Why is it necessary to make adjustments at the end of each period a financial statement is issued?

Adjusting journal entries are used to adjust the financial statements and bring them into compliance with relevant accounting standards, such as GAAP or IFRS. This activity is routinely performed by accountants to allocate income and expenses to the actual period in which the income or expense occurred or earned—a feature of accrual accounting.

Given the nature of adjusting entries, they often impact both the balance sheet as well as the income statement. The most common types of adjusting entries are as follows:

1.       Accruals: In this case, no entries have been made in the company’s accounting records for certain expenses or revenues, but those expenses and/or revenues occurred in the period and must be included in the period’s income statement and balance sheet

2.       Deferrals: An entry has been made in the company’s accounting records, but the amount needs to be moved to the period in which the expense is incurred or the revenue is earned or divided up between two or more accounting periods

3.       Provisions: To estimate the amount of a reserve, such as an allowance for doubtful accounts

Adjusting entries are also used to correct financial errors, and must be completed before a company’s financial statements can be issued. For example, something is capitalized and booked to a Fixed Asset account that, under company policy, should be booked to an expense account like Supplies Expense, or vice versa.

Where Do Adjusting Journal Entries Fit Into the Financial Close Process?

At the end of each financial period, accountants go through all of the prepaid and accrued expenses as well as unearned and accrued revenue and identify necessary adjusting entries.

This is often a time-consuming process that involves spreadsheets to track expenses, and payments made against those expenses, as well as revenue earned and payments received against that revenue.

These adjustments are also often a result of the account reconciliation process during the financial close, or may be detected by doing variance analysis of account balances to detect any unusual balance fluctuations.

When the need for an adjusting journal entry is identified, accountants prepare the journal entry to credit and debit appropriate accounts. These journal entries should include supporting documentation, links to applicable policies and procedures, and be properly reviewed and approved before being posted.

Examples of Adjusting Journal Entries that Accountants Often Work On

One example is to accrue for unpaid wages at month-end. A potentially more intricate example may be rebate accruals. Rebates are payments made back to you from a supplier (or from you to a customer) retrospectively, reducing the overall cost of a product or service.

In this case, you may have an arrangement with a supplier to earn a quarterly rebate based on your overall spend with that supplier. Imagine the supplier's policy is to pay the rebate at the end of the year. Then, from an accounting perspective, this may need to be accrued for when the rebate is earned, not when it is received.

When preparing the entry, it's helpful to reference your company's policy and procedure to ensure compliance, and it's best practice to attach supporting documents to the journal entry, like the contract and terms. This will help speed up the approval process, as well as any audit work later on.

What Solutions Does BlackLine Offer?

BlackLine Journal Entry automates the process for creating and managing adjusting journal entries. It provides an integrated system for the creation, review, approval, and posting of adjusting journal entries. Journal entry templates ensure standardization across the organization, and validation rules check entries for errors before posting.

Advanced features include the automatic creation of journal entries through cloning of recurring journal entries or import of journal and journal lines from report writers or spreadsheets. It also provides integrated storage of supporting documentation, links to policies and procedures, and automatic posting and status tracking for real-time updates.

BlackLine Account Reconciliations integrates with Journal Entry to automate and streamline the account reconciliation process. This gives accounting teams more time to analyze and book any necessary adjusting journal entries.

This solution also simplifies the process of handling prepaid amounts. It includes an amortizable prepaid template that records the original amount, open date, and the dates amortization should begin and end.

Amortized amounts are automatically calculated based on this information. The amounts can also be manually updated if there is a change to the balance or if an item should not be amortized on a straight-line basis.

A built-in control displays when the amounts entered do not equal the total amount being amortized. This template provides an easy way for accountants to handle prepaids, eliminating the need to manually set up and manage spreadsheets.

Account Reconciliations also integrates with Transaction Matching to provide automated analysis of transaction details. The integration of these products with Journal Entry centralizes all information concerning a given journal in one easily accessible place with comments, documents, and links to underlying matching transactions and reconciling items.

In addition, BlackLine Variance Analysis monitors fluctuations in account balances and helps identify errors that require adjusting journal entries.

Get your copy of this white paper to learn more about how your F&A organization can make the move to modern accounting by centralizing, managing, and automating journal entries.

Why are adjustments needed at the end of an accounting period?

Why the year end adjustments are necessary in preparing the financial statements?