What are adjusting entries?

At month- or year-end, the books are almost right but not quite. Some revenue has been earned but not billed yet. Some expenses have been incurred but not paid yet. Some cash has been received for services not yet performed. Some cash has been paid for benefits not yet consumed. Plus, the laptop you bought last year is now worth a little less. Adjusting entries fix all of this so your financial statements obey the matching principle: match revenues to the expenses incurred to earn them, in the period they belong to.

The four types

1. Accrued Revenue

You’ve earned revenue but haven’t billed (or received) yet. Common for service contracts that bill in arrears, interest income that accrues daily.

Mar 31  Accrued Revenue / AR        Dr.   40,000
             To Service Revenue                 40,000
        (Being revenue earned but not yet billed)

2. Accrued Expense

You’ve incurred an expense but haven’t paid yet. Salaries for the last week of the month, electricity used but not yet billed, interest accrued on a loan.

Mar 31  Salaries Expense           Dr.   1,50,000
             To Salaries Payable               1,50,000

3. Deferred Revenue (also called Unearned Revenue)

You received cash before earning it. Annual SaaS subscriptions, rent collected in advance, retainer fees.

Mar 31  Unearned Revenue           Dr.   3,000
             To Subscription Revenue            3,000
        (Being 3 months of the 12-month plan earned)

4. Prepaid Expense

You paid cash for a benefit you’ll consume over time. Annual insurance premium, software licence, prepaid rent.

Mar 31  Insurance Expense          Dr.   6,000
             To Prepaid Insurance               6,000

Bonus: depreciation

Depreciation is technically a prepaid-expense-like adjustment — you paid for a long-term asset upfront, and you “consume” its useful life over many years. Each period you record:

Mar 31  Depreciation Expense       Dr.   5,000
             To Accumulated Depreciation        5,000

Common methods:

• Straight-line: (Cost − Salvage) ÷ Useful life. A ₹60,000 laptop, 3-year life, no salvage → ₹20,000/year = ₹1,667/month.
• Written-down value (WDV): a fixed percentage of the asset’s remaining book value each year. Required for Indian Income Tax Act computations.
• Units of production: based on actual usage. Common for machinery.

Bad debt provisions

Not all customers pay. At year-end you estimate uncollectible AR and set up a provision:

Mar 31  Bad Debt Expense           Dr.   25,000
             To Allowance for Doubtful Debts   25,000

The allowance is a “contra-asset” — it sits on the balance sheet as a negative against AR, reducing the net realisable value of receivables.

Why adjustments matter

Without adjusting entries:

• Net income is wrong — either inflated (missed expense accruals) or deflated (missed revenue accruals).
• Balance sheet is wrong — assets or liabilities are misstated.
• Cash flow statement looks normal but the operating section misleads.

This is the difference between bookkeeping and accounting. Bookkeeping records what happened with cash. Accounting tells the truth about the period.

Practice

Lesson recap

• Adjusting entries align revenues and expenses with the period they belong to.
• Four types: accrued revenue, accrued expense, deferred revenue, prepaid expense.
• Plus: depreciation, bad-debt provisions, inventory write-downs.
• Always made on the last day of the accounting period — never in between.