How to Record Adjusting Entries: Step-by-Step with Examples for Every Type
A practical guide to adjusting journal entries covering the four types (accrued revenues, accrued expenses, deferred revenues, deferred expenses), when each is needed, how to record them step by step, and the common mistakes that throw off your financial statements.
A practical guide to adjusting journal entries covering the four types (accrued revenues, accrued expenses, deferred revenues, deferred expenses), when each is needed, how to record them step by step, and the common mistakes that throw off your financial statements.
Learning Objectives
- ✓Identify the four types of adjusting entries and explain why each is necessary under accrual accounting
- ✓Record adjusting entries for accrued revenues, accrued expenses, deferred revenues, and deferred expenses
- ✓Trace the impact of each adjusting entry through T-accounts to the adjusted trial balance
- ✓Detect common adjusting entry errors that misstate revenue, expenses, or net income
1. Why Adjusting Entries Exist (and Why You Cannot Skip Them)
Adjusting entries exist because cash and economic reality do not always move at the same time. Under accrual accounting — which is required by GAAP for any business beyond the smallest sole proprietorship — revenue is recognized when earned and expenses when incurred, regardless of when cash changes hands. The gap between cash movement and economic activity is what adjusting entries close. Here is a concrete example that makes this click. Your company pays $12,000 on January 1 for a full year of insurance coverage. The cash leaves on January 1, but the expense is not $12,000 in January — it is $1,000 per month for 12 months, because you consume one month of coverage each month. Without an adjusting entry at the end of January, your balance sheet shows $12,000 in Prepaid Insurance (an asset) and your income statement shows $0 in Insurance Expense. Both are wrong. The adjusting entry debits Insurance Expense $1,000 and credits Prepaid Insurance $1,000, moving one month of cost from the asset to the expense. This happens every month for 12 months until the prepaid is fully consumed. Skipping adjusting entries means your financial statements lie. Assets are overstated (the prepaid insurance that has been consumed is still sitting on the balance sheet), expenses are understated (the insurance cost is not on the income statement), and net income is overstated (because expenses are too low). Every adjusting entry corrects one of these distortions. Auditors check them. Professors test them. And AccountingIQ walks you through them step by step if you snap a photo of the problem.
Key Points
- •Adjusting entries close the gap between cash timing and economic reality under accrual accounting
- •Without adjustments, assets and liabilities are misstated and net income is wrong
- •Four types: accrued revenue, accrued expense, deferred revenue, deferred expense
- •Every adjusting entry affects one balance sheet account and one income statement account
2. Accruals: Revenue Earned but Not Collected, Expenses Incurred but Not Paid
Accrued revenue is revenue you have earned but have not yet billed or collected. A law firm that completes 40 hours of work in December but does not send the invoice until January has earned revenue in December. The adjusting entry: debit Accounts Receivable (asset increases — someone owes you), credit Service Revenue (revenue increases — you earned it). The amount is 40 hours multiplied by the billing rate. Without this entry, December revenue is understated and January revenue is overstated when the invoice is finally sent. Accrued expenses are expenses you have incurred but not yet paid. The most common example is salaries. If your pay period ends on Friday but the accounting period ends on Wednesday, three days of salaries have been incurred but will not be paid until Friday. The adjusting entry: debit Salaries Expense (expense increases), credit Salaries Payable (liability increases — you owe your employees). The amount is three days of payroll. Without this entry, December expenses are understated and January expenses are overstated. Interest accrual is another frequent example. A company borrows $100,000 at 6% annual interest on November 1, with the first payment due February 1. By December 31, two months of interest have accumulated: $100,000 × 6% × 2/12 = $1,000. The adjusting entry: debit Interest Expense $1,000, credit Interest Payable $1,000. The cash has not been paid yet, but the expense has been incurred. The pattern for all accruals: you are recording something that has happened economically but has not been captured in the accounting records yet because no cash has moved. Debit the expense or asset, credit the liability or revenue.
Key Points
- •Accrued revenue: earned but not billed. Debit Accounts Receivable, credit Revenue.
- •Accrued expense: incurred but not paid. Debit Expense, credit Payable.
- •Interest accrual: Principal × Rate × Time/12. Record the expense even though payment has not been made.
- •All accruals record economic events that have occurred but are missing from the books
3. Deferrals: Cash Received or Paid Before the Revenue or Expense Is Recognized
Deferred revenue (also called unearned revenue) is cash received before the service is performed. A gym that collects $1,200 for a 12-month membership on January 1 has a liability — it owes 12 months of gym access. On January 1, the entry is: debit Cash $1,200, credit Unearned Revenue $1,200 (a liability — you owe the service). At the end of each month, the adjusting entry moves one month from the liability to revenue: debit Unearned Revenue $100, credit Membership Revenue $100. After 12 months, the liability is zero and $1,200 of revenue has been recognized. Deferred expense (prepaid expense) is cash paid before the expense is incurred. The insurance example from earlier is the classic case: $12,000 paid upfront for 12 months of coverage. On January 1: debit Prepaid Insurance $12,000 (asset), credit Cash $12,000. Monthly adjusting entry: debit Insurance Expense $1,000, credit Prepaid Insurance $1,000. The asset shrinks by $1,000 per month as the coverage is consumed. Other common deferrals: prepaid rent (same logic as insurance — the asset is consumed monthly), supplies (purchased in bulk, consumed over time — the adjusting entry debits Supplies Expense and credits Supplies for the amount used during the period, based on a physical count), and depreciation (the cost of a long-lived asset allocated over its useful life — debit Depreciation Expense, credit Accumulated Depreciation). The pattern for all deferrals: cash moved first, but the revenue or expense recognition happens later, one period at a time. The adjusting entry transfers a portion from the balance sheet (asset or liability) to the income statement (revenue or expense).
Key Points
- •Deferred revenue: cash received before service performed. Starts as liability, adjusts to revenue over time.
- •Deferred expense: cash paid before expense incurred. Starts as asset, adjusts to expense over time.
- •Supplies adjusting entry is based on a physical count: Supplies Expense = beginning + purchased - ending.
- •All deferrals move amounts from the balance sheet to the income statement as time passes
4. Working Through a Complete Example: From Unadjusted to Adjusted Trial Balance
Here is a complete example that ties everything together. On December 31, your unadjusted trial balance shows: Prepaid Insurance $6,000, Unearned Revenue $3,600, Supplies $2,500, Equipment $48,000, and Accumulated Depreciation $8,000. You need to record these adjustments: 1. Insurance: the $6,000 prepaid covers 12 months starting July 1. Six months have been consumed (July-December). Adjusting entry: debit Insurance Expense $3,000, credit Prepaid Insurance $3,000. Adjusted Prepaid Insurance = $3,000 (the remaining 6 months). 2. Unearned Revenue: the $3,600 represents 12 months of service starting October 1. Three months have been performed (Oct-Dec). Adjusting entry: debit Unearned Revenue $900, credit Service Revenue $900. Adjusted Unearned Revenue = $2,700 (the remaining 9 months). 3. Supplies: a physical count shows $800 of supplies on hand. Supplies used = $2,500 - $800 = $1,700. Adjusting entry: debit Supplies Expense $1,700, credit Supplies $1,700. Adjusted Supplies = $800. 4. Depreciation: the equipment costs $48,000, has a 10-year useful life and $0 salvage value. Annual depreciation = $48,000 / 10 = $4,800. Adjusting entry: debit Depreciation Expense $4,800, credit Accumulated Depreciation $4,800. Adjusted Accumulated Depreciation = $12,800. Total impact on net income: these four adjustments increase total expenses by $3,000 + $1,700 + $4,800 = $9,500 and increase revenue by $900. Net income decreases by $8,600 from the unadjusted amount. This is the kind of multi-step problem where snapping a photo and letting AccountingIQ trace through each adjustment saves serious time — it builds the T-accounts, posts each entry, and shows the adjusted balances.
Key Points
- •Work each adjustment independently: calculate the amount, identify the accounts, record the entry
- •Prepaid adjustments: divide total by number of periods, expense the periods consumed
- •Unearned revenue: divide total by service periods, recognize revenue for periods performed
- •Always verify: total debits = total credits for each adjusting entry, and the adjusted trial balance still balances
High-Yield Facts
- ★Every adjusting entry affects one balance sheet account and one income statement account — never two of the same
- ★Accruals add new amounts to the books (accrue revenue or expense). Deferrals move existing amounts between accounts.
- ★The supplies adjusting entry requires a physical count: Supplies Expense = Beginning + Purchased - Ending on hand
- ★Depreciation is a deferral — it allocates a previously recorded asset cost to expense over time
- ★Forgetting to adjust prepaid expenses overstates assets and understates expenses, inflating net income
Practice Questions
1. On November 1, a company receives $9,000 for 6 months of consulting services. By December 31, what adjusting entry is needed?
2. A company has a $200,000 note payable at 9% annual interest. The note was issued October 1 and interest is due April 1. What adjusting entry is needed on December 31?
FAQs
Common questions about this topic
Regular journal entries record transactions that have already occurred — a sale, a purchase, a payment. Adjusting entries do not record new transactions. They update existing account balances to reflect economic reality at the end of an accounting period. Adjusting entries are made on the last day of the period and always involve at least one income statement account and one balance sheet account. They never involve cash — if cash is changing hands, it is a regular journal entry, not an adjustment.
Yes. Snap a photo of any adjusting entry problem and AccountingIQ identifies the adjustment type (accrual or deferral), calculates the amount, records the journal entry with the correct accounts and amounts, traces the impact through T-accounts, and shows the effect on the adjusted trial balance.