Key Takeaways:
- Adjusting journal entries align financial statements with accrual accounting by recognizing revenue when earned and expenses when incurred, regardless of cash timing.
- They are recorded at the end of each accounting period before financial statements are finalized.
- Every adjusting journal entry impacts one balance sheet account and one income statement account.
- The six common types are accrued revenues, accrued expenses, prepaid expenses, unearned revenues, depreciation, and bad debt expense.
- Proper adjusting entries prevent financial statement errors, ensure GAAP/IFRS compliance, and provide accurate reporting for decision-making.
- Without adjusting journal entries, financial statements become misstated and non-compliant with GAAP or IFRS.
- Automating adjusting journal entries reduces errors and shortens month-end close cycles by 30–50%.
Do you find it hard to close your books accurately, as some transactions don’t tally with the correct accounting period?
Are discrepancies between your cash flow and actual revenue a common occurrence when preparing financial statements?
If yes, you are not alone.
Even seasoned accountants find themselves in these situations at times, facing inaccurate financial statements, compliance issues, or audit challenges.
So, the question is: How can you overcome this situation to ensure your reports reflect your company’s actual financial position?
Fret not, as there’s a solution: mastering adjusting journal entries. And here’s the detailed guide to help you with that.
Here, we’ve covered everything you need to know about adjusting journal entries, from definition and types to examples and best practices.
Here’s what you will read:
- What Are Adjusting Journal Entries?
- Why Are Adjusting Journal Entries Important?
- When to Make Adjusting Journal Entries
- What Are the Types of Adjusting Journal Entries?
- How to Create Adjusting Journal Entries: Step-by-Step
- Common Mistakes to Avoid When Making Adjusting Entries
- How Automation Transforms Adjusting Entry Processes
- Frequently Asked Questions (FAQs)
What Are Adjusting Journal Entries?
Adjusting journal entries (AJEs) are end-of-period accounting entries you make to record revenues earned and expenses incurred so financial statements reflect your organization’s actual financial picture under accrual accounting, even if your accounting system hasn’t captured any transactions yet.
Adjusting journal entries are accounting entries you make often at the end of an accounting period to update account balances. They ensure your financial statements reflect your true business activity during that period.
Under accrual accounting, these entries ensure your books reflect not only cash movements but also economic reality. Using them, you can update accounts for transactions with timing differences, such as cash receipts or payment timing that differ from when you earned revenue or incurred an expense.
Think about adjusting the journal this way. You complete a consulting project in December. You invoice the client in January. Accrual accounting requires you to record that December revenue in December, not January when you receive payment.
What makes a journal entry “adjusting”?
Adjusting journal entries aren’t the same as regular journal entries, and they differ in different ways, as follows:
- Adjusting journal entries are only for when a specific period ends, i.e., monthly, quarterly, or annually. They don’t record these entries when recording daily transactions. Adjusting entries don’t record brand new transactions; they simply update existing account balances.
- For every adjusting journal entry, you need one balance sheet account and one income statement account. It helps you comply with the matching principle, which requires you to match revenues with related expenses.
- If you don’t make adjusting entries, your financial statements may fail to represent your company’s actual economic position. The consequences can be poorly informed strategic or financial decisions, inadvertent non-compliance issues, or qualified or adverse opinions during audits.
Why Are Adjusting Journal Entries Important?
Adjusting journal entries ensures error-free, accurate financial reporting; compliance with regulatory accounting standards like GAAP/IFRS; informed business decision-making; and audit readiness by aligning accounting records with actual economic activity, regardless of cash timing.
1. Ensure accurate financial reporting
Adjusting journal entries prevent your financial statements from showing incorrect figures. Your income statements might show inflated profits if you don’t record expenses, and your revenue could be understated if you don’t record income.
Your balance sheet could misrepresent your asset values, like prepaid expenses you haven’t used yet. Similarly, you may fail to account for liabilities if you don’t record accrued expenses. Every number is important when stakeholders base their decisions on what you report.
2. Comply with accounting standards
Both Generally Accepted Accounting Principles and International Financial Reporting Standards mandate accrual-based accounting. Adjusting entries ensure you adhere to the accrual accounting principles, comprising the matching principle, revenue recognition principle, and accrual basis needs. If you fail to make adjusting journal entries, it leads to non-compliance, resulting in audit qualifications or even regulatory penalties in some industries. To avoid this situation, adjusting entries is a must.
3. Support informed business decisions
Only when your financial statements show your company’s actual position, you make strategic plans, prepare the budget, and analyze performance. To ensure that, you need adjusting journal entries.
If you don’t have them, your data stays incomplete, and you obviously can’t make decisions based on that.
Improper or missing adjusting journal entries lead to consequences like these:
- Cash flow projects become unreliable.
- Investors’ and lenders’ confidence and trust in your organization erodes.
- Performance metrics, such as gross margin, operating income, and EBITDA, are misleading.
These, together, create significant issues that can threaten your business continuity.
4. Prepare for audits and tax filing
Auditors review adjusting journal entries during every audit engagement. So, proper adjusting entries are crucial for creating audit trails that clearly document when your team made adjustments.
These adjusting entries also help calculate taxable income correctly, so there’s no violation of any applicable tax norms. Further, they minimize audit adjustments and restatements, saving you time and money. Last but not least, they clearly serve as a testimony to the effectiveness of your internal controls.
According to the 2024 Financial Cents State of Workflow Automation Report, 66.1% accounting firms prioritize recurring tasks as the top feature in workflow automation, and adjusting entries could be considered one of them.
Automated journal entry adjustments minimize errors and save time when closing financials.
Struggling with time-consuming manual adjusting entries every month-end? See how our AI-powered reconciliation solution automates recurring adjustments and reduces close time by up to 50%.
When to Make Adjusting Journal Entries?
Quick Summary: Adjusting journal entries are made at the end of each accounting period, such as monthly, quarterly, or annually, before you finalize financial statements, typically within the first 3-7 days after the period ends.
1. Standard timing for adjusting entries
If you own a business and prepare monthly financial statements, you can record adjusted journal entries at each month-end. That’s what most companies do: make monthly adjustments for accurate performance data and reliable interim reporting. It makes the year-end close smoother, as adjustments occur incrementally, not all at once.
If you own a publicly traded company, you can prepare quarterly statements. Quarterly adjusting entries facilitate 10-Q filings for public companies and facilitate quarterly performance analysis. Plus, they satisfy lender covenant reporting requirements that you need for contracts.
Annual adjusting entries finalize year-end financial statements and support annual audits. Their primary purpose is to determine taxable income for tax filings and establish opening balances for the next fiscal year.
2. Specific scenarios requiring adjusting entries
You need adjusting entries for the following cases:
- You earn revenue that isn’t billed yet, called accrued revenue. Similarly, you need adjusting entries for expenses that you have incurred but haven’t paid, called accrued expenses.
- You receive cash before you deliver services, called unearned revenue,e or you pay cash before you actually incur expenses, called prepaid expenses.
- Assets that depreciate over time require you to record depreciation expense.
- Receivables that you sometimes fail to collect require bad debt expense entries.
- Inventory counts reveal discrepancies that need inventory adjustment entries.
3. The adjusting entry timeline
Below is the typical month-end close timeline:
Days 1-30: Regular transaction recording happens.
Day 31 through Day 3: Review the unadjusted trial balance, and prepare and post the adjusting entries.
Days 4-5: Generate adjusted trial balance and financial statements.
Days 6-7: Review, finalize, and distribute reports.
Pro Tip: Don’t wait until the last day to make adjusting entries. Spot recurring adjustments such as depreciation, amortization, and prepaid expenses early. Schedule them systematically to streamline your close process.
What Are the Types of Adjusting Journal Entries?
Adjusting journal entries fall into two main categories: accruals and deferrals, divided into six common types: accrued revenues, accrued expenses, prepaid expenses, unearned revenues, depreciation, and bad debt expense.
1. Accrued revenues
Accrued revenues represent the ones you earned but haven’t billed or received yet. It happens when you complete services, in one period but generate invoices in the next period.
Similarly, accrued revenue can also comprise the interest earned on investments but not yet paid, and rent earned but not yet collected from tenants.
Example: Your consulting firm completes a $10,000 project on December 28. You won’t generate an invoice until January 5.
Adjusting entry (December 31):
Debit: Accounts Receivable $10,000
Credit: Service Revenue $10,000
Without this entry, December revenue stays understated by $10,000. Your income statement doesn’t reflect the work you actually performed during the period.
2. Accrued expenses
Accrued expenses mean expenses you incurred but haven’t yet paid or recorded.
They can be wages your employees earned but haven’t been paid yet, utilities consumed but not yet billed, and interest expenses on loans that you haven’t paid. These are common month-end business adjustments every business makes.
Example: Your company owes $5,000 in wages for work performed December 28-31. Payroll runs on January 5.
Adjusting entry (December 31):
Debit: Wages expense $5,000
Credit: Wages payable $5,000
Without this entry, December expenses are understated by $5,000. That inflates net income and misrepresents liabilities on your balance sheet.
3. Prepaid expenses
Prepaid expenses are the costs your business pays in advance for goods or services you haven’t realized or recognized the benefits of.
Examples include insurance premiums you pay annually but use monthly, or the rent you pay per quarter but recognize monthly. Similarly, annual software subscriptions you pay upfront for, but use them across the year.
Example: You paid $12,000 on December 1 for a 12-month insurance policy. Coverage runs December 1, 2024, through November 30, 2025. By December 31, one month has been used.
Adjusting Entry (December 31):
Debit: Insurance Expense $1,000
Credit: Prepaid Insurance $1,000
Without this adjustment, December expenses are understated by $1,000. Assets are overstated by $1,000. Both numbers matter for accurate reporting.
4. Unearned revenue
It’s the cash you received for goods or services you haven’t yet delivered. Examples include customer prepayments for annual subscriptions, advance deposits for future services, and gift card sales before redemption. These create liabilities until you deliver the promised value.
Example: You receive $24,000 on December 1 for a 12-month SaaS subscription. By December 31, you’ve delivered one month of service worth $2,000.
Adjusting entry (December 31):
Debit: Unearned Revenue $2,000
Credit: Service Revenue $2,000
Without this entry, December revenue is understated by $2,000. Liabilities are overstated by $2,000. Both distort your financial position.
5. Depreciation expense
It’s the accounting method for allocating the cost of a tangible asset (such as machinery, vehicles, or buildings) over its useful life. It depicts the gradual wear and tear or obsolescence on the income statement as an expense, thereby reducing taxable income and showing a more realistic asset value.
Equipment, vehicles, buildings, and furniture depreciate monthly. To calculate depreciation for fixed asset reconciliation, you can use a schedule such as the straight-line, declining balance, or units-of-production method. Each method spreads costs differently.
Example: Equipment costing $120,000 with a 10-year useful life and no salvage value depreciates $1,000 monthly. That’s $120,000 divided by 10 years, divided by 12 months.
Adjusting entry (December 31):
Debit: Depreciation Expense: Equipment $1,000
Credit: Accumulated Depreciation: Equipment $1,000
Depreciation ensures asset costs match the revenue you generate over the asset’s life. That’s the matching principle in action.
6. Bad debt expense
These are accounting costs for the estimated number of accounts receivable that you can’t collect from your customers. These are bad debts, credit sales, loans, or other owed funds you record on your income statements but fail to receive.
Aging analysis reveals high-risk receivables, and historical collection patterns indicate expected losses that accounting standards require you to recognize.
Example: Your accounts receivable balance is $100,000. Based on aging analysis, you estimate 2% will be uncollectible. That’s $2,000.
Adjusting Entry (December 31):
Debit: Bad Debt Expense $2,000
Credit: Allowance for Doubtful Accounts $2,000
With this adjustment, you can ensure your balance sheet shows the net value of receivables that you can actually realize. Your income statements reflect realistic revenue expectations, not wishful thinking.
Pro Tip: Most adjusting entries follow predictable patterns. Create a recurring adjusting entries schedule for depreciation, amortization, and prepaid expenses. This streamlines your month-end close significantly.
How to Create Adjusting Journal Entries: Step-by-Step
Creating adjusting journal entries involves five systematic steps: review the unadjusted trial balance, identify accounts needing adjustment, calculate adjustment amounts, record journal entries, and post to the general ledger.
Step 1: Review the unadjusted trial balance
The first step in creating adjusting journal entries is printing or viewing your unadjusted trial balance, which shows all account balances before adjustments.
Identify accounts with these:
- Unusual balances
- Prepaid accounts that need allocation
- Revenue/expense accounts that might be incomplete.
- Asset accounts that require depreciation calculation
- Liability accounts that require accruals.
Compare your current period to prior periods. And if you find significant variances, it means there are missing adjustments that nobody has caught yet.
Step 2: Identify accounts needing adjustment
Systematically review each account category.
For asset accounts,
- Do prepaid expenses need to be allocated?
- Does equipment need depreciation?
- Are receivables fully recorded?
- Is the allowance for doubtful accounts adequate?
For liability accounts,
- Are all expenses accrued?
- Are unearned revenues being recognized as earned?
- Are accounts payable complete?
For revenue accounts: Is all earned revenue recorded, even if not yet billed?
For expense accounts: Are all incurred expenses recorded, even if not yet paid?
Step 3: Calculate the adjustment amount
Once you identify what needs adjustment, calculate your precise amount.
- For prepaid expenses: The total prepaid amount divided by the number of periods equals the monthly expense.
- For accrued expenses: Rate times time period equals accrued amount.
- For depreciation: Asset cost minus salvage value, divided by useful life, equals annual depreciation. Divide it by 12 for monthly depreciation.
- For bad debt: Total receivables times estimated uncollectible percentage equals bad debt expense.
Step 4: Record the adjusting entry
Create the journal entry following standard debit and credit rules.
Every adjusting entry has one balance sheet account and one income statement account. Debits must equal credits. Adjusting entries rarely involve cash. Document the reason for each adjustment clearly.
Step 5: Post to the general ledger and verify
After you record adjusting journal entries, post them to the affected general ledger accounts. Create an adjusted trial balance, and verify that debits are equal to credits.
Review account balances to ensure fair judgment, and document supporting calculations and rationale for every adjustment you make. It will help you during audits.
Organizations using modern automated reconciliation platforms complete the monthly close in 2-3 days instead of 15-20 days, without manual adjusting entry bottlenecks. Want to see how? Book a demo to explore AI-powered solutions.
Common Mistakes to Avoid When Making Adjusting Journal Entries
Common adjusting entry mistakes include forgetting recurring adjustments, incorrectly using cash accounts, mismatching revenue and expense timing, using wrong account classifications, and failing to document adjustments properly.
Forgetting recurring adjustments
As monthly depreciation, amortization, and prepaid expense allocations don’t appear directly in transaction documents, accountants sometimes forget these adjustments during hectic close periods.
To avoid this, create a monthly adjusting entry checklist of all recurring adjustments. Schedule reminders during the close process. Assign responsibility clearly so nobody assumes someone else handled it.
Recording entries with cash accounts
Including cash in adjusting journal entries indicates something is amiss. Adjusting entries fix timing differences between accrual and cash basis accounting. If there’s cash involved, it’s ideally a regular journal entry, not an adjusting entry.
The exception: Rare cases where cash needs adjustment from bank reconciliation corrections or petty cash adjustments. Those should have been addressed before the unadjusted trial balance anyway.
Mismatching revenue and expense timing
Recording revenue in one period and related expenses in another violates the matching principle. GAAP requires expenses to be recognized in the same period as the revenues they help generate.
Wrong approach: Recognize December revenue but defer December commissions expense to January.
Right approach: Recognize both December revenue and December commissions in December together.
Using incorrect account classifications
If you debit or credit the wrong account types, it creates issues.
Some common mistakes include these:
- Recording accrued expenses as assets instead of liabilities
- Posting prepaid expenses as expenses instead of accounts
- Mixing up revenue and unearned revenue accounts
Debiting or crediting the wrong account types creates cascading problems. Common mistakes include recording accrued expenses as assets instead of liabilities. Recording prepaid expenses as expenses instead of assets. Mixing up revenue and unearned revenue accounts.
Always ask yourself: Is this an asset, liability, revenue, or expense? That simple question prevents most classification errors.
Failing to document adjustments
If you make adjusting entries without supporting documentation or explanations, it can cause problems. When auditors question undocumented adjustments, you may not be able to justify them when there’s a missing context.
The fix is to document everything, including the reason for the adjustment and supporting calculations, as well as source documents such as contracts, invoices, or schedules. Create approval trails that show who authorized the entry.
Pro Tip: Implement a month-end close checklist that includes all standard adjusting entries. Include calculation methods and required documentation. This reduces errors and dramatically accelerates your close process.
Catch Reconciliation Gaps Before Adjusting Entries Pile Up
Recogent tracks transactions in real time and flags anomalies early—so finance teams identify missing accruals, timing gaps, and mismatches before month-end adjusting journal entries begin.
How Automation Transforms Adjusting Entry Processes?
Modern accounting automation eliminates manual adjusting entry work by automatically detecting accruals, allocating prepaid expenses, calculating depreciation, and maintaining complete audit trails, reducing close time by 30-50%.
The Manual Challenge
Traditional adjusting entry processes are time-consuming. Reviewing each account takes hours, and calculating adjustments manually leads to errors. Creating entries one by one slows everything down.
Manual processes, such as data entry, can lead to entry mistakes and are difficult to scale as your transaction volume grows. Similarly, forgotten adjustments result in restatements.
How Automation Solves Problems
Modern accounting platforms automatically detect transactions requiring accruals based on dates and transaction types. They calculate accrued amounts based on predefined rules and generate and post adjusting entries without manual intervention. They automatically reverse accruals in the next period.
For prepaid expenses, automation tracks balances and allocation schedules. It automatically calculates monthly expense amounts, posts allocation entries on schedule, and alerts when prepaid balances are depleted.
Depreciation and amortization happen automatically, too. AI-powered reconciliation systems help automate these processes:
- Maintain asset registers with depreciation schedules
- Calculate monthly depreciation using appropriate methods
- Automatically post depreciation entries
- Update accumulated depreciation balances continuously.
Automation provides a complete history of all adjusting entries. Supporting calculations and documentation get attached automatically. Approval workflows ensure proper authorization. Reversal tracking for the next period happens seamlessly.
This makes audits faster. Companies report 60-80% fewer audit adjustments related to adjusting entries when using automated systems.
Pro Tip: Start by automating recurring adjustments first. Depreciation, amortization, and prepaid allocations are predictable and rule based. That makes automation straightforward. Then expand to more complex accruals once you’ve proven success.
Make Adjusting Journal Entries with Confidence, Not Guesswork
Don’t leave issues to be discovered at close with AI-powered account reconciliation. Track and address them in real time with clean adjusting entries every time.
Frequently Asked Questions on Adjusting Journal Entries
What is the meaning of adjusting journal entries?
Adjusting journal entries are end-of-period accounting entries that update account balances to ensure financial statements accurately reflect earned revenues and incurred expenses under accrual accounting, regardless of when cash is exchanged.
What are the five types of adjusting entries?
The five main types are accrued revenues, accrued expenses, prepaid expenses, unearned revenues, and depreciation. A sixth common type is bad debt expense for estimating uncollectible receivables.
How often should adjusting entries be made?
Adjusting entries should be made at the end of each accounting period, typically monthly, quarterly, or annually, before financial statements are finalized. Monthly adjustments provide the most accurate interim reporting.
Do adjusting entries always involve cash?
No. Adjusting entries almost never involve cash. Their purpose is to align accrual accounting with cash-basis accounting for timing differences. The rare exceptions are cash adjustments from bank reconciliations.
What's the difference between adjusting entries and correcting entries?
Adjusting entries are routine period-end entries that update accounts to reflect accrual accounting principles. Correcting entries fixes errors in previously recorded transactions, such as wrong accounts or amounts.
Can adjusting entries be reversed?
Yes, some adjusting entries are reversed at the beginning of the next period. Reversing entries simplify accounting for accrued revenues and accrued expenses. Prepaid expenses, depreciation, and unearned revenue adjustments typically aren’t reversed.
What happens if adjusting entries are not made?
Failing to make adjusting entries results in misstated financial statements, GAAP/IFRS non-compliance, poor business decisions based on inaccurate data, tax filing errors, audit findings, and loss of stakeholder confidence.
Who is responsible for making adjusting entries?
In small businesses, the owner, bookkeeper, or external accountant typically makes adjusting entries. In larger companies, the accounting manager, controller, or CFO reviews and approves adjusting entries prepared by staff accountants.
How do adjusting entries affect the trial balance?
Adjusting entries transform the unadjusted trial balance into the adjusted trial balance. The adjusted trial balance serves as the basis for preparing accurate financial statements, including the income statement, balance sheet, and cash flow statement.
Conclusion
Adjusting journal entries are essential to accurate financial reporting. They ensure your financial statements reflect economic reality under accrual accounting, aligning revenues with the periods in which they’re earned and expenses with the periods in which they’re incurred.
Remember these key points:
- Adjusting entries are made at period-end to update accounts before financial statements are finalized. They always involve one balance sheet account and one income statement account. The six main types are accrued revenue, accrued expenses, prepaid expenses, unearned revenue, depreciation, and bad debt expense.
- Systematic processes and automation reduce errors and accelerate financial close. Proper documentation ensures audit readiness and compliance with accounting standards.
- Manual adjusting entry processes consume valuable time and introduce unnecessary errors. Modern accounting teams leverage automation to handle recurring adjustments, reducing close time by 30-50% while significantly improving accuracy.
- Want to streamline your adjusting entry process and reduce close time? Explore AI-powered reconciliation solutions that automatically identify, calculate, and post adjusting entries with complete audit trails. See how Recogent transforms the month-end close for finance teams worldwide.
