Adjusting Entries in Accounting: Examples & Complete Guide
Adjusting Entries in Accounting: Examples & Complete Guide
- What Are Adjusting Entries?
- Why Are They Necessary?
- When Are They Made?
- Six Common Types
- How to Calculate an Adjusting Entry
- Debit and Credit Rules
- Step-by-Step Method
- Adjusted Trial Balance
- Effect on Financial Statements
- Adjusting vs Correcting vs Closing vs Reversing
- Reversing Entries
- Month-End Closing Example
- Mini Case Study
- Common Mistakes
- Adjusting Entries in an ERP System
- Practice Questions
- Cheat Sheet
- FAQ
Adjusting entries are one of the most important parts of accrual accounting because they help make sure that revenues and expenses are recorded in the correct accounting period. A business may receive cash before earning revenue, pay money before using a service, owe employees wages that have not yet been paid, or use an asset over several years. If these transactions are not properly adjusted at period-end, the financial statements can show the wrong revenue, expenses, assets, liabilities, and profit.
For beginners, adjusting entries in accounting can initially seem confusing because they are usually prepared after the regular transactions for the period have already been recorded. The good news is that the underlying idea is simple: adjust the accounts so the balances represent what actually belongs to the accounting period.
This complete guide explains what adjusting entries are, why they are needed, when they are prepared, the major types of adjusting entries, how to calculate them, how to record them using debit and credit, and how they affect the adjusted trial balance and financial statements.
If you are still building your accounting fundamentals, you can also review our guide to Basic Accounting before continuing.
Key Takeaways
- Adjusting entries are normally prepared at the end of an accounting period.
- They are primarily used under accrual accounting.
- The main purpose is to recognize revenues and expenses in the periods to which they relate and ensure assets and liabilities are appropriately stated.
- Many adjusting entries involve one income statement account and one balance sheet account.
- Adjusting entries generally do not involve a new cash transaction.
- They update the trial balance before financial statements are prepared.
- The six common categories are accrued expenses, accrued revenue, prepaid expenses, unearned revenue, depreciation, and bad debts or allowance adjustments.
- After adjustments, the business prepares an adjusted trial balance.
- Adjusting entries help improve the accuracy of profit, assets, liabilities, and equity.
- In an ERP system, many recurring adjustments can be supported through schedules, recurring journals, depreciation modules, and period-end workflows.
What Are Adjusting Entries in Accounting?
Adjusting entries in accounting are journal entries made at the end of an accounting period to update account balances before financial statements are prepared.
The important point is that an adjusting entry does not necessarily mean that something went wrong with the original transaction. In many cases, the original transaction was recorded correctly when cash was paid or received. The adjustment is needed because time has passed or because an amount has been earned or incurred but has not yet been recorded.
For example, suppose a company pays $12,000 for one year of insurance on January 1. The entire $12,000 may initially be recorded as prepaid insurance because the business has purchased a future benefit. After one month, $1,000 of insurance has been used. At the end of January, an adjusting entry recognizes $1,000 of insurance expense and reduces prepaid insurance by $1,000.
The adjustment is therefore about timing. The company did not make another $1,000 cash payment in January. Instead, part of an existing asset has been consumed.
A Simple Definition
You can remember adjusting entries with this formula:
Another useful way to think about it is:
“What has happened economically during this period, even if the cash has not moved yet?”
Why Are Adjusting Entries Necessary?
Without adjusting entries, accrual-based financial statements may not accurately represent the company's actual performance or financial position.
Consider a business that has employees who work during the last week of December but receive their salaries in January. If the company records salary expense only when cash is paid, December expenses will be understated and January expenses will be overstated.
An adjusting entry fixes this timing issue by recording the salary expense in December and creating a liability for the unpaid amount.
This supports the accounting concept commonly known as the matching principle: expenses should be recognized in the period in which the related economic benefit is consumed or the obligation is incurred, rather than simply when cash changes hands.
What Happens Without Adjustments?
| Situation | Possible Problem Without Adjustment |
|---|---|
| Employees earned unpaid wages | Expenses and liabilities may be understated. |
| Revenue has been earned but not billed | Revenue and receivables may be understated. |
| Prepaid insurance has been consumed | Expenses may be understated and assets overstated. |
| Customer advance has now been earned | Revenue may be understated and liabilities overstated. |
| Equipment has been used during the period | Depreciation expense may be understated and assets overstated. |
| Some receivables may be uncollectible | Receivables and profit may be overstated. |
When Are Adjusting Entries Made?
Adjusting entries are commonly prepared at the end of an accounting period. Depending on the business, the period may be monthly, quarterly, or annually.
Many businesses prepare adjustments every month because monthly financial statements are more useful when expenses and revenues are recognized consistently.
Typical adjustment periods include:
- Month-end close
- Quarter-end close
- Year-end close
- Before management reporting
- Before external financial reporting
- Before preparing final financial statements
In a small business, some adjustments may be made only at year-end. In a larger company using an ERP system, many adjustments are part of a structured monthly closing process.
Where Adjusting Entries Fit in the Accounting Cycle
Adjusting entries are not an isolated accounting activity. They are part of the larger accounting cycle.
If you want to understand the full sequence, read our detailed guide to the Accounting Cycle.
The exact workflow can vary between organizations, but this sequence gives beginners a useful mental model.
Step 1: Record Regular Transactions
Sales, purchases, payroll payments, rent payments, cash receipts, invoices, and other routine transactions are recorded during the period.
Step 2: Prepare the Unadjusted Trial Balance
At the end of the period, the company lists account balances to check whether total debits equal total credits.
Step 3: Review Accounts
Accountants review prepaid expenses, accrued liabilities, revenue received in advance, fixed assets, receivables, interest, payroll, and other accounts that may need adjustment.
Step 4: Prepare Adjusting Entries
Necessary adjustments are calculated and recorded.
Step 5: Prepare the Adjusted Trial Balance
The updated balances are checked again after the adjustments.
Step 6: Prepare Financial Statements
The adjusted balances are used to prepare the income statement, balance sheet, statement of changes in equity, and other required reports.
Adjusting Entries vs Regular Journal Entries
A regular journal entry records a transaction when it occurs. An adjusting entry updates an account because the passage of time or the completion of an economic activity has changed what should be recognized in the current period.
| Feature | Regular Journal Entry | Adjusting Entry |
|---|---|---|
| Purpose | Record a transaction | Update accounts for period-end recognition |
| Timing | Usually when transaction occurs | Usually at period-end |
| Cash involvement | May involve cash | Usually does not involve new cash |
| Example | Paying monthly rent | Recognizing one month of prepaid insurance |
For more information about recording transactions, see our guide to Journal Entries in Accounting.
Six Common Types of Adjusting Entries
Most introductory accounting courses focus on six major categories:
- Accrued expenses
- Accrued revenue
- Prepaid expenses
- Unearned or deferred revenue
- Depreciation expense
- Bad debt expense and allowance adjustments
Let's examine each category carefully.
1. Accrued Expenses
An accrued expense is an expense that has already been incurred but has not yet been paid or recorded.
Common examples include:
- Accrued salaries
- Accrued wages
- Accrued interest
- Accrued utilities
- Accrued rent
- Professional fees incurred but not yet billed
Basic Formula
If the amount is known or reasonably estimated:
Example: Accrued Salary
A company has five employees. At December 31, employees have earned $4,500 in wages that will be paid on January 5.
The company needs to recognize the expense in December because employees performed the work in December.
| Account | Debit | Credit |
|---|---|---|
| Wages Expense | $4,500 | |
| Wages Payable | $4,500 |
What does this do? It increases December expense by $4,500 and creates a $4,500 current liability. When the wages are paid in January, the payment clears the payable rather than creating January wage expense for the same amount.
Example: Accrued Interest
Suppose a company has a $100,000 loan carrying 12% annual interest. One month of interest has accrued.
Monthly interest:
The adjusting entry is:
| Account | Debit | Credit |
|---|---|---|
| Interest Expense | $1,000 | |
| Interest Payable | $1,000 |
2. Accrued Revenue
Accrued revenue occurs when a business has earned revenue but has not yet received cash or issued an invoice for the full amount.
It is also commonly called:
- Accrued income
- Unbilled revenue
- Revenue earned but not yet collected
Example: Consulting Revenue
A consulting company completed $3,000 of work for a client during December. The invoice will be issued in January.
Although cash has not been received, the company has earned the revenue.
| Account | Debit | Credit |
|---|---|---|
| Accounts Receivable | $3,000 | |
| Consulting Revenue | $3,000 |
The adjustment increases revenue and creates an asset because the business now has a right to receive $3,000 from the customer.
Financial Statement Effect
| Account | Effect |
|---|---|
| Revenue | Increases |
| Accounts Receivable | Increases |
| Net Income | Increases |
| Equity | Generally increases through higher profit |
3. Prepaid Expenses
A prepaid expense occurs when a business pays for a future benefit before that benefit is consumed.
Common examples include:
- Prepaid insurance
- Prepaid rent
- Annual software subscriptions
- Maintenance contracts
- Advertising paid in advance
Initially, the payment is often recorded as an asset because the business has a future economic benefit.
Example: Prepaid Insurance
A company pays $12,000 for 12 months of insurance on January 1.
Initial entry:
| Account | Debit | Credit |
|---|---|---|
| Prepaid Insurance | $12,000 | |
| Cash | $12,000 |
After one month, $1,000 has been consumed.
Adjusting entry:
| Account | Debit | Credit |
|---|---|---|
| Insurance Expense | $1,000 | |
| Prepaid Insurance | $1,000 |
After the adjustment, the remaining prepaid insurance is $11,000.
Example: Prepaid Software Subscription
A business pays $2,400 for a 12-month accounting software subscription.
Monthly cost:
If three months have passed, the expense recognized should be:
The remaining prepaid asset would be $1,800, assuming no other changes.
4. Unearned or Deferred Revenue
Unearned revenue occurs when a business receives cash before it has earned the related revenue.
It is also called:
- Deferred revenue
- Revenue received in advance
- Customer advance
- Prepaid revenue
The term “prepaid revenue” is sometimes used informally, but unearned revenue and deferred revenue are more standard accounting terms.
Example: Annual Service Contract
A company receives $12,000 from a customer on January 1 for 12 months of service.
At the beginning, the company has received cash but has not yet provided all 12 months of service.
Initial entry:
| Account | Debit | Credit |
|---|---|---|
| Cash | $12,000 | |
| Unearned Revenue | $12,000 |
After one month, $1,000 has been earned.
Adjusting entry:
| Account | Debit | Credit |
|---|---|---|
| Unearned Revenue | $1,000 | |
| Service Revenue | $1,000 |
The liability decreases because the company now owes less service to the customer, while revenue increases because part of the service has been provided.
5. Depreciation Expense
Depreciation is the systematic allocation of the depreciable cost of a long-term asset over its useful life. It is not normally a measurement of the asset's current market value.
Common depreciable assets include:
- Equipment
- Vehicles
- Machinery
- Office furniture
- Computers
- Buildings, subject to applicable accounting rules
Straight-Line Depreciation Formula
Example: Equipment
A company buys equipment for $24,000. Its estimated useful life is 4 years and estimated salvage value is $4,000.
Depreciable amount:
Annual depreciation:
Monthly depreciation:
A monthly adjusting entry would be approximately:
| Account | Debit | Credit |
|---|---|---|
| Depreciation Expense | $416.67 | |
| Accumulated Depreciation | $416.67 |
Notice that accumulated depreciation is credited instead of directly crediting the equipment account. This allows the original historical cost of the asset to remain visible while accumulated depreciation is reported as a contra-asset.
6. Bad Debt Expense and Allowance for Doubtful Accounts
When a business sells on credit, some customers may ultimately fail to pay. Depending on the applicable accounting framework, expected credit losses or uncollectible amounts are typically recognized through an expense and a related contra-asset allowance. The exact terminology, timing, and measurement method can differ between frameworks such as US GAAP and IFRS, so treat the example below as an introductory illustration rather than a universal rule.
The exact method and terminology can depend on the applicable accounting framework. For a beginner-level example, the allowance approach can be illustrated as follows.
Example: Required Ending Allowance
Suppose a company determines that the required ending allowance for doubtful accounts should be $2,000. Before adjustment, the Allowance for Doubtful Accounts account has a credit balance of $1,300.
The required additional adjustment is:
Note: This simplified formula assumes the existing allowance already has a credit balance below the required amount. If the existing credit balance is higher than required, the excess is reversed instead of adding more allowance. If the existing balance is a debit (meaning prior write-offs exceeded the allowance), that debit amount must first be added to the required ending balance before determining the adjustment. Always check the direction of the existing balance before applying the formula.
Adjusting entry:
| Account | Debit | Credit |
|---|---|---|
| Bad Debt Expense | $700 | |
| Allowance for Doubtful Accounts | $700 |
This example demonstrates an important accounting point: the adjusting entry is not automatically equal to the desired ending allowance. You must consider the existing balance in the allowance account.
How to Calculate an Adjusting Entry
Every adjusting entry starts with the same question: how much of this has actually happened during the current period? The formula depends on the type of adjustment, but each one follows a simple pattern.
| Type | Formula |
|---|---|
| Accrued Expense | Amount earned/incurred during the period but not yet paid or recorded |
| Accrued Revenue | Amount earned during the period but not yet billed or received |
| Prepaid Expense | Total prepaid amount ÷ total coverage period × months used |
| Unearned Revenue | Total amount received in advance ÷ total service period × periods completed |
| Depreciation (Straight-Line) | (Cost − Estimated Salvage Value) ÷ Useful Life |
| Bad Debt / Allowance | Required ending allowance balance − existing allowance balance |
Once the amount is calculated, the rest is mechanical: identify the income statement account and the balance sheet account involved, then apply the debit and credit rules from the table above.
Accruals vs Deferrals
One of the easiest ways to understand adjusting entries is to divide them into two broad groups: accruals and deferrals.
| Category | Meaning | Examples |
|---|---|---|
| Accrued Expense | Expense incurred before cash payment | Salary payable, interest payable |
| Accrued Revenue | Revenue earned before cash collection | Unbilled consulting work |
| Prepaid Expense | Cash paid before expense is consumed | Insurance, rent, subscription |
| Unearned Revenue | Cash received before revenue is earned | Advance customer payment |
A simple memory trick is:
Deferral: Cash happens first; the economic activity is recognized later.
Adjusting Entries: Debit and Credit Rules
Beginners often make mistakes because they memorize journal entries without understanding the account relationships.
Instead, identify what happened first. The table below is a master reference for all six types: what actually changes on the accounts, and the typical entry used to record it.
| Type | What Changes | Typical Entry |
|---|---|---|
| Accrued Expense | Expense increases; Liability increases | Dr Expense / Cr Payable |
| Accrued Revenue | Asset increases; Revenue increases | Dr Receivable / Cr Revenue |
| Prepaid Expense Consumed | Expense increases; Asset decreases | Dr Expense / Cr Prepaid Asset |
| Unearned Revenue Earned | Liability decreases; Revenue increases | Dr Unearned Revenue / Cr Revenue |
| Depreciation | Expense increases; Contra-asset increases | Dr Depreciation Expense / Cr Accumulated Depreciation |
| Bad Debt / Allowance | Expense increases; Contra-asset increases | Dr Bad Debt Expense / Cr Allowance for Doubtful Accounts |
The easiest approach is to ask two questions:
- Which account needs to increase or decrease?
- What other account balances that adjustment?
A Complete Step-by-Step Method for Preparing Adjusting Entries
Step 1: Start With the Unadjusted Trial Balance
Review all account balances before adjustments.
Step 2: Identify Accounts That May Need Adjustment
Pay special attention to:
- Prepaid expenses
- Unearned revenue
- Accrued payroll
- Accrued interest
- Accounts receivable
- Fixed assets
- Depreciation
- Allowance accounts
Step 3: Review Supporting Documents
Use contracts, invoices, payroll records, bank information, asset schedules, insurance policies, subscription schedules, and other supporting documentation.
Step 4: Calculate the Amount
Do not guess. Determine how much of the asset has been consumed, how much revenue has been earned, or how much expense has been incurred.
Step 5: Determine the Accounts
Identify the income statement account and balance sheet account affected.
Step 6: Record the Debit and Credit
Make sure total debits equal total credits.
Step 7: Review the Financial Effect
Ask whether the adjustment increases or decreases revenue, expenses, assets, liabilities, and profit.
Step 8: Post the Adjustment
After approval, post the adjustment to the accounting system.
Step 9: Prepare the Adjusted Trial Balance
Verify that the revised account balances remain in balance.
Adjusting Entries and the Trial Balance
The trial balance is used to check whether total debits equal total credits. However, an unadjusted trial balance can still contain accounts that need period-end updates.
For example, imagine the following simplified balances before any period-end adjustments:
| Account | Debit | Credit |
|---|---|---|
| Cash | $20,000 | |
| Accounts Receivable | $8,000 | |
| Prepaid Insurance | $6,000 | |
| Equipment | $30,000 | |
| Accounts Payable | $5,000 | |
| Unearned Revenue | $4,000 | |
| Owner's Equity | $30,000 | |
| Revenue | $25,000 | |
| Expenses (recorded so far) | $0 | |
| Total | $64,000 | $64,000 |
At period-end, suppose the accountant identifies two required adjustments: $1,000 of the prepaid insurance has expired, and $1,000 of the unearned revenue has now been earned.
| Account | Debit | Credit |
|---|---|---|
| Insurance Expense | $1,000 | |
| Prepaid Insurance | $1,000 | |
| Unearned Revenue | $1,000 | |
| Service Revenue | $1,000 |
Here is how those two adjustments move each affected account from its unadjusted balance to its adjusted balance:
| Account | Unadjusted | Adjustment | Adjusted |
|---|---|---|---|
| Prepaid Insurance | $6,000 Dr | −$1,000 | $5,000 Dr |
| Insurance Expense | $0 | +$1,000 | $1,000 Dr |
| Unearned Revenue | $4,000 Cr | −$1,000 | $3,000 Cr |
| Service Revenue | $25,000 Cr | +$1,000 | $26,000 Cr |
All other accounts (Cash, Accounts Receivable, Equipment, Accounts Payable, Owner's Equity) are unaffected by these two adjustments and carry forward unchanged. The adjusted trial balance still totals $64,000 on both sides, confirming that debits still equal credits after adjustment even though several individual account balances changed.
Those adjustments change the individual account balances and therefore change the final adjusted trial balance used for financial statements.
Adjusted Trial Balance: What Is It?
An adjusted trial balance is the list of account balances after all necessary adjusting entries have been recorded.
It is important because financial statements should generally be prepared from adjusted balances rather than the original unadjusted balances.
Mini Example
Suppose a company has $5,000 of prepaid insurance before adjustment. During the period, $1,000 has expired.
Adjustment:
| Account | Debit | Credit |
|---|---|---|
| Insurance Expense | $1,000 | |
| Prepaid Insurance | $1,000 |
After adjustment:
- Insurance Expense increases by $1,000.
- Prepaid Insurance decreases from $5,000 to $4,000.
- Profit decreases by $1,000 before considering tax and other effects.
How Adjusting Entries Affect Financial Statements
Adjusting entries directly influence the numbers that appear in financial statements.
| Adjustment | Income Statement | Balance Sheet |
|---|---|---|
| Accrued expense | Expense increases; profit decreases | Liability increases |
| Accrued revenue | Revenue increases; profit increases | Receivable increases |
| Prepaid expense consumed | Expense increases; profit decreases | Prepaid asset decreases |
| Unearned revenue earned | Revenue increases; profit increases | Liability decreases |
| Depreciation | Expense increases; profit decreases | Accumulated depreciation increases |
| Bad debt allowance | Expense increases; profit decreases | Net receivables decrease through allowance |
For more background on financial statements, see our guide to Financial Statements.
Adjusting Entries and the Income Statement
Adjusting entries can change both revenue and expense amounts. As a result, they can significantly change reported profit.
For example, if a company forgets to record $5,000 of accrued wages, expenses are understated by $5,000 and profit is overstated by $5,000 before considering related tax effects.
If the company instead forgets $5,000 of accrued revenue, revenue and profit may be understated by $5,000.
This is why period-end adjustments matter even though they may not involve cash.
You can also review our Profit and Loss Statement guide for a broader explanation of income statement accounts.
Adjusting Entries and the Balance Sheet
Adjusting entries also update assets and liabilities.
For example:
- Accrued salary creates a liability.
- Accrued revenue creates a receivable.
- Prepaid insurance adjustment reduces an asset.
- Unearned revenue adjustment reduces a liability.
- Depreciation increases accumulated depreciation.
- Allowance for doubtful accounts reduces the net carrying amount of receivables.
For more information about balance sheet accounts, see our Balance Sheet guide.
Regular Entries vs Adjusting Entries vs Correcting Entries vs Closing Entries
These terms are often confused because all of them involve journal entries. Their purposes, however, are different.
| Entry Type | Main Purpose | Typical Timing |
|---|---|---|
| Regular Entry | Record normal business transaction | When transaction occurs |
| Adjusting Entry | Recognize revenue/expense in correct period and update balances | Period-end |
| Correcting Entry | Fix an accounting error | When error is discovered |
| Closing Entry | Close temporary income statement accounts for the period | End of reporting cycle |
| Reversing Entry | Reverse selected prior adjustments to simplify future recording | Beginning of next period, when used |
Adjusting vs Correcting Entries, in Practice
An adjusting entry is not necessarily a correction.
Suppose a company correctly records a $12,000 annual insurance payment as prepaid insurance. After three months, $3,000 has expired. Recording $3,000 of insurance expense is an adjusting entry, not a correction.
By contrast, if the company accidentally records a $12,000 equipment purchase as office expense, fixing that error would be a correcting entry.
Adjusting vs Closing Entries, in Practice
Adjusting entries update accounts before financial statements are finalized. Closing entries transfer temporary account balances as part of the period-end closing process.
Revenue and expense accounts are generally temporary accounts, while assets and liabilities are generally permanent accounts.
Adjusting entries and closing entries therefore have different purposes even though both may occur around the end of an accounting period.
Reversing Entries
A reversing entry is an optional entry used at the beginning of a subsequent accounting period to reverse certain prior adjusting entries.
For example, suppose December 31 accrued salary was $4,500:
December 31 adjustment:
| Account | Debit | Credit |
|---|---|---|
| Wages Expense | $4,500 | |
| Wages Payable | $4,500 |
If a reversing entry is used on January 1:
| Account | Debit | Credit |
|---|---|---|
| Wages Payable | $4,500 | |
| Wages Expense | $4,500 |
The January payroll entry can then be recorded normally without creating duplicate expense recognition.
Two Common Bookkeeping Approaches for Prepaids and Unearned Revenue
Businesses may structure initial entries differently depending on their accounting procedures.
For example, a prepaid expense can initially be recorded as an asset and then expensed over time. In another bookkeeping approach, the initial payment may be recorded as an expense and adjusted at period-end to recognize the remaining asset.
Similarly, customer advances are commonly recorded as a liability first, but specific bookkeeping systems may use different workflows.
The key principle remains the same: the final adjusted accounts must correctly represent what has been earned, incurred, consumed, or still owed at the reporting date.
Detailed Month-End Closing Example
Consider a small consulting business preparing its monthly financial statements.
At the end of the month, the accountant identifies the following items:
- $4,500 employee wages earned but unpaid
- $3,000 consulting revenue earned but not yet billed
- $1,000 insurance consumed from prepaid insurance
- $1,000 of customer advance now earned
- $416.67 monthly depreciation
- $700 additional bad debt expense required
The six adjustments would be:
Adjustment 1: Wages
| Wages Expense | $4,500 | |
| Wages Payable | $4,500 |
Adjustment 2: Accrued Revenue
| Accounts Receivable | $3,000 | |
| Consulting Revenue | $3,000 |
Adjustment 3: Insurance
| Insurance Expense | $1,000 | |
| Prepaid Insurance | $1,000 |
Adjustment 4: Unearned Revenue
| Unearned Revenue | $1,000 | |
| Service Revenue | $1,000 |
Adjustment 5: Depreciation
| Depreciation Expense | $416.67 | |
| Accumulated Depreciation | $416.67 |
Adjustment 6: Bad Debt
| Bad Debt Expense | $700 | |
| Allowance for Doubtful Accounts | $700 |
What Is the Net Effect of These Adjustments?
Let's separate revenue and expenses.
Revenue Increases
- Accrued consulting revenue: $3,000
- Revenue earned from customer advance: $1,000
Total revenue increase = $4,000.
Expense Increases
- Wages expense: $4,500
- Insurance expense: $1,000
- Depreciation expense: $416.67
- Bad debt expense: $700
Total expense increase = $6,616.67.
Ignoring taxes and other effects, the net effect on profit from these adjustments is:
This demonstrates why period-end adjustments can materially affect reported results even when none of the entries involve new cash.
Mini Case Study: ABC Consulting
ABC Consulting closes its books every month. At March 31, the accountant reviews the accounts and discovers the following:
- The company owes employees $6,200 for work completed in March.
- It has earned $4,000 from a client but has not yet billed the client.
- $1,500 of prepaid insurance has expired.
- $2,000 of customer advances have now been earned.
- Monthly depreciation is $800.
Step 1: Record Accrued Payroll
| Wages Expense | $6,200 | |
| Wages Payable | $6,200 |
Step 2: Record Accrued Revenue
| Accounts Receivable | $4,000 | |
| Service Revenue | $4,000 |
Step 3: Recognize Insurance Expense
| Insurance Expense | $1,500 | |
| Prepaid Insurance | $1,500 |
Step 4: Recognize Earned Revenue
| Unearned Revenue | $2,000 | |
| Service Revenue | $2,000 |
Step 5: Record Depreciation
| Depreciation Expense | $800 | |
| Accumulated Depreciation | $800 |
After posting these adjustments, ABC Consulting can prepare an adjusted trial balance and then its financial statements.
Common Mistakes When Preparing Adjusting Entries
1. Recording Cash in Every Adjustment
Many beginners think every journal entry must include cash. That is incorrect. Adjusting entries frequently update non-cash balances.
2. Treating Unearned Revenue as Immediate Revenue
Receiving cash from a customer does not automatically mean all of the cash is revenue. If the company still owes goods or services, the amount may initially be a liability.
3. Forgetting Accrued Expenses
Unpaid wages, interest, utilities, and professional services can easily be missed if the accountant looks only at cash payments.
4. Expensing the Entire Prepayment
If an insurance policy covers 12 months, the entire payment may not belong to the current month.
5. Using the Wrong Depreciation Amount
Depreciation should be calculated based on the relevant cost, useful life, salvage value, method, and applicable accounting rules.
6. Ignoring Existing Allowance Balances
For allowance-based bad debt adjustments, the required adjustment may differ from the desired ending balance because an existing allowance balance may already exist.
7. Forgetting the Adjusted Trial Balance
Posting adjustments without reviewing the resulting account balances can allow errors to remain unnoticed.
8. Double Counting an Expense
An expense may already have been recorded through a regular transaction. Before creating an adjustment, determine what has already been recognized.
9. Using the Wrong Accounting Period
The adjustment should correspond to the reporting period being closed.
10. Confusing an Error With an Adjustment
A normal period-end accrual is not the same thing as correcting an incorrectly recorded transaction.
Adjusting Entries at Month-End vs Year-End
The underlying principles are the same, but the scale and documentation may differ.
| Area | Month-End | Year-End |
|---|---|---|
| Payroll accruals | Common | Common |
| Prepaid expenses | Common | Common |
| Depreciation | Often recorded monthly | Reviewed carefully |
| Bad debt allowance | May be estimated monthly | Often receives detailed review |
| External reporting | Management reporting | May support annual financial reporting |
| Documentation | Supporting schedules | Usually more extensive review |
Adjusting Entries in an ERP System
Modern accounting software and ERP systems can make period-end adjustments more organized, but automation does not remove the need for accounting judgment.
An ERP system may support:
- Recurring journal entries
- Accrual schedules
- Prepaid expense schedules
- Fixed asset depreciation
- Accounts receivable aging
- Allowance calculations
- Deferred revenue schedules
- Month-end close checklists
- Approval workflows
- Audit trails
For example, if a company has a 12-month insurance policy, the ERP may automatically generate a monthly expense entry based on the schedule. Similarly, fixed asset modules can calculate and post depreciation according to configured policies.
However, accountants still need to review whether the underlying data, dates, estimates, contracts, and assumptions are correct.
Adjusting Entries and Automation
Accounting automation is particularly useful when the same type of adjustment occurs repeatedly.
Examples include:
- Monthly depreciation
- Recurring rent accruals
- Subscription expense recognition
- Deferred revenue recognition
- Interest accruals
A strong accounting workflow does not simply automate journal creation. It should also include review controls, supporting schedules, approval, reconciliation, and documentation.
This is one reason ERP systems can become important as businesses grow from spreadsheet-based accounting to integrated financial management.
How to Review an Adjusting Entry Before Posting
Before posting an adjustment, use this checklist:
- What economic event occurred?
- Which accounting period does it belong to?
- Has any part already been recorded?
- What amount should be recognized?
- Which account needs a debit?
- Which account needs a credit?
- Does the entry balance?
- What happens to profit?
- What happens to assets or liabilities?
- Is supporting documentation available?
- Could this entry be reversed or repeated next period?
- Has another person or system already recorded the same item?
Practice Questions: Adjusting Entries
Question 1: Accrued Salary
Employees have earned $2,500 by the end of the month, but they will be paid next month. Prepare the adjusting entry.
Question 2: Prepaid Insurance
A company paid $6,000 for six months of insurance. One month has expired. What adjusting entry is required?
Question 3: Accrued Revenue
A consulting company completed $1,800 of work that has not yet been billed. What adjustment is required?
Question 4: Unearned Revenue
A company received $9,000 in advance for nine months of service. One month of service has now been completed. What is the adjustment?
Question 5: Depreciation
Equipment costs $20,000, has an estimated salvage value of $2,000, and has a useful life of six years. Using straight-line depreciation, calculate annual depreciation.
Question 6: Interest
A business has a $60,000 loan at 10% annual interest. Calculate one month's accrued interest.
Question 7: Allowance for Doubtful Accounts
The required ending allowance is $3,500. The existing credit balance is $2,400. What additional adjustment is required?
Question 8: Conceptual Question
Why does an accrued expense adjustment usually increase both an expense and a liability?
Answers to Practice Questions
Answer 1
| Salary/Wages Expense | $2,500 | |
| Salary/Wages Payable | $2,500 |
Answer 2
Monthly insurance expense:
| Insurance Expense | $1,000 | |
| Prepaid Insurance | $1,000 |
Answer 3
| Accounts Receivable | $1,800 | |
| Consulting Revenue | $1,800 |
Answer 4
$9,000 ÷ 9 = $1,000 earned.
| Unearned Revenue | $1,000 | |
| Service Revenue | $1,000 |
Answer 5
Depreciable amount = $20,000 − $2,000 = $18,000.
Annual depreciation = $18,000 ÷ 6 = $3,000 per year.
Answer 6
Annual interest = $60,000 × 10% = $6,000.
Monthly interest = $6,000 ÷ 12 = $500.
| Interest Expense | $500 | |
| Interest Payable | $500 |
Answer 7
Additional bad debt adjustment = $1,100.
| Bad Debt Expense | $1,100 | |
| Allowance for Doubtful Accounts | $1,100 |
Answer 8
The expense has already been incurred, so expense must be recognized. Because cash has not yet been paid, the company also has an obligation to pay, creating a liability.
Adjusting Entries Cheat Sheet
| Situation | Debit | Credit |
|---|---|---|
| Unpaid wages | Wages Expense | Wages Payable |
| Unpaid interest | Interest Expense | Interest Payable |
| Earned unbilled revenue | Accounts Receivable | Revenue |
| Prepaid insurance consumed | Insurance Expense | Prepaid Insurance |
| Prepaid rent consumed | Rent Expense | Prepaid Rent |
| Customer advance earned | Unearned Revenue | Revenue |
| Depreciation | Depreciation Expense | Accumulated Depreciation |
| Expected uncollectible receivables | Bad Debt Expense | Allowance for Doubtful Accounts |
Quick Memory Trick for Beginners
If you are studying adjusting entries for an accounting exam, remember these four questions:
Think accrued expense.
2. Has revenue been earned but not recorded?
Think accrued revenue.
3. Was cash paid before an expense was consumed?
Think prepaid expense.
4. Was cash received before revenue was earned?
Think unearned revenue.
Then remember depreciation and bad debt/allowance as additional common period-end adjustments.
What If You Do Not Make Adjusting Entries?
If necessary adjustments are omitted, financial statements may not accurately represent the company's results and financial position.
For example, failure to record accrued wages can cause:
- Expenses to be understated
- Liabilities to be understated
- Profit to be overstated
- Equity to be overstated through higher reported profit
Failure to recognize expired prepaid insurance can cause:
- Expenses to be understated
- Prepaid assets to be overstated
- Profit to be overstated
Failure to recognize accrued revenue can cause:
- Revenue to be understated
- Receivables to be understated
- Profit to be understated
The exact financial and tax consequences depend on the circumstances and applicable reporting requirements, but the accounting principle is clear: the accounts should reflect the correct reporting period.
Relationship Between Adjusting Entries and Accrual Accounting
Adjusting entries are closely associated with accrual accounting.
Under accrual accounting, economic activity is recognized when it is earned or incurred rather than relying solely on the timing of cash receipts and payments.
For a broader explanation of the two accounting bases, see Cash Basis vs Accrual Basis Accounting.
The key difference can be summarized simply:
| Cash Basis | Accrual Basis |
|---|---|
| Focuses primarily on cash timing. | Focuses on economic activity and period recognition. |
| Adjustments may be less extensive. | Period-end adjustments are commonly important. |
| May be simpler for some small businesses. | Provides a more complete period-based view when properly applied. |
Why Adjusting Entries Matter for Management Decisions
Accurate adjusting entries are not only about passing accounting exams. They can affect real business decisions.
Management may use monthly financial statements to evaluate:
- Whether sales are growing
- Whether operating expenses are increasing
- Whether profit margins are changing
- Whether customers are paying on time
- Whether liabilities are increasing
- Whether subscriptions and prepaid contracts are being used efficiently
- Whether fixed assets are generating sufficient returns
- Whether cash planning needs improvement
If period-end adjustments are missing, management may make decisions using incomplete or distorted accounting information.
Adjusting Entries and Financial Controls
A reliable period-end process should include controls around adjusting entries.
Useful controls include:
- Standard adjustment templates
- Supporting documentation
- Preparer and reviewer separation
- Approval thresholds
- Recurring-entry review
- Reconciliation of major balance sheet accounts
- Review of unusual period-end entries
- Comparison with previous periods
- Clear descriptions for journal entries
- Audit trails in accounting software
A journal entry that balances mathematically is not automatically correct. Accounting accuracy requires both numerical balance and proper economic substance.
Frequently Asked Questions About Adjusting Entries
What is an adjusting entry in accounting?
An adjusting entry is a period-end journal entry used to update account balances so that revenues and expenses are recognized in the appropriate accounting period and assets and liabilities are properly stated.
What are the six types of adjusting entries?
The six common categories are accrued expenses, accrued revenue, prepaid expenses, unearned or deferred revenue, depreciation, and bad debt or allowance adjustments.
Do adjusting entries involve cash?
Usually, no. Adjusting entries generally recognize economic activity that has occurred without requiring a new cash transaction at the time of adjustment.
Why are adjusting entries necessary?
They help ensure that financial statements reflect the revenues earned, expenses incurred, assets consumed, and liabilities existing during the reporting period.
Are adjusting entries made before or after the trial balance?
They are normally prepared after the unadjusted trial balance has been prepared and reviewed. The resulting balances are then used to prepare the adjusted trial balance.
What is an accrued expense?
An accrued expense is an expense that has been incurred but has not yet been paid or recorded.
What is accrued revenue?
Accrued revenue is revenue that has been earned but has not yet been received in cash or fully recorded.
What is prepaid expense?
A prepaid expense is a payment made before the related goods or services are consumed. As the benefit is used, the appropriate portion becomes an expense.
What is unearned revenue?
Unearned revenue is money received from a customer before the business has earned the related revenue. It is generally recognized as revenue as the promised goods or services are provided, subject to applicable accounting rules.
Is depreciation an adjusting entry?
Yes. Periodic depreciation expense is commonly recorded through an adjusting or recurring period-end entry, depending on the accounting system and workflow.
What is an adjusted trial balance?
An adjusted trial balance lists account balances after all required adjusting entries have been posted. It is commonly used as the basis for preparing financial statements.
Are adjusting entries the same as correcting entries?
No. Adjusting entries recognize or update normal period-end accounting activity, while correcting entries are used to fix errors in previously recorded transactions.
Can adjusting entries increase profit?
Yes. For example, recognizing accrued revenue or revenue earned from an advance can increase revenue and profit, assuming there are no offsetting effects.
Can adjusting entries decrease profit?
Yes. Accrued expenses, prepaid expense recognition, depreciation, and bad debt expense can reduce reported profit.
Why is cash usually not included in adjusting entries?
Because the purpose of the adjustment is usually to recognize the passage of time or the earning/incurring of an amount that has already been paid or will be paid later. A new cash transaction is often not occurring at the adjustment date.
Final Takeaway
Adjusting entries in accounting are essential for producing reliable accrual-based financial statements. They make sure that revenues are recognized when earned, expenses are recognized when incurred or consumed, assets are reduced when their benefits are used, and liabilities are recognized when obligations exist.
The most important categories to understand are accrued expenses, accrued revenue, prepaid expenses, unearned revenue, depreciation, and bad debt or allowance adjustments.
For beginners, the best way to master adjusting entries is not to memorize dozens of journal entries. Instead, focus on the underlying question:
Once you can answer that question, the debit and credit usually become much easier to determine.
Adjusting entries also form an important bridge between day-to-day bookkeeping and accurate financial reporting. Whether a business uses spreadsheets, accounting software, or a full ERP system, the objective remains the same: make the accounts represent the correct economic activity for the correct period.
For a broader understanding of double-entry accounting, you can also read our guide to Double-Entry Accounting.
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