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Adjusting Journal Entries: What They Are and Why They Matter in Business Finance


What Are Adjusting Journal Entries?

Adjusting journal entries (AJEs) are accounting entries made at the end of an accounting period to ensure that revenues and expenses are recorded in the period in which they are actually earned or incurred, regardless of when cash is received or paid. These adjustments modify the balances of accounts to reflect the true financial position and performance of the business for a specific period.


They are a direct application of the accrual basis of accounting, which is the standard under both GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards). The accrual basis requires businesses to recognize income and expenses when they occur, not when money changes hands.


Without these entries, financial statements would reflect only cash movements, which can severely distort the economic reality of the business.



Why Adjusting Entries Matter

Adjusting entries are fundamental to producing accurate, complete, and compliant financial statements. They serve as a corrective tool to update the trial balance before finalizing the financial statements, ensuring the numbers reflect what truly happened during the period.


Let's see why they’re critical...



The Five Main Types of Adjusting Entries

Let’s explore the five core types of adjusting entries, with practical examples for each:


1. Accrued Revenues

These are revenues earned but not yet recorded because the invoice has not been issued, or cash has not been received. Without an adjustment, the business understates income and accounts receivable.


Example: A marketing agency completes a campaign for a client on March 29 but plans to invoice on April 5. If the period ends March 31, the agency must accrue the revenue:

This ensures revenue is correctly reflected in March’s income statement, and the balance sheet shows a receivable.


2. Accrued Expenses

These are expenses incurred but not yet paid or recorded, such as utilities, salaries, or interest. Omitting these understates liabilities and expenses.


Example: Employees worked the last five days of March, but payroll will be processed in early April. Assuming $5,000 in wages are owed:

This recognizes the cost in the correct period and records a liability on the balance sheet.


3. Deferred Revenues (Unearned Revenue)

These occur when cash is received before the revenue is earned. This is common with subscription services, retainers, or prepayments.


Example: A software company receives $24,000 on January 1 for a 12-month license. Each month, $2,000 should be recognized as revenue. At the end of January:

This reduces the liability and moves the amount into revenue.


4. Prepaid Expenses

These are payments made in advance for services or benefits to be received in future periods. Common examples include rent, insurance, and subscriptions.


Example: A company pays $6,000 for six months of insurance on February 1. At the end of February, one month’s worth has been used:

This records one month of expense and reduces the prepaid asset.


5. Depreciation and Amortization

These entries allocate the cost of long-term assets over their useful life. Instead of expensing the full cost upfront, businesses systematically reduce the asset’s value.


Example: Equipment worth $12,000 is depreciated over 4 years (straight-line). Each month, $250 in depreciation should be recorded:

This reflects the usage of the asset without impacting cash.


When to Record Adjusting Entries

Adjusting entries are recorded at the end of each accounting period, before financial statements are finalized. This could be monthly, quarterly, or annually depending on the business’s reporting frequency.


Key triggers for adjustments include:

  • Period-end closing;

  • Reconciliations that uncover timing differences;

  • Review of balance sheet accounts (e.g., prepaids, accruals);

  • Identifying unbilled revenues or unpaid liabilities.


Adjusting entries are not made daily—they are strategic entries made to align the financials with accrual principles at cut-off dates.


How to Record Adjusting Journal Entries

Adjusting entries always involve at least one income statement account (revenue or expense) and one balance sheet account (asset or liability). The dual-entry system ensures that every transaction keeps the accounting equation balanced.


General rules:

  • Accrued items increase both income and assets (for revenues) or expenses and liabilities (for expenses);

  • Deferred items transfer amounts from assets or liabilities to expenses or revenues as they are earned or used;

  • Depreciation and amortization lower asset values and increase expenses without affecting liabilities.


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Automation and Best Practices

Modern accounting software like QuickBooks, Xero, NetSuite, or SAP often includes automated adjusting functions for recurring entries such as depreciation, prepaid amortizations, or subscription-based revenue recognition.


However, manual entries remain necessary when:

  • Accruals depend on internal estimates;

  • Services are rendered but not yet invoiced;

  • Expense reports are submitted after the cut-off;

  • Adjustments require professional judgment.


Best practices include:

  • Creating a monthly checklist of recurring adjustments;

  • Maintaining detailed documentation for each entry;

  • Reviewing the aging of payables and receivables;

  • Performing regular trial balance reviews and reconciliations;

  • Ensuring segregation of duties between preparers and reviewers.

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