What are Adjusting Entries?
Definition
Adjusting entries are accounting entries made before financial statements are finalized to update accounts for revenues, expenses, assets, and liabilities that are not fully captured by routine transactions. They are a core part of accrual accounting because they help record financial activity in the period where it economically belongs, not only when cash is received or paid.
How Adjusting Entries Work
An adjusting entry is usually posted during the period-end close after the finance team reviews account balances, invoices, contracts, schedules, and estimates. The purpose is to bring the general ledger in line with the real financial position of the company. For example, if a company used electricity in March but receives the utility bill in April, it records a March adjustment so March expenses are complete.
Each Adjusting Journal Entry normally affects at least one income statement account and one balance sheet account. This keeps the accounting equation balanced while ensuring the income statement shows the right revenue and expense activity and the balance sheet shows the correct assets and liabilities.
Common Types of Adjusting Entries
Accrued expenses: Recording accrued expenses for costs incurred but not yet invoiced, such as utilities, bonuses, interest, freight, or consulting fees.
Accrued revenue: Recording revenue earned but not yet billed to the customer.
Prepaid expenses: Releasing prepaid expenses into expense over the period that receives the benefit.
Deferred revenue: Moving billings or cash received in advance into revenue only when earned.
Depreciation and amortization: Allocating asset cost through depreciation expense or amortization over useful life.
Allowance estimates: Updating estimates for bad debts, rebates, returns, warranties, or inventory reserves.
Worked Example
Assume a company received marketing services worth $9,000 in June, but the vendor invoice will arrive in July. Without an adjusting entry, June expenses would be understated and June profit would be overstated. The finance team records an adjustment by debiting marketing expense for $9,000 and crediting accrued liabilities for $9,000. When the invoice arrives in July, the accrual is reversed or cleared against the invoice so the same cost is not recorded twice.
Another example is insurance paid upfront. If a company pays $12,000 for 12 months of insurance, it may initially record the amount as a prepaid asset. Each month, it records $1,000 of insurance expense and reduces the prepaid asset by $1,000. This matches the expense with the period that receives the insurance benefit.
Why Adjusting Entries Matter
Adjusting entries improve financial reporting by making period results more complete and comparable. They help management understand true profitability, operating costs, margin movement, and cash flow timing differences. Without adjustments, a period may appear more profitable simply because incurred expenses were not yet invoiced, or less profitable because a full annual cost was recorded in one month instead of being spread across the benefit period.
They also support the matching principle by aligning revenue with related costs. For example, sales commissions, warranty estimates, and product costs should be recorded in the same period as the related sales where the relationship is clear.
Audit and Review Considerations
Adjusting entries are often reviewed closely because they can materially change reported profit, liabilities, and asset balances. Finance teams may use Analytical Review (Journal Entries) to compare current-period adjustments with prior periods, budgets, or expected trends. Auditors may also perform Substantive Testing (Journal Entries) by checking supporting documents, approvals, calculations, and posting dates.
Strong documentation explains why the entry was needed, how the amount was calculated, who reviewed it, and whether it should reverse in the next period. This creates a clear audit trail and helps prevent duplicate or unsupported adjustments.
Best Practices
Maintain a recurring checklist for accruals, deferrals, depreciation, amortization, allowances, and tax entries.
Use clear descriptions and supporting schedules for every material adjustment.
Set approval rules for manual journal entries based on amount and account sensitivity.
Review unusual or late-posted entries before financial statements are issued.
Reconcile adjusted balances to subledgers, invoices, contracts, and management reports.
Summary
Adjusting entries update the books before financial statements are prepared so revenues, expenses, assets, and liabilities reflect the correct accounting period. They capture accruals, deferrals, depreciation, allowances, and other period-end updates. When applied consistently, they strengthen reporting accuracy, profitability analysis, audit readiness, and financial decision-making.
