Learn It
Adjusting entries exist because cash movement and the recognition of revenue or expenses do not always happen at the same time. As we covered in Prepaids, Accruals, and Deferrals, a business might pay for 12 months of insurance in January, but the expense belongs across all 12 months.
At the end of each period — usually each month — the bookkeeper reviews the books and asks: Does everything in these books reflect what actually happened during this period?
If something happened but was not yet recorded, an adjusting entry is needed. If something was recorded but belongs to a different period, an adjusting entry fixes the timing.
Common Adjusting Entries
Prepaid Expenses
An asset like prepaid insurance or prepaid rent is used up over time. Each month, a portion moves from the asset account to an expense account. Debit the expense, credit the asset.
Accrued Expenses
Employees earned wages this month but will not be paid until next month. The expense belongs in this period. Debit the expense, credit a payable (liability).
Accrued Revenue
Work was completed this month but has not been invoiced yet. The revenue belongs in this period. Debit Accounts Receivable, credit Revenue.
Deferred Revenue
A customer paid in advance. As the work is completed, a portion moves from the liability (Unearned Revenue) to actual revenue. Debit Unearned Revenue, credit Revenue.
Depreciation
As we covered in Fixed Assets and Depreciation, each month a portion of a fixed asset's cost moves to Depreciation Expense. Debit Depreciation Expense, credit Accumulated Depreciation.
Adjustments vs. Corrections
An adjusting entry is not the same as fixing a mistake. An adjusting entry records something that happened but was not yet in the books — like one month of insurance expiring or wages earned but not yet paid. A correction fixes something that was recorded wrong — like a bill posted for the wrong amount or to the wrong account.
Both change the books, but they serve different purposes. Adjusting entries are a normal part of every period-end close. Corrections happen when an error is found.
Every Adjustment Should Have a Reason
A good bookkeeper does not make adjusting entries from memory or guesswork. Every adjustment should be supported by documentation — an insurance policy showing the term and cost, a payroll report showing earned but unpaid wages, a depreciation schedule showing the monthly amount.
If you cannot explain why an adjustment is needed and how the amount was calculated, you should not be making the entry. Documentation protects the books and makes it possible for someone else to understand the adjustment later.
See It
Here is a small group of unadjusted balances at month-end, along with information discovered during the close:
| Account | Unadjusted Balance |
|---|---|
| Prepaid Insurance | $12,000 |
| Insurance Expense | $0 |
| Wage Expense | $0 |
| Wages Payable | $0 |
| Depreciation Expense | $0 |
| Accumulated Depreciation | $0 |
| Accounts Receivable | $0 |
| Service Revenue | $0 |
Discovered at month-end:
- Insurance: $12,000 paid on January 1 for 12 months. One month has expired.
- Wages: Employees earned $2,500 in the last three days of the month. Payday is next month.
- Depreciation: Equipment cost $12,000, 5-year life, no residual value. No depreciation recorded this month.
- Accrued revenue: $1,800 of work completed for a client but not yet invoiced.
Each of these items requires an adjusting entry. The exercise below will walk you through all four.
Do It
Complete the Month-End Adjustments Workpaper. For each adjustment, select the correct accounts and type the debit and credit amounts. Check your work after each entry.
Do It — Month-End Adjustments Workpaper
Four adjustments are needed at month-end. For each one, read the supporting information, then construct the adjusting journal entry by selecting the accounts and typing the debit and credit amounts.
Each entry must balance — debits must equal credits.
Adjustment 1: Prepaid Insurance
The business paid $12,000 for 12 months of insurance on January 1. One month has now passed. Record the expired portion.
Construct the adjusting journal entry:
| Account | Debit | Credit |
|---|---|---|
| — | ||
| — | ||
| Totals | $0 | $0 |
Prove It
Answer each question, then read the explanation. There's no score — this is just to help the ideas stick.
Question 1
Why are adjusting entries needed at the end of a period?
Question 2
A business paid $12,000 for 12 months of insurance on January 1. By the end of January, how much should be in Prepaid Insurance, and how much should be in Insurance Expense?
Question 3
What is the difference between an adjusting entry and a correction of an error?
Key Takeaways
- Adjusting entries make sure revenue and expenses are recorded in the correct period.
- Prepaid expenses: debit the expense, credit the asset (e.g., Insurance Expense / Prepaid Insurance).
- Accrued expenses: debit the expense, credit a payable (e.g., Wage Expense / Wages Payable).
- Accrued revenue: debit Accounts Receivable, credit Revenue.
- Deferred revenue: debit Unearned Revenue, credit Revenue.
- Depreciation: debit Depreciation Expense, credit Accumulated Depreciation — never credit Cash or the asset's original cost account.
- Adjusting entries are not corrections — they record things that happened but were not yet in the books.
- Every adjustment should be supported by documentation and a clear reason.