Overview

• What you’ll learn: The four types of adjusting entries (prepaid expenses, unearned revenue, accrued expenses, accrued revenue), depreciation, and why adjustments are essential for accurate financial reporting.
• Prerequisites: Lesson 2 — Posting to the General Ledger
• Estimated reading time: 18 minutes

Introduction

The Grand Historian records: At the end of each accounting period, the trial balance stands like a fortress — impressive but incomplete. Some revenues have been earned but not yet recorded. Some expenses have been consumed but not yet acknowledged. Insurance paid months ago continues to protect the enterprise day by day, yet the books still show the full prepayment as an asset. Without adjusting entries, the financial statements would be a beautiful lie — balanced, yes, but fundamentally misleading.

Adjusting entries are the corrections that transform the unadjusted trial balance into an accurate picture of reality. They are the accountant’s conscience — insisting that the books tell the truth, even when it requires additional work.

Why Adjusting Entries Are Necessary

Under accrual accounting, revenue must be recorded when earned and expenses when incurred — regardless of cash flow. But during the period, many events go unrecorded because no cash changes hands:

• Employees work in the last week of December but are not paid until January.
• Insurance is prepaid for 12 months but must be expensed one month at a time.
• Equipment depreciates every day, but no cash transaction signals this decline.
• Interest accrues on loans daily, but the payment may only come quarterly.

The Four Categories of Adjusting Entries

1. Prepaid Expenses (Deferrals — Assets to Expenses)

Cash was paid before the expense was incurred. The payment was initially recorded as an asset; now we must recognize the portion that has been consumed.

Example: On January 1, the company pays $12,000 for a 12-month insurance policy.

  Jan 1 (original entry):
  Debit:  Prepaid Insurance    $12,000
  Credit: Cash                 $12,000

  Jan 31 (adjusting entry):
  Debit:  Insurance Expense     $1,000
  Credit: Prepaid Insurance     $1,000
  (Recognized one month of insurance consumed)

2. Unearned Revenue (Deferrals — Liabilities to Revenue)

Cash was received before the revenue was earned. The receipt was initially recorded as a liability; now we recognize the portion that has been earned.

Example: On January 1, a client pays $6,000 for six months of consulting.

  Jan 1 (original entry):
  Debit:  Cash                  $6,000
  Credit: Unearned Revenue      $6,000

  Jan 31 (adjusting entry):
  Debit:  Unearned Revenue      $1,000
  Credit: Service Revenue       $1,000
  (Recognized one month of revenue earned)

3. Accrued Expenses (Accruals — Expenses Not Yet Paid)

An expense has been incurred but not yet paid or recorded. No cash transaction has occurred, so no entry exists in the books.

Example: Employees earned $3,000 in wages during the last week of January, to be paid February 5.

  Jan 31 (adjusting entry):
  Debit:  Wages Expense          $3,000
  Credit: Wages Payable          $3,000
  (Accrued wages for the last week of January)

4. Accrued Revenue (Accruals — Revenue Not Yet Received)

Revenue has been earned but not yet received or recorded.

Example: The company earned $500 in interest on a note receivable during January, to be collected in March.

  Jan 31 (adjusting entry):
  Debit:  Interest Receivable      $500
  Credit: Interest Revenue         $500
  (Accrued interest earned in January)

Depreciation

Depreciation is a special type of adjusting entry that allocates the cost of a long-lived asset over its useful life. It is not a cash transaction — no cash leaves the business — but it recognizes the gradual consumption of the asset’s value.

  Jan 31 (adjusting entry):
  Debit:  Depreciation Expense          $500
  Credit: Accumulated Depreciation      $500
  (Monthly depreciation on equipment)

Accumulated Depreciation is a contra asset account — it has a credit balance and is subtracted from the related asset account on the balance sheet. The result is the asset’s book value (or carrying value).

Summary of Adjusting Entry Types

Key Takeaways

• Adjusting entries are required at period end to ensure revenues and expenses are recorded in the correct period.
• Four categories: prepaid expenses, unearned revenue, accrued expenses, and accrued revenue.
• Depreciation allocates the cost of long-lived assets over their useful lives using a contra asset account.
• Adjusting entries never involve the Cash account — if cash is changing hands, it is not an adjusting entry.
• Without adjustments, financial statements will overstate or understate income and asset/liability positions.

What’s Next

In Lesson 4, you will learn to prepare the trial balance — the checkpoint that verifies your ledger is mathematically sound before financial statements are produced.

  借：保險費用     $1,000
  貸：預付保險     $1,000

  借：預收收入     $1,000
  貸：服務收入     $1,000

  借：薪資費用     $3,000
  貸：應付薪資     $3,000

  借：應收利息       $500
  貸：利息收入       $500

  借：折舊費用       $500
  貸：累計折舊       $500

  借方：保険費用     $1,000
  貸方：前払保険     $1,000

  借方：前受収益     $1,000
  貸方：役務収益     $1,000

  借方：給与費用     $3,000
  貸方：未払給与     $3,000

  借方：未収利息       $500
  貸方：受取利息       $500

  借方：減価償却費     $500
  貸方：減価償却累計額 $500