 4,800.00 |
8 more rows — copy the schedule to see them all.
September's two adjustments together agrees with the book: 1,100.00.
Post the three and prove the books again. Five accounts exist now that did not exist an hour ago — and this is the version the statements are built from.
Debits equal credits at 101,450.00. The arithmetic is proved; nothing else is.
Adjusting entries never touch cash. If your adjusting entry has a bank account in it, it is not an adjusting entry — it is a transaction you forgot to record.
Check yourself
If Northwind skipped the adjusting entries, what net income would September report?
Requirements, conventions and mechanics are three different things. These are the sources behind the requirements — and the ones marked as conventions are ours, not the standard-setters'.
The full map is in US GAAP, and where these rules come from.
Each links to its definition in the glossary, where it also states the authority behind it and the components that render it.
The ideas in this lesson, explained for the founder who runs the company. Each has its own entry in the founder glossary.