Most small business owners have never heard of adjusting entries until their accountant mentions them at year-end — usually while explaining why the profit figure on the books does not match what they expected. Adjusting entries are not a complicated concept. They are simply the mechanism that makes accrual accounting work properly. And once you understand what they are, a lot of things about bookkeeping start to make more sense.

What Are Adjusting Entries?

Adjusting entries are journal entries made at the end of an accounting period to record items that have been earned or incurred but have not yet been captured through regular transactions. They bring the books in line with what actually happened economically during the period, regardless of when cash changed hands.

This distinction — between when something happened economically and when cash moved — is at the heart of accrual accounting. In cash accounting, you record income when you receive money and expenses when you pay them. In accrual accounting, you record income when it is earned and expenses when they are incurred, even if the cash has not moved yet.

Adjusting entries are how accrual accounting puts this principle into practice at the end of each period.

When Are Adjusting Entries Made?

Adjusting entries are made at the end of each accounting period, typically at month-end as part of the month-end close process. They are made before the financial statements are produced, because the purpose of an adjusting entry is to ensure the financial statements accurately reflect the period being reported on.

Without adjusting entries, a company's profit and loss statement and balance sheet would only reflect cash movements — not the full economic picture of what was earned and spent during the period.

The Five Types of Adjusting Entries

1. Accrued Revenue

Accrued revenue occurs when a business has earned income but has not yet invoiced the client or received payment. This happens when work is completed near the end of a period and the invoice has not been issued yet.

Example: A consulting firm completes a $5,000 project on March 28th but will not invoice the client until April 2nd. On March 31st, the bookkeeper makes an adjusting entry: debit accounts receivable $5,000, credit service revenue $5,000. The revenue is recognised in March, when it was earned, not in April when the invoice goes out.

2. Accrued Expenses

Accrued expenses occur when a cost has been incurred during the period but the bill has not yet been received or paid. The most common example is accrued wages — employees have worked during the period but will not be paid until after it ends.

Example: A business has $3,200 in salary owed to employees for the last week of March, but the payroll run does not occur until April 5th. On March 31st, the bookkeeper makes an adjusting entry: debit salary expense $3,200, credit accrued salary payable $3,200. The expense is recognised in March, when it was incurred.

3. Deferred Revenue

Deferred revenue (also called unearned revenue) occurs when a business receives payment before it has delivered the goods or services. The payment is not yet revenue — it is a liability — because the business still owes the customer the delivery.

Example: A software company receives $12,000 in January for an annual subscription. In January, the entry is: debit cash $12,000, credit deferred revenue $12,000. Each month, an adjusting entry moves $1,000 from deferred revenue to revenue as the subscription is delivered: debit deferred revenue $1,000, credit service revenue $1,000.

4. Prepaid Expenses

Prepaid expenses occur when a business pays for something in advance that will be used or consumed over future periods. The payment is initially recorded as an asset, not an expense, because it has not yet been used.

Example: A business pays $6,000 in January for a 12-month insurance policy. The entry in January: debit prepaid insurance $6,000, credit cash $6,000. Each month, an adjusting entry records one month of insurance being used: debit insurance expense $500, credit prepaid insurance $500. By December, the full $6,000 has been expensed.

5. Depreciation

Depreciation is the process of spreading the cost of a long-term asset — equipment, vehicles, furniture — across the periods it is expected to be used. Rather than recording the full cost of a $30,000 piece of equipment as an expense in the year it is purchased, depreciation allocates that cost over the asset's useful life.

Example: A business purchases a delivery van for $36,000 with an expected useful life of 6 years and no residual value. Annual depreciation is $6,000, or $500 per month. Each month, the adjusting entry is: debit depreciation expense $500, credit accumulated depreciation $500. The van remains on the balance sheet at its original cost, with accumulated depreciation reducing the carrying value over time.

Who Makes Adjusting Entries?

In most small businesses, adjusting entries are made by the bookkeeper as part of the monthly close process, often in consultation with the accountant or CPA. Depreciation schedules are typically set up by the accountant and updated periodically. Accrual entries for wages, interest, and similar items are made by the bookkeeper based on information from the business owner.

If your business uses cash-basis accounting rather than accrual, you will have fewer adjusting entries — primarily depreciation. If you use accrual accounting, adjusting entries are a standard and necessary part of every month-end close.

Adjusting Entries and Your Financial Statements

Every adjusting entry affects at least one income statement account (revenue or expense) and one balance sheet account (asset or liability). This is by design — adjusting entries are how the two statements stay connected and accurate.

Without adjusting entries, your profit and loss statement would only reflect cash receipts and payments. It would miss revenue that has been earned but not invoiced, expenses that have been incurred but not paid, and the ongoing cost of assets being used. The resulting financial statements would be unreliable for making business decisions, applying for credit, or filing taxes under accrual accounting.

The Short Version

Adjusting entries are journal entries made at the end of each accounting period to record items that cash transactions have not yet captured. There are five types: accrued revenue, accrued expenses, deferred revenue, prepaid expenses, and depreciation. Together they ensure that financial statements reflect what actually happened economically during the period, not just when money moved.

They are a routine part of proper bookkeeping under accrual accounting. If your bookkeeper handles your month-end close, they are already making these entries — or should be.