Adjusting Journal Entries Explained: A Beginner's Complete Guide
Understand the five core types of adjusting entries and why they're essential for accurate financial statements.
At the end of every accounting period, businesses need to ensure their financial records accurately reflect what has happened during that period. Not every transaction is recorded at exactly the right time, which is why accountants make adjusting journal entries as part of the double-entry accounting system.
These entries help match revenues with expenses, record assets and liabilities correctly, and produce accurate financial statements. Whether you use accounting software or manual bookkeeping, understanding adjusting journal entries is an essential accounting skill.
In this guide, you'll learn what adjusting entries are, why they matter, the most common types, and how to prepare them using simple examples.
What Are Adjusting Journal Entries?
Adjusting journal entries are entries recorded at the end of an accounting period to update account balances before financial statements are prepared. They are necessary because some revenues and expenses occur over time rather than at the moment cash changes hands.
Adjusting entries ensure your financial statements comply with the accrual basis of accounting.
Here's the thing — cash moving and value being earned rarely happen on the same day.
Why Are Adjusting Entries Important?
Without adjusting entries:
- Revenue may be understated or overstated.
- Expenses may appear in the wrong period.
- Assets may be incorrect.
- Liabilities may be missing.
- Net profit may be inaccurate.
- Financial statements may mislead owners, lenders, or investors.
Adjusting entries improve the reliability of financial reporting.
When Are Adjusting Entries Made?
Businesses typically prepare adjusting entries:
- At month-end
- At quarter-end
- At year-end
- Before financial statements are issued
- Before annual audits
Many businesses make them as part of their regular month-end closing process.
The Matching Principle
One of the key reasons for adjusting entries is the matching principle. The matching principle requires expenses to be recorded in the same accounting period as the revenue they helped generate.
Quick answer: If a business pays one year's insurance in January, only one month's insurance expense belongs in January — the rest is recorded as a prepaid asset until future months. This produces more accurate financial statements.
The Five Main Types of Adjusting Entries
The most common adjusting entries include:
- Accrued revenue
- Accrued expenses
- Deferred revenue
- Prepaid expenses
- Depreciation
Let's look at each one.
1. Accrued Revenue
Accrued revenue is income that has been earned but has not yet been invoiced or received.
| Type | Account | Amount |
|---|---|---|
| Debit | Accounts Receivable | $2,000 |
| Credit | Consulting Revenue | $2,000 |
Revenue is recorded in the correct accounting period.
2. Accrued Expenses
These are expenses that have been incurred but not yet paid. Examples include salaries, utilities, interest, and professional fees.
| Type | Account | Amount |
|---|---|---|
| Debit | Wages Expense | $4,000 |
| Credit | Wages Payable | $4,000 |
3. Deferred Revenue
Sometimes customers pay before goods or services are delivered. Initially, the payment is recorded as a liability because it has not yet been earned. As work is completed, revenue is recognized.
| Type | Account | Amount |
|---|---|---|
| Debit | Unearned Revenue | $1,000 |
| Credit | Service Revenue | $1,000 |
4. Prepaid Expenses
Businesses often pay for services before receiving the full benefit. Common examples include insurance, rent, software subscriptions, and maintenance contracts.
| Type | Account | Amount |
|---|---|---|
| Debit | Insurance Expense | $1,000 |
| Credit | Prepaid Insurance | $1,000 |
5. Depreciation
Long-term assets lose value over time. Rather than recording the entire cost as an expense immediately, businesses spread the cost across the asset's useful life.
| Type | Account | Amount |
|---|---|---|
| Debit | Depreciation Expense | $500 |
| Credit | Accumulated Depreciation | $500 |
Accounts Commonly Affected
Did you know? A single month-end close can touch every category of account on your books — assets, liabilities, revenue, and expenses.
Assets: Accounts Receivable, Prepaid Expenses, Inventory, Equipment, Accumulated Depreciation
Liabilities: Accounts Payable, Wages Payable, Interest Payable, Unearned Revenue
Revenue: Service Revenue, Sales Revenue, Interest Revenue
Expenses: Rent Expense, Utilities Expense, Salaries Expense, Insurance Expense, Depreciation Expense
How Adjusting Entries Affect Financial Statements
Income Statement
They ensure revenues and expenses are reported in the correct period on your income statement, resulting in a more accurate profit figure.
Balance Sheet
Assets and liabilities are updated to reflect the business's true financial position — which is exactly what you're reading when you read a balance sheet.
Cash Flow Statement
Most adjusting entries do not involve cash, so they generally do not directly affect the cash flow statement.
Step-by-Step Process for Preparing Adjusting Entries
Follow this simple process:
- Review the trial balance.
- Identify accounts requiring adjustment.
- Gather supporting documents such as invoices, contracts, payroll records, and schedules — and keep them on hand for as long as you're required to keep your business records.
- Calculate the adjustment.
- Prepare the journal entry.
- Post the entry to the general ledger.
- Prepare an adjusted trial balance.
- Generate the financial statements.
🧠 Memory Trick
Think "ADPE" — Accrue what's owed, Defer what's unearned, Prepay gets used up, Equipment wears down. Four buckets, five entries — deferred revenue and prepaid expenses are just mirror images of the same idea (cash moved first, value follows later).
⚠️ Common Mistakes
- Forgetting month-end adjustments
- Recording cash transactions instead of accruals
- Posting adjustments twice
- Using incorrect dates
- Omitting depreciation
- Ignoring prepaid expenses
- Failing to reverse entries when appropriate
- Lacking supporting documentation
Regular review procedures help prevent these mistakes.
Tips for Small Businesses
To simplify the adjustment process:
- Close your books monthly.
- Maintain organized documentation.
- Reconcile all bank accounts.
- Review unpaid invoices.
- Track prepaid expenses.
- Maintain a fixed asset register.
- Use accounting software reminders.
- Review recurring journal entries.
Consistent month-end procedures reduce errors and improve reporting quality.
Example Month-End Adjustments
Suppose your business has the following at month-end:
- Insurance paid in advance: $600 remaining
- Employee wages owed: $2,500
- Depreciation: $400
- Consulting work completed but not billed: $1,200
Required adjustments: record insurance expense, accrue wages payable, record depreciation, and recognize accrued revenue. After posting these entries, your financial statements more accurately represent the month's activities.
✅ Adjusting Entries Checklist
- ✓ Reconciled bank accounts
- ✓ Reviewed accounts receivable
- ✓ Reviewed accounts payable
- ✓ Recorded accrued expenses
- ✓ Recognized accrued revenue
- ✓ Updated prepaid expenses
- ✓ Calculated depreciation
- ✓ Reviewed loan interest
- ✓ Updated deferred revenue
- ✓ Prepared an adjusted trial balance
Conclusion
Adjusting journal entries are one of the most important parts of the accounting cycle. They ensure revenues and expenses are recognized in the correct accounting period, resulting in accurate financial statements and better financial insights. By understanding the different types of adjustments and following a consistent month-end process, small businesses can improve bookkeeping accuracy and be better prepared to prepare for a financial audit, tax reporting, and strategic decision-making.
Key Takeaways
- Adjusting entries update account balances before financial statements are prepared.
- They exist because of the matching principle — revenue and the expenses tied to it belong in the same period.
- The five main types are accrued revenue, accrued expenses, deferred revenue, prepaid expenses, and depreciation.
- Most adjusting entries don't involve cash, so they rarely touch the cash flow statement directly.
- A consistent month-end checklist is the easiest way to avoid missed adjustments.
Frequently Asked Questions
Are adjusting journal entries required every month?
Businesses that prepare monthly financial statements should generally make adjusting entries each month to maintain accurate records.
Do adjusting entries involve cash?
Usually not. Most adjusting entries recognize revenues or expenses that have already been earned or incurred, rather than recording cash movements.
Can accounting software create adjusting entries automatically?
Yes. Many cloud accounting systems can automate recurring adjustments such as depreciation, prepaid expense amortization, and recurring accruals, though they should still be reviewed for accuracy.
What is an adjusted trial balance?
An adjusted trial balance is a trial balance prepared after all adjusting journal entries have been posted. It serves as the basis for preparing financial statements.
What happens if adjusting entries are missed?
Missing adjusting entries can overstate or understate income, assets, liabilities, or expenses, leading to inaccurate financial statements and poor business decisions.
About the Author
Ishara Vithana is a senior finance professional with over two decades of experience in accounting, bookkeeping, and small business finance. He is a Xero Certified Advisor and Partner, Dext Certified Expert, Fathom Advisor, and Tally Prime expert. Through Finance Made Simple, he helps small business owners and DIY bookkeepers understand accounting, bookkeeping, and business finance with practical, easy-to-follow guides. Connect with Ishara →
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