Adjusting Entries Explained

A company's books can be fully up to date – every invoice entered, every bank transaction matched – and still be wrong. That is not a contradiction: accrual accounting requires revenue and expenses to land in the period they economically belong to, not the period cash happened to move, and day-to-day bookkeeping only captures the cash-triggered half of that. Adjusting entries close the gap. They are end-of-period journal entries that update the general ledger so recorded balances match what actually happened during the period, regardless of when money changed hands.

Two rules make an adjusting entry recognizable. Every one of them touches at least one income statement account and one balance sheet account – that pairing is what keeps net income and the balance sheet in sync. And none of them ever touches cash: if a transaction involves cash moving, it is a regular transaction, not an adjustment. This article works through why the entries exist, how they differ from the other entry types they get confused with, the five core categories with worked examples, the procedure for recording them, and the mistakes that most often break a close.

Why Adjusting Entries Are Necessary

Cash-basis bookkeeping records a sale when payment arrives and an expense when the bill is paid. Accrual accounting, which most formal financial statements are built on, requires something different: revenue gets recorded when it is earned, and expenses get recorded when they are incurred, independent of the payment date. The matching principle sits behind this – expenses should appear in the same period as the revenue they helped generate, so a period's profit actually reflects that period's activity rather than whatever happened to get paid or billed during it.

Skip the adjustment step and the consequences are not cosmetic. Income gets overstated or understated depending on which items were missed. Assets or liabilities end up wrong – unbilled revenue that never became a receivable, an unpaid bill that never became a payable. Decisions made off those numbers inherit the distortion, and if the books are ever reviewed externally, unadjusted balances are exactly the kind of gap an audit is built to catch.

Adjusting Entries vs. Correcting and Closing Entries

Three entry types get mixed up because they all happen around period end, but each does a different job. Correcting entries fix outright mistakes – a transposed figure, an entry posted to the wrong account – and can be made any time an error is found, not just at period end. Adjusting entries update balances for economic activity that has not yet been recorded anywhere, and they happen specifically at the close. Closing entries come after adjustments are finished; they zero out temporary accounts (revenue, expenses, dividends) and roll the result into retained earnings, covered in full in closing entries and trial balance.

Where Adjusting Entries Fit in the Accounting Cycle

The accounting cycle runs in a fixed order: record transactions, post them to the ledger, prepare an unadjusted trial balance, record adjusting entries, prepare an adjusted trial balance, produce the financial statements, then record closing entries and a post-closing trial balance. Adjusting entries sit specifically between the unadjusted and adjusted trial balances. The unadjusted trial balance only proves that debits equal credits mechanically – it says nothing about whether the underlying balances are complete. That is exactly what adjusting entries are for: a trial balance can be perfectly balanced and still describe the wrong period.

Accruals and Deferrals: The Two Broad Classes

Every adjusting entry falls into one of two families, and the distinction is what makes the individual types easy to remember instead of a list to memorize. Accruals cover activity that has already happened but nothing has been recorded yet – revenue earned but not billed, an expense incurred but not paid. Deferrals cover the opposite case: something was already recorded, usually because cash moved, but it has to be split across more than one period. Both classes still follow the core rule – one income statement account, one balance sheet account, no cash – they just start from opposite directions.

Accrued Revenues

Accrued revenue is revenue that has been earned but not yet billed or collected – common in services, project work, long-term contracts, and interest earned on an investment. The entry debits Accounts Receivable and credits Service Revenue for the amount earned during the period. On the income statement, revenue for the period is higher than what has actually been invoiced; on the balance sheet, accounts receivable rises to reflect the amount the business is now owed. Without this entry, a business that completed real work before period end would understate both its revenue and what it is owed.

Accrued Expenses

Accrued expenses mirror accrued revenue from the other side: a cost has been incurred but no bill or payment has been recorded yet. Wages earned in the final days of a period but paid after it closes are the classic case, alongside accrued interest, utilities used but not yet billed, and professional services rendered but not yet invoiced. The entry debits the relevant Expense account and credits a Payable account for the amount owed. This keeps the expense in the period the cost was actually incurred, which is what the matching principle requires, and it keeps the payable visible on the balance sheet until it is settled.

Deferred (Unearned) Revenues

Deferred revenue is the reverse timing problem: cash has already arrived, but the business has not yet delivered what it was paid for – subscriptions, retainers, prepaid contracts, and gift cards are common examples. Because the obligation to deliver is still outstanding, the amount is recorded as a liability, Unearned Revenue, rather than as revenue. As the business fulfills its side of the arrangement, the adjusting entry debits Unearned Revenue and credits Revenue for the portion now earned. Both statements move: the liability shrinks as revenue is recognized, and the income statement reflects only what was actually delivered during the period.

Prepaid Expenses

Prepaid expenses are the mirror image of deferred revenue: cash was paid in advance for a benefit that extends across more than one period, so it is initially recorded as an asset – Prepaid Insurance, Prepaid Rent – rather than as an immediate expense. Insurance premiums, rent paid ahead, software subscriptions, and bulk supplies are typical cases. As the benefit is used up, the adjusting entry debits the appropriate Expense account and credits the Prepaid account for the portion consumed during the period. Consider a hypothetical case: a business pays $12,000 for a full year of insurance upfront. Each month's adjusting entry debits Insurance Expense and credits Prepaid Insurance for $1,000, so only one month's worth lands on that month's income statement rather than the full amount at once.

Depreciation and Amortization

Depreciation and amortization allocate the cost of a long-lived asset across the periods it actually gets used, instead of expensing the full cost the moment it is purchased. Depreciation applies to physical assets – equipment, vehicles, buildings; amortization applies to intangible assets such as patents or licenses. The logic is the same matching principle at work again: a machine that will be productive for ten years should not dump its entire cost onto the year it was bought. The entry debits Depreciation Expense and credits Accumulated Depreciation, a contra-asset account that reduces the asset's book value on the balance sheet without ever touching cash. These schedules are typically set up once and then adjusted on a recurring basis, with periodic review for impairment if an asset's value has genuinely declined faster than the schedule assumed.

Inventory Adjustments and Write-Downs

Inventory adjustments correct a different kind of gap: the difference between what the books say is on hand and what is physically there or still sellable. Loss, damage, spoilage, obsolescence, theft, and simple counting errors all create this gap over time. When inventory's value has genuinely declined – goods that will sell for less than their recorded cost, or not sell at all – it gets written down to net realizable value. The entry debits an Inventory Write-Down Expense account and credits Inventory. The effect flows straight through cost of goods sold, gross profit, and net income, which is why unreconciled inventory counts distort profitability even when every sales transaction was recorded correctly.

Bad Debt Expense and Provisions

Some receivables will not be collected, and the conservatism principle says a business should recognize that reality rather than carry every receivable at full value until it is proven uncollectible. Bad debt expense estimates the uncollectible portion using a method such as a percentage of sales or an aging analysis of outstanding receivables. The entry debits Bad Debt Expense and credits Allowance for Doubtful Accounts, a contra-asset account that reduces receivables on the balance sheet without removing any specific invoice. Because this entry rests on an estimate rather than a known fact, it gets revisited each period as more information about actual collections comes in.

How Adjusting Entries Affect the Financial Statements

Every type covered above lands on the statements the same way: it shifts revenue or an expense into the period it actually belongs to, which changes net income on the income statement, and it updates an asset or liability balance on the balance sheet to match. That paired movement is not incidental – it is the entire mechanism that keeps accrual-based reporting internally consistent. A business could, in theory, adjust only the income statement or only the balance sheet, but doing so would break the connection between the two, which is exactly what the two-account rule is designed to prevent.

When to Record Adjusting Entries

Adjusting entries are made at the end of every reporting period – monthly, quarterly, or annually, depending on how often the business closes its books – and always as part of the month-end or period-end close, before closing entries are recorded. How long the step takes depends on the complexity of the books: a business with a handful of prepaid items and one depreciation schedule can finish quickly, while one with multiple deferred-revenue contracts and several bad-debt estimates needs more time to gather supporting documentation. Businesses that keep a pure cash-basis system generally skip this step entirely, since the timing gap it exists to close does not apply to them under IRS accrual-method rules for formal accounting (IRS Publication 538, checked 2026-09-29).

How to Record Adjusting Journal Entries, Step by Step

The procedure is mechanical once the categories above are understood. Review the unadjusted trial balance line by line. Identify which balances need adjusting – unbilled revenue, unpaid expenses, prepaid balances that have been partly used, depreciation schedules due for their periodic entry, receivables that need a bad-debt estimate. Calculate the correct amount from supporting documentation – a contract, an invoice, a depreciation schedule, an aging report. Record the entry using standard debit-and-credit rules, covered in full in debit and credit basics. Update the trial balance and verify that debits still equal credits after every entry is posted. Document each entry with the evidence behind it, since this documentation is what an auditor or reviewer will ask for later.

Common Mistakes with Adjusting Journal Entries

A handful of errors show up repeatedly at close. Forgetting to reverse an accrual at the start of the next period leads to double-counting once the actual bill or payment arrives. Double-counting deferred revenue happens when the same delivered portion gets recognized twice, usually from a spreadsheet tracking error. Posting an adjustment to the wrong period misstates two periods at once instead of one. Skipping documentation creates audit risk even when the number itself was correct, because nobody can verify it later. Failing to reconcile the adjusted trial balance after posting entries lets a keying error slip through undetected. And treating adjusting entries as a routine fix for broken day-to-day recording – rather than a genuine timing correction – is a sign the underlying bookkeeping process needs attention, not just the closing step.

Automating Adjusting Entries

Because much of this work repeats every period in a predictable pattern, automation handles a meaningful share of it well. Recurring journal entries can auto-post and auto-reverse routine accruals. Depreciation and amortization schedules, once set up, post on their own schedule without manual re-entry each period. Software can maintain a full audit trail with supporting documentation attached to each entry automatically. Some businesses move toward continuous accounting, spreading adjustments through the month as transactions occur rather than batching everything into a single end-of-period push – reducing the volume of adjustments that pile up right before a close deadline.

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