Adjusting Entries: All Four Types Explained With Full Journal Entry Examples
Adjusting entries are recorded at the end of every accounting period to ensure the financial statements accurately reflect all economic activity — not just cash movements. Without them, revenues would be understated or overstated, expenses would land in the wrong period, and the balance sheet would misrepresent what the company actually owns and owes. Understanding all four types, when each is required, and the exact journal entries involved is one of the most important skills in introductory and intermediate accounting.
Why Adjusting Entries Are Necessary
The accrual basis of accounting — the foundation of GAAP — requires recognising revenues when earned and expenses when incurred, regardless of when cash moves. The problem is that many revenue-earning and expense-incurring events happen gradually, or in a different period than the related cash flow. Regular journal entries capture discrete transactions. Adjusting entries capture the passage of time and the consumption of resources.
Every adjusting entry has exactly two features: it always affects at least one income statement account (revenue or expense) and at least one balance sheet account (asset or liability). If your adjusting entry only touches two balance sheet accounts or only two income statement accounts, it is wrong. This rule is a reliable self-check. For a full picture of where adjusting entries fit, see the complete accounting cycle guide.
Type 1: Accrued Revenues
Accrued revenues arise when a company has earned revenue but not yet recorded it — typically because it has not yet invoiced the customer or received payment. The cash will come in a future period, but the earning happened in this one.
Classic example: Meridian Consulting completes $4,000 of advisory work on December 28. The invoice will be sent and collected in January. At December 31 year-end, the work is done — the revenue is earned — but nothing has been recorded.
CREDIT Service Revenue $4,000
(To record consulting revenue earned but not yet billed)
When cash is collected in January: Debit Cash $4,000 / Credit Accounts Receivable $4,000. No additional revenue is recognised in January — it was already recorded in December. This is the matching principle working exactly as intended. Practise accrued revenue questions on PrepQBank to build automatic pattern recognition.
Type 2: Accrued Expenses
Accrued expenses arise when a company has incurred an expense but not yet paid or recorded it. The obligation exists at period-end even though no invoice has been received and no cash has left the business.
Example 1 — Accrued wages: The pay period ends on January 3. Employees have worked December 29–31 and earned $6,500 in wages that will be paid on January 5.
CREDIT Wages Payable $6,500
(To accrue wages earned but not yet paid)
Example 2 — Accrued interest: A company borrowed $100,000 on December 1 at 6% annual interest. Interest for December = $100,000 × 6% × 1/12 = $500.
CREDIT Interest Payable $500
When the liability is paid in January: Debit Wages/Interest Payable / Credit Cash. The expense was already recognised in December — paying in January just settles the liability.
Type 3: Deferred Revenues
Deferred revenues (also called unearned revenues) arise when a company receives cash before it has earned it. At the time of receipt, no revenue is recognised — the cash creates a liability because the company owes a service or product to the customer.
Example: On November 1, Sunrise Magazine receives $24,000 for 12-month subscriptions. At receipt: Debit Cash $24,000 / Credit Unearned Subscription Revenue $24,000 (a liability). By December 31, two months have elapsed — $4,000 has been earned ($24,000 ÷ 12 × 2).
CREDIT Subscription Revenue $4,000
(To recognise 2 months of subscription revenue earned)
The remaining $20,000 stays as a liability — it represents 10 months of magazines still to be delivered. This treatment aligns with ASC 606's performance obligation model: revenue is recognised as each performance obligation (each monthly magazine) is satisfied. See the ASC 606 guide for the full framework.
Type 4: Prepaid Expenses
Prepaid expenses arise when a company pays cash before the expense period arrives. At payment, the cost is recorded as an asset (a prepaid). As time passes and the benefit is consumed, the asset is reduced and expense is recognised.
Example: On October 1, Atlas Corp pays $12,000 for a 12-month insurance policy running October 2025–September 2026. At payment: Debit Prepaid Insurance $12,000 / Credit Cash $12,000. By December 31, three months of coverage have been consumed ($3,000).
CREDIT Prepaid Insurance $3,000
(To recognise 3 months of insurance expense consumed: $12,000 ÷ 12 × 3)
Remaining prepaid at December 31: $12,000 − $3,000 = $9,000 — nine months of coverage still to come, correctly shown as a current asset on the balance sheet.
Other common prepaid items: prepaid rent, prepaid subscriptions, office supplies. All follow the same pattern: pay → record as asset → adjust as consumed. For a comparison of how this differs under cash vs accrual accounting, see the accrual vs cash accounting guide.
Depreciation: The Fifth Adjusting Entry
Depreciation is technically a prepaid expense — the company paid for a long-lived asset upfront and now allocates that cost over its useful life. But it is distinct enough to merit its own discussion. The depreciation adjusting entry is made every period for every depreciable asset.
CREDIT Accumulated Depreciation — [Asset] $X
Note the credit goes to Accumulated Depreciation — a contra-asset account — rather than directly to the asset account. This preserves the original cost on the books (useful for insurance and tax purposes) while showing the net book value (cost minus accumulated depreciation) on the balance sheet. See the complete guide on all four depreciation methods for how to calculate the annual amount.
Common Exam Mistakes
| Type | Situation | Debit | Credit |
|---|---|---|---|
| Accrued Revenue | Earned, not yet received | Asset (Receivable) | Revenue |
| Accrued Expense | Incurred, not yet paid | Expense | Liability (Payable) |
| Deferred Revenue | Cash received, not yet earned | Liability (Unearned) | Revenue |
| Prepaid Expense | Paid in advance, now consumed | Expense | Asset (Prepaid) |
| Depreciation | Asset used during period | Depreciation Expense | Accumulated Depreciation |
The three most common exam errors: (1) reversing debits and credits on accrued expenses — remember, expense is debited because you are recognising a cost that increases expense; (2) recording the full prepaid amount as expense in the payment period rather than allocating it; (3) forgetting that depreciation credits Accumulated Depreciation, not the asset account directly.
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