Adjusting entries explained

What adjusting entries are

Adjusting entries are journal entries made at the end of an accounting period so that income and expenses are recorded in the period they belong to and balance sheet items are stated at the right amount. They cover accruals, deferrals, depreciation, allowances and inventory adjustments. They matter because without them profit, assets and liabilities are all misstated, even when every invoice and payment was recorded correctly.

Day-to-day bookkeeping is driven by documents: an invoice arrives, a payment leaves the bank. But some economic events produce no document on the date they happen. Interest builds up daily on a loan, insurance is used up month by month, a machine wears out, a customer becomes unlikely to pay. Adjusting entries capture these events. They are the practical application of the accrual basis, which our guide on accrual versus cash basis accounting explains.

The five families and three rules

Every adjusting entry belongs to one of five families. Accruals record income earned or costs incurred before any invoice. Deferrals move amounts already recorded, such as a prepayment or a customer deposit, into the period they belong to. Depreciation spreads the cost of long-lived assets over their useful lives. Allowances and provisions recognise expected losses. Inventory adjustments bring the stock figure into line with the count and with what the goods can be sold for.

The example throughout is Fjord Outdoor Supplies, a retailer with a 31 December 2025 year end whose unadjusted trial balance shows a profit of EUR 80,000. Each section adds one adjustment and states what goes wrong if it is forgotten.

• Rule 1: every adjusting entry touches one income statement account and one balance sheet account.
• Rule 2: no adjusting entry touches cash or bank. If cash moves, it is a normal transaction, not an adjustment.
• Rule 3: every adjusting entry needs evidence, whether a contract, a calculation, an ageing report or a count sheet, because it is based on judgement rather than a third-party document.

Accrued expenses: costs incurred but not yet billed

An accrued expense is a cost the business has incurred during the period but not yet been invoiced for or paid. Typical examples are interest, utilities, wages for the last days of the period and professional fees for work already done. The entry debits the expense and credits an accruals liability. Our guide on provisions and contingent liabilities explains when an uncertain estimate becomes a provision instead of an accrual.

Fjord has a bank loan of 60,000 at 6 percent a year, with interest paid quarterly in arrears. The next payment, on 31 January, covers November, December and January. At 31 December two months of interest have built up: 60,000 times 6 percent times 2 over 12 equals 600. The entry is Dr Interest expense 600 / Cr Accrued interest 600. When the bank takes 900 on 31 January, 600 clears the accrual and only 300 is January's expense.

If forgotten: expenses are understated by 600, profit is overstated by 600 and liabilities are understated by 600. Next year's profit is then understated by the same amount, because January bears three months of interest. Errors from missed accruals always reverse in the following period, which is why they can hide in one year's accounts but show up as odd swings in monthly results.

Accrued revenue: income earned but not yet invoiced

Accrued revenue is income the business has earned by delivering goods or services but has not yet invoiced. It is common in services, construction and any contract billed at milestones. Under IFRS 15 an amount for which the right to payment depends only on time passing is a receivable; one that still depends on further performance is a contract asset. At a beginner level both are recorded as accrued income; our guide on IFRS 15 revenue recognition covers contract assets in depth.

Fjord runs a paid equipment-hire service. In late December it completed a hire contract for a school expedition worth 4,000, to be invoiced on 5 January. The entry is Dr Accrued income 4,000 / Cr Revenue 4,000. When the invoice is raised in January, the receivable replaces the accrued income and no revenue is recorded a second time.

If forgotten: revenue and assets are understated by 4,000 this year, and next year's revenue is overstated by the same amount. Because accrued revenue increases profit, auditors test it carefully: it must be supported by evidence of performance, such as a signed delivery note or timesheet, not by optimism.

Prepaid expenses: paid now, used later

A prepaid expense is a payment for goods or services that will be received in a future period, such as insurance, rent or annual software licences. The unused portion is an asset at the period end. How the adjustment looks depends on how the payment was first recorded, and both methods reach the same balances.

Fjord paid 3,600 on 1 October for twelve months of insurance. By 31 December three months, or 900, have been used. If the payment was first recorded as an asset (Dr Prepaid insurance 3,600 / Cr Bank 3,600), the adjustment is Dr Insurance expense 900 / Cr Prepaid insurance 900. If it was first recorded as an expense, the adjustment moves the unused part back to the balance sheet: Dr Prepaid insurance 2,700 / Cr Insurance expense 2,700. Either way the year ends with an expense of 900 and a prepayment of 2,700.

If forgotten under the asset method: the expense is understated by 900 and assets overstated by 900. If forgotten under the expense method: the expense is overstated by 2,700 and assets understated by 2,700. The method used determines the direction of the error, which is one reason teams should pick one method and document it.

Unearned revenue: cash received before it is earned

Unearned revenue, also called deferred revenue or, under IFRS 15, a contract liability, is money received from customers before the business has delivered what they paid for. Subscriptions, gift cards, deposits and annual service plans all create it. It is a liability because the business owes either the service or a refund. Our guide on deferred revenue accounting builds a full monthly release schedule.

On 1 November Fjord sold a twelve-month equipment maintenance plan for 1,200, recorded as Dr Bank 1,200 / Cr Unearned revenue 1,200. By 31 December two months of service have been provided, so 200 has been earned: Dr Unearned revenue 200 / Cr Revenue 200. The remaining 1,000 stays as a liability.

If forgotten: revenue is understated by 200 and liabilities overstated by 200. The opposite mistake, recording the whole 1,200 as revenue when received, is more common and more serious, because it inflates this year's profit with income the business may never earn if the customer cancels.

Depreciation: spreading the cost of long-lived assets

Depreciation allocates the cost of property, plant and equipment, less any residual value, over the asset's useful life. IAS 16 requires the method to reflect the pattern in which the asset's benefits are consumed and requires residual values and useful lives to be reviewed at least at each financial year end. Straight-line depreciation, an equal charge each period, is the most common method.

Fjord bought a delivery van on 1 April for 30,000. It expects to use it for four years and then sell it for 6,000. Annual depreciation is 30,000 minus 6,000, divided by 4, which is 6,000 a year or 500 a month. For the nine months from April to December the charge is 4,500: Dr Depreciation expense 4,500 / Cr Accumulated depreciation, vehicles 4,500. The van's carrying amount at year end is 25,500.

If forgotten: expenses are understated by 4,500 and non-current assets overstated by 4,500. Unlike accruals, a missed depreciation charge does not correct itself next year; the asset stays overstated until someone notices. Our guide on maintenance and the balance sheet covers when repair costs should be capitalised and depreciated instead of expensed, and our guide on depreciation compares the main methods with worked schedules.

Allowance for doubtful debts: expected credit losses

Some customers will not pay. Rather than waiting for a specific customer to fail, the business estimates the loss across its receivables at the period end and records an allowance, a contra-asset that reduces receivables on the balance sheet. Under IFRS 9 trade receivables are usually measured with the simplified approach, recognising lifetime expected credit losses, often through a provision matrix by age, which our guide on IFRS 9 expected credit losses builds step by step.

Fjord's receivables of 50,000 are aged as follows: current 30,000, expected loss rate 1 percent, which is 300; 1 to 30 days overdue 12,000 at 3 percent, which is 360; 31 to 60 days 6,000 at 10 percent, which is 600; over 60 days 2,000 at 40 percent, which is 800. The required allowance is 2,060. The existing allowance is 1,200, so only the increase of 860 is recorded: Dr Impairment loss on receivables 860 / Cr Allowance for doubtful debts 860.

When a specific debt of 500 is later confirmed as lost, it is written off against the allowance: Dr Allowance for doubtful debts 500 / Cr Accounts receivable 500, with no further effect on profit, because the loss was already expected. If the allowance adjustment is forgotten, profit and receivables are both overstated by 860, and the loss hits a later year when customers actually default.

Inventory adjustments: counts and net realisable value

Two inventory adjustments are routine at year end. The first reconciles the stock records to a physical count. Fjord's records show inventory of 42,000, but the count finds goods costing 40,800, a shortfall of 1,200 from theft, damage or recording errors. The entry is Dr Cost of goods sold (inventory losses) 1,200 / Cr Inventory 1,200, after investigating whether any of the difference is a cut-off or recording error that should be corrected instead.

The second applies IAS 2, which requires inventory to be measured at the lower of cost and net realisable value (NRV): the estimated selling price less the costs to complete and sell. Fjord holds 50 last-season tents that cost 80 each, a total of 4,000. They will now sell for only 70 each and selling costs are 10 each, so NRV is 60 each, or 3,000. The write-down is 1,000: Dr Cost of goods sold (inventory write-down) 1,000 / Cr Inventory 1,000.

If forgotten: inventory and profit are both overstated. Our guide on inventory costing explains how cost itself is calculated with FIFO or weighted average.

The combined effect on profit

Individually the adjustments look small. Together they move Fjord's profit from 80,000 to 75,140, a fall of 4,860 or about 6 percent, and they change several balance sheet lines that a bank would read closely. This is why accounts produced without adjustments, sometimes called management figures, can mislead.

• Unadjusted profit: 80,000.
• Accrued interest: minus 600. Accrued hire revenue: plus 4,000.
• Insurance used: minus 900. Maintenance plan earned: plus 200.
• Van depreciation: minus 4,500.
• Increase in allowance for doubtful debts: minus 860.
• Stock count shortfall: minus 1,200. Tent write-down to NRV: minus 1,000.
• Adjusted profit: 80,000 plus 4,200 minus 9,060 equals 75,140.

Making adjusting entries in Skyline Nexus ERP

In Skyline Nexus ERP adjusting entries such as accruals, prepayment releases, deferred revenue releases and allowance changes are made as manual journals under Fiscal Authority, Journal Entries, New Journal Entry, with a journal date in the period being adjusted, a description and a line per account. The monthly release of a prepayment or of deferred revenue is posted by the accountant each period, which keeps every release visible and reviewable in the ledger. An accrual is taken back in the new period with Reverse Journal Entry, which asks for a reversal date and creates a mirror-image posted journal.

Depreciation is the exception: fixed assets in Asset Management offer straight line, declining balance, sum of years digits and units of production methods, depreciation runs monthly, and it posts to the ledger when Auto-post Depreciation Entries is switched on. Once adjustments are complete, closing the fiscal period stops any further posting into it; a soft-closed period can be reopened if a late adjustment is needed, while a locked period cannot.

A period-end checklist and related guides

Use this list as a prompt at every period end, and keep the calculation behind each entry with the journal so that a reviewer or auditor can re-perform it.

• Accruals: interest, utilities, wages and bonuses, professional fees, goods received but not invoiced.
• Accrued income: work performed or goods delivered but not invoiced.
• Prepayments: insurance, rent, licences and subscriptions paid in advance.
• Deferred revenue: deposits, subscriptions and service plans not yet delivered.
• Depreciation and amortisation on every asset in use, and a review of useful lives and residual values at year end.
• Expected credit losses on receivables, updated from the latest ageing.
• Inventory: count differences and write-downs to net realisable value.
• Related guides: accrual versus cash basis accounting, the accounting cycle, inventory costing, depreciation, deferred revenue, IFRS 9 expected credit losses, provisions under IAS 37 and the month-end close checklist.