Adjusting Entry

An adjusting entry is a journal entry made at period end to put income and expenses in the period they actually belong to, rather than the period the money moved. It is the mechanism that turns a bank-feed record into a set of accounts, and skipping it is the single clearest difference between bookkeeping that is done and bookkeeping that is finished.

The Four Kinds You Will Actually Meet

Accrued expenses. Something used this month, invoiced next. The cost belongs now, with a liability for the amount owed. See accrued expense.

Prepayments. Something paid now and used later — insurance, annual software, a licence. The payment creates an asset released monthly.

Deferred revenue. Money collected for work not yet done. A liability until earned. See deferred revenue.

Depreciation. Spreading the cost of an asset over the periods that use it rather than the month it was bought.

There are others — inventory adjustments, bad debt provisions, accrued payroll for a period spanning month end — but those four account for most of the work in a small business.

Why It Matters More Than It Sounds

Without adjusting entries, your monthly figures follow payment timing rather than activity. A month with an annual insurance renewal looks terrible. A month where a large supplier invoice arrived late looks excellent. Neither reflects how the business performed.

The practical damage is in decisions. Owners read monthly figures and act on them — hiring, pricing, distributions — and figures that swing for accounting reasons produce decisions that respond to noise. Lenders and investors read them too, and a statement that lurches without explanation invites questions a stable one does not.

It is also what makes months comparable. You cannot tell whether March was better than February if the two were measured differently.

What Goes Wrong

They are never made. The commonest state: a bank-feed record described as a set of books.

They are made once a year. Better than never, and it means eleven months of figures were wrong while decisions were being made on them.

They are made and never reversed. An accrual for an invoice that then arrives creates a double count unless the accrual is reversed. See reversing entry.

They are estimated and never revisited. A standing accrual carried at the same figure for two years is no longer an estimate of anything.

Related Terms