What are Adjusting Entries? 

Adjusting entries are journal entries made at the end of an accounting period to account for income or expenses that have been earned or incurred but not yet recorded. These adjustments ensure that revenues and expenses are recognized in the correct period, in line with the accrual basis of accounting.

    They are necessary because not all business transactions occur neatly within the accounting period—they may happen over time, involve estimates, or simply get recorded late.

Adjusting entries serve several key purposes:

  • Match Revenues with expenses in the correct period (Matching Principle)
  • Recognize Income and Expenses when they are earned or incurred, not when cash is exchanged (Revenue Recognition Principle)
  • Present Accurate Financial Statements

Comply with Generally Accepted Accounting Principles (GAAP) or IFRS

Types of Adjusting Entries:
       There are typically five main categories of adjusting entries:

1. Accrued Revenues:
        Revenues that have been earned but not yet recorded or received in cash.

Example: A company performed a service worth $2,000 in December but will invoice the client in January. An adjusting entry is needed in December to recognize the revenue.

2. Accrued Expenses:
        Expenses that have been incurred but not yet paid or recorded.

Example: Salaries of $1,500 are owed to employees at the end of the period but will be paid next month. An adjusting entry records the expense now.

3. Deferred Revenues (Unearned Revenues):
        Cash received in advance for services or goods to be provided in the future.

Example: A client pays $6,000 in advance for a 6-month service contract. Each month, $1,000 must be recognized as revenue through an adjusting entry.

4. Prepaid Expenses:
        Expenses paid in advance that need to be allocated over time.

Example: A business pays $1,200 for a one-year insurance policy. Each month, $100 of the insurance is recognized as an expense.

5. Depreciation:
       Allocating the cost of a tangible asset over its useful life.

Example: Equipment worth $12,000 has a 3-year useful life. Depreciation of $4,000 per year must be recorded.