Adjusting entries are journal entries made at the end of an accounting period so that revenue and expenses land in the period they belong to. They are needed under accrual accounting, where revenue is recorded when it is earned and expenses when they are incurred, not when cash moves.
Every adjusting entry has two features: it never touches Cash, and it always affects one income statement account (revenue or expense) and one balance sheet account (asset or liability).
The 5 types at a glance
| Type | Debit | Credit |
|---|---|---|
| Prepaid expense used up | Expense | Prepaid asset |
| Unearned revenue now earned | Unearned Revenue | Revenue |
| Accrued revenue | Receivable | Revenue |
| Accrued expense | Expense | Payable |
| Depreciation | Depreciation Expense | Accumulated Depreciation |
How to prepare an adjusting entry
- Find the account that is out of date at the end of the period, such as insurance that has partly expired or wages that are owed but unpaid.
- Calculate the amount that belongs to this period.
- Record the entry using the pattern from the table above.
1. Prepaid expenses
A prepaid expense is paid in advance and recorded as an asset. As time passes, part of it is used up and becomes an expense.
Example: On October 1, a company pays $1,200 for 12 months of insurance and records it as Prepaid Insurance. By December 31, 3 months have expired: $1,200 ÷ 12 × 3 = $300.
| Account | Debit | Credit |
|---|---|---|
| Insurance Expense | 300 | |
| Prepaid Insurance | 300 |
Supplies work the same way. If the Supplies account shows $800 but a count finds $300 left, $500 was used:
| Account | Debit | Credit |
|---|---|---|
| Supplies Expense | 500 | |
| Supplies | 500 |
2. Unearned revenue
Unearned revenue is cash received before the work is done. It starts as a liability, because the business owes the customer the service. As the work is done, it becomes revenue.
Example: On November 1, a company receives $3,000 for 6 months of services and records it as Unearned Revenue. By December 31, 2 months are earned: $3,000 ÷ 6 × 2 = $1,000.
| Account | Debit | Credit |
|---|---|---|
| Unearned Revenue | 1,000 | |
| Service Revenue | 1,000 |
3. Accrued revenue
Accrued revenue is earned during the period but not yet billed or recorded.
Example: A company finished $900 of work in late December but will send the invoice in January.
| Account | Debit | Credit |
|---|---|---|
| Accounts Receivable | 900 | |
| Service Revenue | 900 |
4. Accrued expenses
An accrued expense is incurred during the period but not yet paid or recorded. Wages and interest are the most common examples.
Example: Employees earned $1,500 of wages from December 29 to 31. They will be paid on January 5.
| Account | Debit | Credit |
|---|---|---|
| Wages Expense | 1,500 | |
| Wages Payable | 1,500 |
5. Depreciation
Depreciation spreads the cost of a long-term asset over its useful life. The credit goes to Accumulated Depreciation, a contra-asset account, so the original cost stays visible on the balance sheet.
Example: A $50,000 machine with a $5,000 salvage value and a 5-year life has straight-line depreciation of $9,000 a year. Use the depreciation calculator to work out any schedule.
| Account | Debit | Credit |
|---|---|---|
| Depreciation Expense | 9,000 | |
| Accumulated Depreciation | 9,000 |
Frequently asked questions
Do adjusting entries affect cash?
No. Adjusting entries never involve the Cash account. They move amounts between balance sheet accounts and income statement accounts.
When are adjusting entries made?
At the end of each accounting period, after the unadjusted trial balance and before the financial statements are prepared.
What happens if adjusting entries are skipped?
Revenues and expenses end up in the wrong period, so net income is wrong, and assets and liabilities on the balance sheet are misstated.
What are the main types of adjusting entries?
Prepaid expenses, unearned revenue, accrued revenue, accrued expenses, and depreciation.
Is every adjusting entry made of one balance sheet and one income statement account?
Yes. Each adjusting entry affects at least one income statement account (a revenue or expense) and one balance sheet account (an asset or liability).