A Complete Guide to Adjusting Entries

Main Ideas and Concepts (Core Lesson)

Adjusting entries are accounting journal entries recorded at the end of each accounting period to ensure the books align with accrual accounting (required by GAAP and IFRS).

Under accrual accounting:

• Revenue is recognized when earned, not when cash is received.
• Expenses are recognized when incurred, not when cash is paid.

The need for adjusting entries arises because a typical transaction involves three events:

1. Goods/services delivered or received (substance)
2. Invoice issued/received (an “accounting trigger”)
3. Payment made (another “accounting trigger”)

If invoice/payment occur in different accounting periods than the delivery/consumption, the books won’t naturally reflect the correct timing—so adjustments are required.

Adjusting entries are mainly organized into two broad categories:

• Advance payments (prepayments / deferred amounts)
• Accrued amounts (earnings/expenses not yet invoiced/paid)

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Methodology / Structure of the Guide (As Presented)

Video structure (5 sections)

1. Why adjusting entries are needed; introduce two main types
2. Explain each adjustment type with examples:
   • Prepaid expenses
   • Deferred (prepaid/unearned) revenue
   • Accrued expenses
   • Accrued (unbilled) revenue
3. (Implied) Walk through examples step-by-step in each category

Consistent workflow implied across examples

• Identify which event(s) happened already (delivery/consumption vs invoice/payment)
• Determine whether the accounting trigger has happened in the current period or future/past
• Record an end-of-period adjusting entry so the income statement reflects the correct amount for that period
• Use the balance sheet to temporarily hold the “timing mismatch” (as an asset or liability), then reverse/release it in later periods

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Detailed Adjustment Categories and How They Work

1) Advance Payments: “Pay Before the Substance”

Concept

• Buyer paid in advance, but goods/services will be received later → prepaid expense (asset).
• Seller receives payment in advance, but goods/services will be delivered later → deferred revenue (liability).

In general:

• Initially, the books may record too much to the income statement.
• End-of-period adjustments move amounts off the income statement and onto the balance sheet.
• Later, subsequent adjustments release those amounts to the income statement as the service is performed or benefit is consumed.

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A) Prepaid Expenses (Advance Payment by the Buyer)

Definition

• A future expense paid in advance for goods/services that haven’t been received/consumed yet.

Key accounting mechanics (from the insurance example)

• Initial payment (before coverage begins):
  • The example describes an initially incorrect coding:
    • Dr Insurance expense
    • Cr Cash
• End of the prepaid period (adjusting entry before period closes):
  • Credit the expense account to remove overstated expense
  • Debit Prepaid expense (asset) on the balance sheet
• During the service/consumption period (e.g., monthly):
  • Each month:
    • Dr Insurance expense (income statement)
    • Cr Prepaid expense (reduce asset)

Insurance timeline method

• Coverage treated as evenly consumed:
  • Monthly expense = total prepaid amount ÷ number of months
  • Each month releases 1/12 of the prepaid asset to expense.

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B) Deferred (Prepaid/Unearned) Revenue (Advance Payment by the Seller)

Definition

• Cash received in advance for goods/services that have not yet been delivered.

Key accounting mechanics (from the airfare/seaplane and airline examples)

• Initial receipt in the pre-service period:
  • Dr Cash
  • Cr Deferred revenue (liability) (proper treatment)
• If revenue was credited directly at first, adjusting entries would later correct it—but the guide emphasizes deferral under accrual accounting.
• End of each subsequent service month:
  • Transfer earned portion from liability to revenue:
    • Dr Deferred revenue (reduce liability)
    • Cr Revenue (income statement)

Airfare example method

• If $800 paid in June, service spans July and August:
  • In July (half delivered):
    • Dr Deferred revenue $400
    • Cr Revenue $400
  • In August:
    • Dr Deferred revenue $400
    • Cr Revenue $400

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2) Accrued Amounts: “Substance Happened Before Invoice/Payment”

Concept

• Buyer received goods/services, but hasn’t received invoice/paid yet → accrued expense (liability).
• Seller delivered goods/services, but hasn’t issued invoice/received payment yet → accrued revenue (asset).

In general:

• End-of-period adjustments recognize amounts for the correct period even though invoice/payment triggers haven’t occurred yet.
• Later, when invoice/payment occurs, reversing entries (or new entries) prevent double counting.

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C) Accrued Expenses (Incurred but Not Yet Recorded/Paid)

Definition

• A past expense that has not yet been recorded or paid.

Key accounting mechanics (from the water utility example)

• Each period end while consumption occurred but invoice not yet received:
  • Dr Utility expense (income statement)
  • Cr Accrued expenses (liability on balance sheet)
• When invoice arrives (later period):
  • The invoice entry uses:
    • Dr Utility expense for the invoice amount
    • Cr Accounts payable (liability)
  • An additional adjusting entry may be needed to avoid double counting (because the expense was already accrued earlier).

Specific logic shown

• Estimated accruals added $50 in November + $50 in December.
• Invoice in January totals $153.
• After invoice entry, total recorded expenses could be too high:
  • Prior estimates recognized $100, but final invoice is only $153.
• Final adjusting entry releases the over-accrued portion:
  • Dr Accrued expenses (reduce liability)
  • Cr Utility expense (reduce income statement expense) for the difference.

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D) Accrued Income / Accrued Revenue (Earned but Not Yet Invoiced)

Definition

• Revenue earned but not yet invoiced.

Key accounting mechanics (from the website developer example)

• End of the earning period before invoice is issued:
  • Seller recognizes revenue:
    • Cr Revenue (income statement)
    • Dr Accrued income (asset) (balance sheet)
• When invoice is later issued:
  • Dr Accounts receivable (asset)
  • Cr Accrued income (remove the asset since it’s now invoiced)

Payment after invoicing

• When cash is later received:
  • Dr Cash
  • Cr Accounts receivable

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Speaker / Sources Featured

• Speaker/host: James (self-identified at the beginning)
• Channel/source name (mentioned): Accounting Stuff (video source/brand)
• Referenced standards/sources:
  • GAAP (Generally Accepted Accounting Principles)
  • IFRS (International Financial Reporting Standards)
• Software mentioned (as an example):
  • QuickBooks Online