Adjusting entries are the journal entries made at the end of a reporting period to move revenue and expense into the period each one was earned or incurred in, so the ledger states accrual-basis results before the financial statements are prepared. Their place in the sequence is fixed: after the period’s ordinary transactions are recorded, and before the adjusted trial balance the statements are summarized from.
They exist because of what the accrual basis measures. Accrual accounting depicts the effects of transactions, and other events and circumstances on a reporting entity’s economic resources and claims in the periods in which those effects occur, even if the resulting cash receipts and payments occur in a different period (FASB Statement of Financial Accounting Concepts No. 8, Chapter 1 (As Amended), paragraph OB17).
The Test That Separates an Adjusting Entry From Every Other Entry
An adjusting entry never touches cash. Each one hits at least one income statement account and at least one balance sheet account, because it moves an amount between a period’s performance and a balance that carries forward. If cash sits on either side, the entry is something else: a payment, a receipt, a correction, or a reclassification between two balance sheet accounts.
The entries a bank reconciliation throws up are where people trip. A service charge the bank took, or interest it credited, moves cash, because the bank moved it and the books had not caught up. The amount belonged to the period either way, so the entry looks like an adjustment, but it fails the cash test and it is not one.
The Types of Adjusting Entry
Two are the timing running in opposite directions. An accrual puts an amount on the books ahead of the cash, and a deferral holds back an amount whose cash arrived early until the period it belongs to.
The rest are estimates the period has to carry: depreciation, spreading an asset’s cost across the periods it serves, and bad debt expense charged against an allowance for doubtful accounts, putting collection risk in the period that made the sale. No standard fixes how many types there are, which is why published lists disagree.
A Worked Example
Say a firm pays for a year of insurance on the first day of January, with coverage running evenly across the term.
January 1, the payment Debit Credit
Prepaid insurance 12,000
Cash 12,000
January 31, the adjusting entry Debit Credit
Insurance expense 1,000
Prepaid insurance 1,000The payment moves cash and reaches no income statement account, so it says nothing about what January cost. The month-end entry takes one month of the twelve: an expense on one side, an asset on the other, cash on neither.
Where They Sit in a Firm’s Close
In a firm closing a client’s books, these are the entries that separate a coded transaction file from a set of books the statements can be built from. They are listed, once they have been journalized and posted, on the adjusted trial balance, though a balanced listing proves only that each entry carried equal debits and credits, and where they fall in the wider sequence is in accounting cycle. Whether the same amount lands on the return for that year is a separate question with its own tests, covered in accrual accounting.
What an Adjusting Entry Is Not
A closing entry comes after. It reduces the temporary accounts to zero and moves the period’s result into equity, so it ends the period rather than measuring it, and the proof it ran is the post-closing trial balance.
A correcting entry fixes something recorded wrongly: the wrong account, the wrong amount, an entry posted twice. It can touch cash and it can be posted at any point. An adjusting entry corrects nothing. The ledger was right as far as it went and stopped short of the period end, so a correction found during the same close runs alongside the adjusting entries without being one.
A reversing entry belongs to the period after. Posted on the first day, it backs an accrual out so the supplier invoice can be coded in full when it lands, and how the two months net out is worked through in accruals.
Common Questions
The count depends on the list in front of you, because no standard sets one. A five-item version is usually accrued revenue, accrued expense, deferred revenue, prepaid expense and depreciation. Lists that run to seven get there by adding estimates such as bad debts and an inventory adjustment, or by separating amortization from depreciation.
Start from what the period earned or incurred, not from what posted, and pull the support behind it: the payroll register, the policy period, the contract, the fixed asset schedule. The amount that belongs to this period comes off that support, and the entry is posted before the listing the statements are built from is run.
Accountably places trained offshore accountants inside US CPA and EA firms, and a firm can put one period of its own close through a trial task before its own reviewer relies on the entries that come back.
