An adjusting entry updates your books for something that changed after the original entry, usually just because time passed. This guide covers the four types of adjusting entries, worked examples for prepaid rent, supplies, wages, unearned revenue, interest, and depreciation, what happens if you forget one, and a practice set with answers.
"Make the adjusting entry." It gets thrown around a bunch, and it's almost never explained. What the heck is an adjusting entry? It turns out to be a pretty simple idea, and once you've got it, every adjusting entry problem on your test follows the same pattern.
Section I. What Is an Adjusting Entry?
We make adjusting entries because something has changed. You made an original entry, then something happened in the middle, so now you need to adjust. On most problems you'll see, that "something" is just that time passed. As time passes, you're using something up, or earning something, or owing something, and when the period ends you have to record what actually changed.
Here's an example. On July 1, you pay $12,000 for a year of rent, July 1 all the way around to the next July 1. You haven't used any of the building yet, so it's not an expense. It's prepaid rent, an asset:
July 1: the original entry
| Prepaid Rent | 12,000 |
| Cash | 12,000 |
December 31: the adjusting entry
| Rent Expense | 6,000 |
| Prepaid Rent | 6,000 |
Now your teacher says, "Make the adjusting entry for December 31," and you think, "What changed between the original entry and now?" Time passed. Standing on December 31, you're looking back on six months you've already used and forward to six months you haven't. The six months behind you, $6,000, are used up, so they're an expense now. The six months ahead of you are still prepaid.
Every adjusting entry has one income statement account and one balance sheet account, and it never touches cash. The cash already moved in the original entry, or it hasn't moved yet. If you see cash in an entry, it isn't an adjusting entry.
Section II. Why We Bother
Adjusting entries exist because of accrual accounting. Under cash accounting, it's all about cash: you record revenue when you get paid and expenses when you pay. Under accrual accounting, which is what you're learning, cash doesn't really matter that much:
- Revenue is recognized when it's earned, not when the cash is received.
- Expenses are recognized when they're incurred, not when they're paid.
That lines up with the matching principle: match expenses to the revenues (or the period) they helped generate. If you pay $12,000 for a year of insurance on January 1, you haven't incurred anything yet. You just swapped one asset (cash) for another (prepaid insurance). By January 31, you've had a month of being insured, so $1,000 of it is an expense. Adjusting entries are how the books catch up with that.
Watch the videoExpense Recognition (9 min)Section III. The Four Types: Accruals and Deferrals
Here's a quick little thing to remember: deferral, cash first. Accrual, cash later. That may sound backwards at first, so break your habit of thinking about everything in relation to cash. What we're deferring or accruing is the revenue or expense. If the cash comes first, the revenue or expense is deferred until later. If the event happens first, we accrue the revenue or expense now and the cash comes later.
Why is each one an asset or a liability? Think about what you're left holding:
- Prepaid expense (asset): you already paid for something you'll get to use in the future. Prepaid rent is rent you don't have to pay later. That's a probable future economic benefit.
- Accrued expense (liability): your employees already did the work, and you owe them. That's a future sacrifice.
- Unearned revenue (liability): the customer already paid, and you still have to do the work.
- Accrued revenue (asset): you already did the work, and the cash is coming later.
I like to think of those balance sheet accounts as buckets. If doing the work and the cash happened at the same moment, you'd never need them; you'd just debit the expense and credit cash, or debit cash and credit revenue. But because the two are separated in time, the amount sits in a holding bucket (prepaid, payable, unearned, receivable) until the other half happens, and then you drain the bucket.
Watch the videoAccruals and Deferrals (16 min)Section IV. The Cheat Sheet
Every adjusting entry problem is one of these. Don't memorize the table; read the "adjusting entry" column and make sure it makes sense given the bucket idea.
| Type | Original entry | Adjusting entry | If you forget it |
|---|---|---|---|
| Prepaid expense | Dr Prepaid Rent Cr Cash | Dr Rent Expense Cr Prepaid Rent | Assets overstated, expenses understated, net income and equity overstated |
| Supplies | Dr Supplies Cr Cash | Dr Supplies Expense Cr Supplies | Assets overstated, expenses understated, net income and equity overstated |
| Depreciation | Dr Equipment Cr Cash | Dr Depreciation Expense Cr Accumulated Depreciation | Assets overstated, expenses understated, net income and equity overstated |
| Unearned revenue | Dr Cash Cr Unearned Revenue | Dr Unearned Revenue Cr Service Revenue | Liabilities overstated, revenue understated, net income and equity understated |
| Accrued expense | None yet | Dr Wages Expense Cr Wages Payable | Liabilities understated, expenses understated, net income and equity overstated |
| Accrued revenue | None yet | Dr Interest Receivable Cr Interest Revenue | Assets understated, revenue understated, net income and equity understated |
Notice the pattern in the deferrals: the adjusting entry just moves some of the original entry's bucket into the income statement. Accruals have no original entry at all (nothing has happened with cash yet), so the adjusting entry creates the bucket.
Section V. Worked Examples
For every one of these, I find it helps to write the original entry first, so you know what you're dealing with. Then ask: what changed?
Supplies
On May 1, we purchased $1,000 of supplies. Supplies on hand on May 31 were $200. Record the adjusting entry for May 31.
This one doesn't tell us how much we used, just how much is left. So draw the T-account. We put $1,000 in, and $200 is left, so $800 must have been used up:
| Supplies (asset) | |
| May 1: 1,000 | |
| May 31: 800 | |
| On hand: 200 | |
| Supplies Expense | 800 |
| Supplies | 800 |
Supplies are an asset until you use them. The $800 you used up turns from an asset into an expense.
Watch the videoAdjusting Entry: Supplies (2 min)Wages
We pay employee wages of $1,000 a week for five workdays, Monday through Friday. Payday is Friday. December 31 is a Wednesday. Record the adjusting entry for December 31.
You are definitely going to see this one on your test. $1,000 for five days is $200 a day. The problem is that the year ends Wednesday night, right in the middle of the week:
The employees have earned $600 in Year 1 (Monday through Wednesday), but we don't pay them until Friday, in Year 2. We've incurred the expense, so it belongs in Year 1. We just haven't paid it, so it goes in the payable bucket:
December 31: adjusting entry
| Wages Expense | 600 |
| Wages Payable | 600 |
January 2 (Friday): payday
| Wages Payable | 600 |
| Wages Expense | 400 |
| Cash | 1,000 |
Careful on payday. You might want to just say "reduce the payable $600 and cash $600," but that's not the whole story. On Friday we pay the full $1,000: the $600 from last year (draining the bucket) plus $400 the employees earned on Thursday and Friday of this year, which is this year's expense.
Watch the videoAdjusting Entry: Wages (5 min)Unearned Revenue
On June 1, a customer prepays $75 for us to cut their lawn three times. By June 30, we've done it twice. Record the adjusting entry for June 30.
On June 1 we got $75 of cash, but we hadn't done anything yet, so it all went into unearned revenue (a liability). One cut is worth $75 ÷ 3 = $25, and we've done two, so we've earned $50. (Or: $75 × ⅔ = $50. Whatever way makes sense in your head.) Move $50 out of unearned and into earned:
June 1: original entry
| Cash | 75 |
| Unearned Revenue | 75 |
June 30: adjusting entry
| Unearned Revenue | 50 |
| Service Revenue | 50 |
Quick check: unearned revenue had a $75 credit and a $50 debit, leaving $25. That makes sense, because we still owe them one more mow.
Watch the videoAdjusting Entry: Unearned Revenue (3 min)Interest Receivable
On December 31, interest of $1,200 has been earned but not yet received. Record the adjusting entry for December 31.
"Earned" should ring a bell: if we earned it, it's revenue. "Not yet received" means it's able to be received, a receivable. When the cash shows up (say January 5), we just drain the bucket:
December 31: adjusting entry
| Interest Receivable | 1,200 |
| Interest Revenue | 1,200 |
January 5: collected
| Cash | 1,200 |
| Interest Receivable | 1,200 |
Depreciation
On January 1, we buy a truck for $20,000. It will last 10 years and be worth $0 at the end. Record the adjusting entry for December 31 using straight-line depreciation.
Buying the truck isn't an expense; we just swapped $20,000 of cash for a $20,000 truck. But every year we use it, we're using up part of it. Straight-line spreads the cost evenly: $20,000 ÷ 10 years = $2,000 a year.
December 31: adjusting entry
| Depreciation Expense | 2,000 |
| Accumulated Depreciation | 2,000 |
Balance sheet, December 31
| Truck | $20,000 |
| Less: Accumulated depreciation | (2,000) |
| Book value | $18,000 |
Notice we don't touch the truck account directly. It keeps the historical cost of $20,000. Instead, the depreciation goes into accumulated depreciation, a contra asset. "Contra" means opposite, so it increases with credits, and its only job is to take away from the value of the asset. And if the truck will still be worth $1,000 at the end (its salvage value), you can only depreciate it down to $1,000: ($20,000 − $1,000) ÷ 10 = $1,900 a year.
Watch the videoDepreciation (8 min)Section VI. How to Do Any Adjusting Entry
- Write the original entry, if there was one. Deferrals have one (cash moved first). Accruals don't.
- Ask what changed. How much time passed? How much was used up, earned, or incurred?
- Figure out the amount. Usually a fraction of the original (6 of 12 months, 2 of 3 mows) or a leftover (what's on hand versus what you started with).
- Move it. One side is an income statement account (an expense or a revenue), the other is a balance sheet bucket. No cash.
Section VII. What If You Forget One?
Tests love asking what happens if you skip an adjusting entry. Don't memorize it; just ask what the entry would have done, then flip it. Take the prepaid rent example. The adjusting entry would have increased rent expense by $6,000 and decreased prepaid rent by $6,000. If you forget it:
- Assets are overstated by $6,000 (prepaid rent is too high).
- Expenses are understated by $6,000, so net income is overstated by $6,000.
- Net income flows into retained earnings, so equity is overstated by $6,000 too.
- Liabilities: no effect.
The last column of the cheat sheet in Section IV works out every type the same way. A good gut check: the balance sheet still balances. Assets and equity are both overstated by the same $6,000.
Section VIII. Try Some Yourself
Record the December 31 adjusting entries. The company's year ends December 31.
- On October 1, the company paid $3,600 for a one-year insurance policy.
- The Supplies account shows $2,500. A count on December 31 finds $700 of supplies on hand.
- Employees earn $1,500 per five-day week, paid every Friday. December 31 is a Tuesday.
- On November 1, a customer paid $6,000 in advance for six months of services, starting November 1.
- Equipment bought on January 1 of this year cost $50,000, has a $5,000 salvage value, and has a five-year life. Use straight-line depreciation.
- The company has earned $400 of interest on a note receivable that it hasn't collected yet.
Bonus: by how much do these six entries change net income?
Show the answers
1. Insurance: 3 of 12 months used ($3,600 × 3/12)
| Insurance Expense | 900 |
| Prepaid Insurance | 900 |
2. Supplies: $2,500 − $700 on hand
| Supplies Expense | 1,800 |
| Supplies | 1,800 |
3. Wages: Monday and Tuesday, 2 × $300
| Wages Expense | 600 |
| Wages Payable | 600 |
4. Unearned revenue: 2 of 6 months earned
| Unearned Revenue | 2,000 |
| Service Revenue | 2,000 |
5. Depreciation: ($50,000 − $5,000) ÷ 5
| Depreciation Expense | 9,000 |
| Accumulated Depreciation | 9,000 |
6. Interest earned, not collected
| Interest Receivable | 400 |
| Interest Revenue | 400 |
Bonus: expenses go up by $900 + $1,800 + $600 + $9,000 = $12,300, and revenues go up by $2,000 + $400 = $2,400. Net income goes down by $9,900. Notice none of the six entries touches cash.
Keep Going More Practice
- Adjusting Entry Identification: spot the entry that isn't an adjusting entry
- Prepaid Rent
- Adjusting Entry: Wage Expense
- Adjusting Entry: Salaries Payable
- Revenue and Expense Recognition
- When You Forget to Do Adjusting Entries
- Adjusting Journal Entries (a full set)
- Adjusting Journal Entries (from an unadjusted trial balance)