A trial balance is created by companies at the end of an accounting period. It contains a list of all accounts within an accounting system that have balances. Companies separate the accounts into different categories, which include assets, liabilities, equities, revenues and expenses. The accounts are listed in order, beginning with assets, and each includes a balance that is either a debit or credit. Asset and expense accounts have debit balances, while the other types have credit balances. Adjusting entries are made to certain accounts to bring their balances up to date. After adjusting entries are made, the trial balance is updated to an adjusted trial balance.
1 Create a trial balance. Using the company’s general ledger, transfer all accounts and balances onto a 10-column worksheet. Each account name is listed first, followed by the balance in each. The first two columns of the worksheet are designated for the trial balance. The amounts are separated by debits and credits. Total each column verifying that the amounts are equal.
2 Determine what adjusting entries are needed. Adjusting entries typically are used for two different types of activities: accrual and deferrals. Accruals are entries used to record a revenue or expense that has occurred but has not been posted yet. Deferrals refer to entries that have been made previously, but the amount of the entry must be divided between two or more periods.
3 Adjust for accrual of expenses. Several common adjusting entries occur due to the accrual of expenses. According to Generally Accepted Accounting Principles (GAAP), all expenses and revenues are to be recorded in the period in which they occur. For example, you must record interest expense for interest accrued on a business loan during the current period. To do this, a debit is posted to Interest Expense and a credit to Interest Payable. Interest Payable is a liability account that represents interest that is accrued but is not paid yet.
4 Adjust for accrual of revenues. Entries must also be made to update the amount of revenue earned for a period. For example, you must record interest earned on a note during the period it was earned, even though it was not received. To do this, a credit is made to Interest Receivable and a debit to Interest Revenue.
5 Record adjustments for deferred expenses. A deferred expense entry is used when a company records a transaction in the past that must be updated now. For example, if an annual insurance policy was purchased and paid for, every month a portion of that prepaid insurance entry must be expensed out. The amount initially would be placed in an asset account called Prepaid Insurance. Every month after a month of insurance is used, an adjusting entry is made by debiting Insurance Expense and crediting Prepaid Insurance.
6 Record any deferred revenues. This entry occurs when money was received and posted to an Unearned Revenue account prior to it being earned. For example, if your company provides a service to another company and the company prepays for the service for a year, an entry is made. The amount was initially posted in a liability account called unearned revenue. At the end of each month, after a portion of the revenue is earned, an adjusting entry is made by debiting the Unearned Revenue account and crediting the Revenue account.