Adjusting Entries
What adjusting entries do
Adjusting entries are recorded at period end, before statements are prepared, to move the books onto the accrual basis: revenue when earned, expenses when incurred, regardless of when cash moves. The families are accrued revenues, accrued expenses, deferred (prepaid) expenses, deferred (unearned) revenues, and estimates such as depreciation and bad debt expense.
Traps
- No adjusting entry ever touches Cash. Cash entries have already been recorded.
- Every adjusting entry pairs one income statement account with one balance sheet account. Two income statement accounts means it is not an adjusting entry.
- Unearned revenue begins as a liability. If the original receipt was recorded as revenue instead, the adjustment runs the other direction - read the question for which method was used.
- A prepayment recorded entirely as an expense needs a year-end adjustment to pull the unconsumed portion back into an asset.
- Estimating entries (depreciation, allowance) adjust balances, not actual transactions.
Worked example
Employees earned $3,200 in the last three days of March, paid April 4. At March 31: debit Wages Expense $3,200; credit Wages Payable $3,200. On payday, debit Wages Payable $3,200, debit Wages Expense for the April days, credit Cash for the full payroll. Omitting the accrual understates March expenses and liabilities and overstates April expenses.
Rule of thumb: if a proposed entry involves Cash, it is a cash transaction, not an adjusting entry.