Adjusting entries: the 5 types, with a worked example
Adjusting entries look like five different topics. They're really one idea: at the end of the period, every account should show its true amount. Learn the one question that sorts them, then work through a full example with answers.
01Why adjusting entries exist
Under the accrual basis, revenue is recorded when it is earned and expenses when they are incurred, not when cash moves. During the month you record transactions as they happen. But some things change quietly with the passage of time: insurance you paid for in advance gets used up, equipment wears out, employees earn salaries you haven't paid yet.
Nothing "happens" on those days, so nothing gets recorded. Adjusting entries, made at the end of the period before the financial statements are prepared, catch these up.
The pattern to memorize: every adjusting entry touches exactly one income-statement account and one balance-sheet account, and never Cash. If your adjusting entry has Cash in it, stop and re-check.
02The five types, sorted by one question
Ask: did cash move before or after the revenue or expense?
- Cash moved before → it's a deferral. Something was paid or received in advance and must now be partly recognized. (Prepaid expenses, depreciation, unearned revenue.)
- Cash moves after → it's an accrual. The revenue or expense already happened but nothing has been recorded yet. (Accrued expenses, accrued revenue.)
| Type | Cash moved… | Adjusting entry | If you forget it… |
|---|---|---|---|
| Prepaid expense | Before the expense | Dr Expense · Cr Prepaid (asset) | Assets overstated, expenses understated → income overstated |
| Depreciation | Before (at purchase) | Dr Depreciation Expense · Cr Accumulated Depreciation | Assets and income overstated |
| Unearned revenue | Before the revenue | Dr Unearned Revenue (liability) · Cr Revenue | Liabilities overstated, revenue understated |
| Accrued expense | After the expense | Dr Expense · Cr Payable | Liabilities understated, income overstated |
| Accrued revenue | After the revenue | Dr Receivable · Cr Revenue | Assets and revenue understated |
Depreciation is a special long-term deferral: you paid for the asset up front, and you spread its cost over the years it is used. The straight-line formula is:
Monthly depreciation = (Cost − Residual value) ÷ Useful life in months
Book value = Cost − Accumulated Depreciation. The asset account itself is never reduced directly; the
contra account keeps the original cost visible.
03Worked example: six adjustments for one business
An original illustration. Tala Printing Services closes its books on December 31. Before adjusting, the ledger and the year-end review show:
- On October 1, Tala paid ₱24,000 for a 12-month insurance policy, debited to Prepaid Insurance.
- The Supplies account shows ₱8,500. A count on December 31 finds ₱2,300 of supplies on hand.
- A printing machine was bought on July 1 for ₱150,000, with a residual value of ₱6,000 and a useful life of 5 years. No depreciation has been recorded this year.
- On November 1, a client paid ₱36,000 in advance for six months of printing services, credited to Unearned Service Revenue.
- Tala finished a ₱9,500 job on December 30 but hasn't billed the client yet.
- Employees have earned three days of salaries at ₱3,000 per day that will be paid in January.
a · Prepaid insurance (deferral)
₱24,000 ÷ 12 = ₱2,000 per month. October, November and December have passed: 3 × ₱2,000 = ₱6,000 used up.
b · Supplies (deferral)
The account shows ₱8,500, but only ₱2,300 is left. The difference was used: ₱8,500 − ₱2,300 = ₱6,200.
Trap: the entry is for the amount used (₱6,200), not the amount on hand (₱2,300). The count tells you what the ending balance should be; the adjustment is whatever gets you there.
c · Depreciation (long-term deferral)
(₱150,000 − ₱6,000) ÷ 60 months = ₱2,400 per month. July to December is 6 months: 6 × ₱2,400 = ₱14,400.
d · Unearned revenue (deferral)
₱36,000 ÷ 6 = ₱6,000 per month. November and December have been served: 2 × ₱6,000 = ₱12,000 earned.
e · Accrued revenue (accrual)
The work is done, so the revenue is earned, even though no invoice has gone out.
f · Accrued salaries (accrual)
3 days × ₱3,000 = ₱9,000 earned by employees this year, paid next year.
The effect on net income
| Adjustment | Revenue ↑ | Expense ↑ |
|---|---|---|
| a · Insurance used | 6,000 | |
| b · Supplies used | 6,200 | |
| c · Depreciation | 14,400 | |
| d · Unearned revenue earned | 12,000 | |
| e · Unbilled revenue | 9,500 | |
| f · Salaries owed | 9,000 | |
| Totals | 21,500 | 35,600 |
| Net income decreases by (₱35,600 − ₱21,500) | 14,100 | |
Without these six entries, Tala's income statement would overstate profit by ₱14,100. That's why examiners test adjustments so heavily: small entries, big effect on the statements.
04The mistakes that cost the most points
- Putting Cash in an adjusting entry. Adjustments recognize what time has already done; cash has already moved or hasn't moved yet.
- Adjusting for the balance instead of the change. For supplies, the count is the ending balance; the entry is the amount used.
- Crediting the asset directly for depreciation. Always credit Accumulated Depreciation, never the equipment account.
- Counting months wrong. October 1 to December 31 is 3 months, not 2. Write the months out if you need to.
- Treating unearned revenue as revenue on receipt. Cash received in advance is a liability until the work is done.
05Self-check (with answers)
1. A company pays ₱18,000 on September 1 for 6 months of rent, debited to Prepaid Rent. What is the December 31 adjustment?
₱18,000 ÷ 6 = ₱3,000 per month × 4 months (Sept–Dec) = ₱12,000. Dr Rent Expense 12,000 · Cr Prepaid Rent 12,000. Prepaid Rent left: ₱6,000.
2. Interest of ₱1,500 on a note receivable has been earned but not collected. Which type is it, and what is the entry?
Accrued revenue: the revenue happened, and cash comes after. Dr Interest Receivable 1,500 · Cr Interest Revenue 1,500.
3. A company forgets to record ₱4,000 of accrued utilities. What is the effect on the statements?
Expenses understated by ₱4,000 → net income overstated by ₱4,000; liabilities (Utilities Payable) understated by ₱4,000.
Practise this until it's automatic
Chapter 6 of the book covers every adjustment family in depth. The companion portal adds an interactive depreciation calculator, a worksheet workbench, and board-exam-style CPALE questions graded with rationales. Start with the free sample questions from every chapter, no sign-up needed.