How to Make Adjusting Entries: A Simple Step-by-Step Guide

Adjusting entries are specialized journal entries made at the end of an accounting period to record transactions that have occurred but haven't yet been recognized in your books. Think of them as the final touch-ups that ensure your financial portrait is complete and accurate before presenting it to stakeholders.

These entries are crucial for compliance with accounting standards like GAAP and IFRS, producing accurate financial statements that truly reflect your business's performance, and enabling informed decision-making based on reliable data. Without proper adjustments, your financial reports might show misleading profits, inaccurate asset values, or understated liabilities—potentially leading to poor business decisions.

This easy-to-follow guide is designed for accountants, finance teams, and business owners who want to master the art of adjusting entries. We'll walk through definitions, types, step-by-step procedures, and real-world examples that demonstrate how these entries work across different industries. We'll also highlight common mistakes to avoid and how automation can streamline the entire process.

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What Are Adjusting Entries?

Adjusting entries are journal entries made at the end of an accounting period to record transactions that have occurred but haven't yet been recognized in the financial records. These specialized entries ensure your financial statements accurately reflect your company's financial position by properly aligning revenues and expenses to the correct accounting periods.

At their core, adjusting entries are directly connected to accrual accounting, where transactions are recorded when they're earned or incurred, regardless of when cash actually changes hands. This differs from cash-basis accounting, which only records transactions when money is received or paid. The matching principle—a fundamental concept in accounting—requires that expenses be recorded in the same period as the revenue they help generate, and adjusting entries make this possible.

Consider this real-world example: Imagine you own a consulting business and completed a $3,000 project for a client on January 28th. The client doesn't pay you until February 15th. Under accrual accounting, you need to recognize that revenue in January when the service was actually provided, not in February when you received payment. An adjusting entry would record this revenue in January, ensuring your financial statements accurately reflect when you earned the income.

Adjusting entries serve as essential tools for accountants to maintain accurate financial records and ensure compliance with generally accepted accounting principles (GAAP). Without them, your financial statements would show incomplete or misleading information about your business's true financial status.

Why Are Adjusting Entries Important?

Adjusting entries ensure accuracy in financial reporting by properly aligning revenues with related expenses, ensuring accurate financial reporting and providing a true picture of your business performance. They guarantee compliance with accounting standards like GAAP and IFRS, which is legally required for public companies and builds credibility with stakeholders for all businesses.

Most critically, these entries reflect the true financial health of your business at period-end. Without proper adjustments, your balance sheet might show inflated assets or understated liabilities, while your income statement could display misleading profit margins—potentially leading to poor business decisions based on inaccurate information.

Adjusting entries impact both balance sheet accounts and income statement accounts by recognizing revenues and expenses appropriately within the correct accounting periods.

By implementing adjusting entries consistently, you establish a foundation of financial transparency that supports better forecasting, budgeting, and strategic planning.

Accounting Principles

Adjusting entries are based on several key accounting principles, including the accrual accounting method, the matching principle, and the materiality principle. The accrual accounting method requires that revenues and expenses be recognized when earned or incurred, regardless of when cash is received or paid.

The matching principle states that expenses should be matched with the revenues they help to generate, ensuring that the income statement accurately reflects the company’s financial performance. The materiality principle requires that all significant transactions be recorded and reported in the financial statements.

By following these principles, businesses can ensure that their financial statements are accurate, complete, and compliant with generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS).

Types of Adjusting Entries

Different business transactions require different types of adjusting entries to ensure your financial statements accurately reflect your company's activities. Each type serves a specific purpose in aligning your accounting records with the true economic reality of your business operations.

Here are the major categories of adjusting entries you'll encounter:

Accrued Revenues

Accrued revenues represent income that has been earned but not yet recorded in the accounting system. It is crucial to accurately record revenue in the correct accounting period to ensure that income earned but not yet received is properly accounted for. This typically happens when you provide services or deliver goods to customers but haven’t billed them by the end of the accounting period.

Example: You completed a $2,000 consulting project on March 28th, but won’t invoice the client until April 5th. Since you earned the revenue in March, you need to record it in March.

Journal Entry:

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Accrued Expenses

Accrued expenses are costs your business has incurred but hasn't yet paid or recorded in the books. These typically include utilities, rent, or salaries that span accounting periods.

Example: Your employees worked the last week of June, but won't be paid until July 5th. You need to record the June portion of their salaries as an expense in June.

Journal Entry:

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Deferred Revenues

Deferred revenues (also called unearned revenues) occur when customers pay you in advance for products or services you haven’t delivered yet. Since you haven’t earned this revenue, you initially record it as a liability.

Transactions may be recorded in the current period but recognized as revenue in a future accounting period.

Example: A customer pays you $6,000 on December 15th for services you’ll provide over the first quarter of next year.

Journal Entry:

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Then, as you earn portions of this revenue:

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Prepaid Expenses

Prepaid expenses represent assets your business has paid for but hasn’t used or consumed yet. Common examples include insurance premiums, subscriptions, and rent paid in advance.

Prepaid expenses are recorded as assets because they provide future economic benefit in subsequent accounting periods.

Example: You pay $12,000 for a year-long insurance policy on November 1st.

Journal Entry:

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At month-end:

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Depreciation and Amortization

Depreciation and amortization spread the cost of long-term assets over their useful lives, reflecting their gradual consumption or obsolescence.

Amortization involves gradually writing down the value of intangible assets like patents and licenses. This process falls under the broader category of adjusting entries, where accountants allocate costs related to these intangible assets systematically over their useful life.

Example: Your company purchased equipment for $60,000 with a 5-year useful life.

Journal Entry:

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Other Estimates (Provisions, Bad Debts)

Businesses also make adjusting entries for various estimates like bad debt provisions, warranty liabilities, and inventory obsolescence, which reflect probable future expenses based on current information.

Example: Based on historical patterns, you estimate that 2% of your $200,000 in credit sales will become uncollectible.

Journal Entry:

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Each of these adjusting entries ensures your financial statements present an accurate, up-to-date picture of your business activities, regardless of when cash changes hands.

Adjusting Entries and Financial Statements

Adjusting entries have a direct impact on a company’s financial statements, including the balance sheet, income statement, and cash flow statement. The balance sheet is affected by adjusting entries related to assets, liabilities, and equity, such as accrued revenues and expenses, prepaid expenses, and deferred revenues.

The income statement is impacted by adjusting entries related to revenues and expenses, such as depreciation expenses, salary expenses, and interest expenses. The cash flow statement is affected by adjusting entries related to cash inflows and outflows, such as changes in accounts receivable and accounts payable. By making adjusting entries, businesses can ensure that their financial statements accurately reflect their financial position and performance.

Step-by-Step: How to Make Adjusting Entries

Making adjusting entries doesn’t have to be complicated. Follow this straightforward process to ensure accurate financial reporting and that your financial statements accurately reflect your business activities:

1. Review your trial balance

Examine your unadjusted trial balance report, which lists all your general ledger account balances at the end of the period. This gives you a snapshot of your accounts before any adjustments.

• ‍Pro Tip: Schedule time for this review a few days before your closing deadline to avoid last-minute stress.

2. Identify accounts needing adjustments

Look for accounts that may not reflect all transactions or economic events from the period. Common examples include unrecorded revenues, unpaid expenses, prepaid items, and assets that need depreciation.

• Pro Tip: Create a recurring checklist of common adjustments your business typically needs to ensure nothing is overlooked.

3. Determine the correct type of entry

Based on what you find, categorize each needed adjustment as accrued revenue, accrued expense, deferred revenue, prepaid expense, depreciation, or an estimate.

• Pro Tip: If you’re unsure about which type of adjustment to make, think about timing—has the cash been received/paid? Has the revenue been earned or expense incurred?

4. Prepare adjusting journal entries

Create the journal entries with the appropriate accounts, making sure each entry follows the double-entry accounting principle with equal debits and credits. Adjusting journal entries follow these principles to ensure accuracy and efficiency in financial reporting.

• Pro Tip: Include detailed descriptions with each entry explaining why it’s being made. This helps with future reference and audit trails.

5. Post entries to the general ledger

Record these adjusting entries in your general ledger, either manually or through your accounting software. Each entry should update the balances of at least two accounts.

• Pro Tip: Modern accounting software can automate recurring adjusting entries, saving time and reducing errors.

6. Prepare the adjusted trial balance

After posting all adjusting entries, generate a new trial balance that incorporates these adjustments. Review this adjusted trial balance to ensure account balances appear reasonable.

• Pro Tip: Compare this period’s adjusted balances with previous periods to spot any unusual changes that might indicate errors.

7. Generate financial statements

Use the adjusted trial balance to prepare your financial statements—income statement, balance sheet, and cash flow statement—which now accurately reflect your business’s financial position.

• Pro Tip: Save documentation for all your adjusting entries, especially for significant or unusual items, to support your financial statements during tax time or audits.

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By following these steps consistently each accounting period, you’ll maintain accurate financial records that provide reliable information for decision-making and comply with accounting standards.

Examples of Adjusting Entries (Real-World Scenarios)

Understanding adjusting entries becomes clearer when you see them applied to real business situations. Below are practical examples from various industries showing how adjusting entries work in everyday accounting scenarios.

These examples demonstrate how different businesses apply adjusting entries to ensure their financial statements accurately reflect the economic reality of their operations. Regardless of industry, the principles remain the same: match revenues with expenses in the appropriate accounting period and represent assets and liabilities at their true values.

Common Mistakes to Avoid with Adjusting Entries

Even experienced accountants can make errors when handling adjusting entries. Being aware of these common pitfalls can help you maintain more accurate financial records and avoid costly mistakes.

Missing an Accrual

One of the most frequent errors occurs when businesses fail to record revenue earned or expenses incurred during the period. This typically happens when invoices or bills arrive after the books are closed, and the accountant forgets to account for them in the proper period.

Quick Fix: Create a standardized checklist of regular accruals to review at each period-end. Request preliminary billing information from vendors for significant expenses that might cross period boundaries.

Misclassifying Deferred Revenues/Expenses

Many businesses struggle with properly handling prepayments. Common errors include recording advance customer payments directly as revenue (instead of as a liability) or recording prepaid expenses as immediate expenses (instead of as assets).

Quick Fix: Remember this simple rule: if you receive money before earning it, it's a liability (deferred revenue); if you pay money before using the service/product, it's an asset (prepaid expense).

Forgetting to Post Depreciation

Depreciation entries are easily overlooked because they don't involve cash transactions and often happen "behind the scenes" in the accounting system. Missing these entries can significantly overstate your profitability and asset values.

Quick Fix: Set up automated monthly or quarterly reminders for depreciation entries. Consider using accounting software that calculates and posts depreciation automatically based on preset schedules.

Overcomplicating Journal Entries

Some accountants create unnecessarily complex adjusting entries that are difficult to understand and trace. This not only confuses future reviews but increases the likelihood of errors.

Quick Fix: Keep entries as straightforward as possible. Each entry should have a clear purpose and include a detailed description explaining the adjustment. Break complex transactions into multiple simpler entries if necessary.

Relying on Manual Entries Without Review

Manually calculating and entering adjustments without proper review procedures increases the risk of mathematical errors, transposed numbers, or incorrect account selections.

Quick Fix: Implement a dual-review process where a second person checks all manual adjusting entries before posting. For significant adjustments, consider having a supervisor or manager approve the entry.

Inconsistent Timing of Adjustments

Applying adjusting entries inconsistently from one period to another creates irregularities in financial reporting and makes trend analysis difficult.

Quick Fix: Establish a formal month-end or period-end closing schedule with specific deadlines for various types of adjusting entries. Document your procedures to ensure consistency.

Tips for Better Adjusting Entries

• Document your methodology: Keep clear records of how recurring adjustments are calculated.
• Leverage technology: Use accounting software that can automate repetitive adjusting entries.
• Create a closing checklist: Develop a comprehensive list of required adjusting entries for each accounting period.
• Stay organized: Maintain supporting documentation for all adjusting entries, especially complex ones.
• Review historical patterns: Look at prior period adjustments to ensure you haven't missed something routine.
• Consider materiality: Focus your efforts on adjustments that will significantly impact your financial statements.

By avoiding these common mistakes and following best practices, you'll create more reliable financial information that stakeholders can confidently use for decision-making.

Best Practices for Adjusting Entries

To ensure accurate and effective adjusting entries, businesses should follow several best practices.

First, they should regularly review their financial transactions to identify any discrepancies or omissions that may require adjusting entries.

Second, they should maintain thorough documentation for all adjusting entries, including the reason for the adjustment and supporting calculations.

Third, they should verify the accuracy and precision of adjusting entries before finalizing them.

Fourth, they should implement a segregation of duties to separate the responsibilities of preparing, reviewing, and approving adjusting entries.

By following these best practices, businesses can minimize errors and ensure that their financial statements are accurate and reliable.

How Automation Simplifies Adjusting Entries

The manual process of creating adjusting entries can be tedious, time-consuming, and error-prone. Modern accounting automation tools are changing this landscape by streamlining these critical tasks.

Reducing Manual Effort

Automation eliminates the need for spreadsheets and manual calculations by identifying accounts needing adjustment and creating journal entries automatically. This transforms the month-end close process from days to hours, freeing your accounting team to focus on analysis rather than data entry.

Automating Recurring Adjusting Entries

Common adjustments like depreciation, regular accruals, and revenue recognition follow predictable patterns. Automation tools apply these systematically each period, ensuring consistency and reducing the risk of forgotten entries that might distort your financial statements.

Improving Accuracy and Audit Trails

Automated adjusting entries significantly reduce human error by:

• Applying consistent calculation methodologies
• Eliminating typos and transposition errors
• Creating comprehensive audit trails that document approvals and rationales

These capabilities prove invaluable during audits, tax preparation, or regulatory reviews when questions arise about specific adjustments.

Solutions like SolveXia can dramatically accelerate your closing timeline while strengthening financial controls through built-in approval workflows and segregation of duties—delivering more reliable financial information, faster.

Wrapping Up

Adjusting entries are critical to financial accuracy and represent the final quality control step before your financial statements are prepared. They ensure your reports truly reflect economic reality rather than just the timing of cash movements.

Adjusting entries are essential for providing a more accurate financial picture by refining non-cash items in the financial statements. Although these entries do not directly influence cash flow, they enhance the overall representation of a company's financial activities.

While adjusting entries might seem technical, following a structured process simplifies the work and helps prevent common errors. Each adjustment serves a specific purpose—whether recording unrecognized revenue, accruing unpaid expenses, or properly allocating costs over time.

As your business grows, consider how SolveXia can help modernize your financial processes, reducing manual effort, minimizing errors, and providing better visibility into your accounting operations. With the right approach and tools, adjusting entries become an opportunity to ensure your financial foundation is rock solid—leading to better compliance, more informed decisions, and ultimately stronger business performance.