1. Purpose of Adjusting Entries
Adjusting journal entries are performed at the exact end of an accounting period to bring the ledger into strict alignment with accrual accounting principles. They ensure that revenues are recognized when the performance obligations are met, and expenses match their respective timing. Adjusting entries never involve a direct cash account.
2. The Four Primary Categories of Adjustments
Prepaid Expenses (Cash Paid Before Expense Incurred)
An entity pays cash in advance for an economic asset that will be consumed over time (e.g., insurance, rent).
  • Initial Entry: Debit Asset (Prepaid Rent), Credit Cash.
  • Adjusting Entry: Debit Expense (Rent Expense), Credit Asset (Prepaid Rent).

Unearned Revenues (Cash Received Before Revenue Earned)
An entity receives upfront cash from a customer prior to fulfilling a performance obligation. This creates a performance liability.
  • Initial Entry: Debit Cash, Credit Liability (Unearned Revenue).
  • Adjusting Entry: Debit Liability (Unearned Revenue), Credit Revenue.

Accrued Expenses (Expense Incurred Before Cash Paid)
An expense has been incurred by the business, but cash has not yet been paid out, nor has an invoice been formally integrated into accounts payable (e.g., employee salaries, utility usage).
  • Adjusting Entry: Debit Expense (e.g., Salaries Expense), Credit Liability (e.g., Salaries Payable).

Accrued Revenues (Revenue Earned Before Cash Received)
Services or goods have been fully delivered to a client, but cash has not been received, and standard billing cycles have not yet generated a formal invoice.
  • Adjusting Entry: Debit Asset (Accounts Receivable / Accrued Revenue), Credit Revenue.

3. Non-Cash Cost Allocation Adjustments: Depreciation
Long-lived tangible operational assets must have their capitalized historical cost methodically allocated over their estimated useful lives. This process is called depreciation.
  • Adjusting Entry Structure:

    Debit: Depreciation Expense (Income Statement impact)

    • Increases an expense → reduces net income.
    • Credit: Accumulated Depreciation (Contra-Asset, Balance Sheet impact)
  • Contra-Asset Account: A contra-asset has a natural credit balance. It is presented on the Balance Sheet directly beneath the primary asset to display the asset’s net book value:

    Net Book Value = Historical Cost − Accumulated Depreciation

 
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