When Wouldn’t an Adjustment Be Made to an Account?

Adjusting entries are a routine procedure in accrual accounting made at the end of an accounting period to uphold the matching principle, which ensures revenues and their associated costs are recognized in the same period. This process involves updating accounts for items like accrued expenses, which are costs incurred but not yet paid, or deferred revenues. While these adjustments are standard practice, several specific circumstances make them unnecessary.

The Cash Basis Accounting Exception

The primary reason an adjusting entry would not be made is the use of cash basis accounting. This method recognizes revenues only when cash is received and expenses only when cash is paid. Because recognition is tied directly to cash flow, the need to match revenues with expenses in a specific period is eliminated, along with most adjusting entries.

Consider a consulting firm that provides services in December but does not receive payment until January. Under the accrual basis, the firm would make an adjusting entry in December to record the earned revenue, ensuring it is reported in the period the work was performed. Under the cash basis, no entry is made in December because no cash was received; the revenue is recorded in January when the payment arrives.

This framework bypasses the need for adjustments related to accrued revenues, accrued expenses, deferred revenues, and prepaid expenses. These categories of adjustments exist to bridge the timing gap between when a service is performed and when the corresponding cash is exchanged. By linking all recognition to the movement of cash, the cash basis method provides a simpler, though often less accurate, picture of a company’s financial performance.

Transactions Completed Within a Single Accounting Period

Even when operating under the accrual basis of accounting, adjusting entries are not needed for transactions that are fully completed within a single accounting period. If a transaction begins and concludes within the same reporting timeframe, there is no cost or revenue to apportion to a future period.

For instance, if a retail business pays for and runs a one-week advertising campaign entirely within the month of April, the full cost is recorded as an expense in April. Because the benefit of the advertisement was received in that same month, no adjusting entry is required, and the initial journal entry is sufficient.

This contrasts with a scenario where the same business pays for a six-month advertising campaign in April. In that case, an adjusting entry would be necessary at the end of each month to recognize one-sixth of the total cost as an expense. The distinction is whether the economic benefit of the transaction crosses the period-end closing date.

The Principle of Materiality

The principle of materiality provides another practical reason to forgo an adjusting entry. This principle allows for the disregard of transactions that are so small their precise accounting treatment would not influence the decisions of someone reading the financial statements.

A common example is the purchase of inexpensive office supplies. Suppose a company buys a box of pens for $20. Technically, under the accrual matching principle, the company should record an adjusting entry at the end of each month to expense only the cost of the pens that were actually used during that period. The remaining unused pens would be reported as an asset.

However, the effort required to make this precise adjustment is disproportionate to the financial impact. Because the $20 amount is considered immaterial, the entire cost is recorded as an expense at the time of purchase, and no subsequent adjusting entry is made. This shortcut is acceptable as long as the amount does not mislead a user of the financial statements.

Differentiating Adjustments from Error Corrections

It is important to distinguish adjusting entries from correcting entries, as they serve different purposes. Adjusting entries are a planned part of the accounting cycle that address timing differences, such as recording depreciation or accruing for interest. These are not mistakes, but routine updates.

A correcting entry, on the other hand, is made to fix a mistake discovered in the accounting records. Errors can take many forms, such as a transposition error where numbers are swapped (e.g., recording $89 as $98), posting a transaction to the wrong account, or duplicating an invoice entry. These are unintentional inaccuracies that must be rectified once found.

For example, recording monthly depreciation on a delivery van is a standard adjusting entry. In contrast, if an accountant discovered that a $500 payment to a supplier was incorrectly debited to the wrong expense account, a correcting entry would be needed. This entry would reverse the incorrect posting and record the expense in the proper account.