Adjustment Entries: Easy Guide to Score Better Marks Fast

 

Adjustment Entries: Easy Guide for Accurate Accounts Now

Adjustment entries are journal entries passed at the end of an accounting period to update incomes, expenses, assets, and liabilities correctly. They help show the real profit or loss of a business and ensure accounts follow the matching and accrual concepts.

Without adjustment entries, financial statements often become misleading.
And honestly, this is where many commerce students start feeling confused — because transactions may happen in one month, but their effect belongs to another.

 

A Real Confusion Students Often Face

Imagine a coaching institute in Indore pays ₹24,000 shop rent for 12 months in advance.

The student immediately asks:

“Sir, if full payment is already made, then why can’t we show ₹24,000 as expense this year?”

Good question.

Because accounting does not only care about payment.
It cares about which period actually used the benefit.

If only 3 months’ rent belongs to this year, then only that part should become expense. The remaining amount is still a future benefit.

That is exactly why adjustment entries exist.

 

What Are Adjustment Entries?

Adjustment entries are entries passed at the end of the accounting year to:

• correct income and expenses,
• update pending amounts,
• apply accrual accounting,
• and prepare accurate final accounts.

These entries are generally passed before preparing:

• Trading Account
• Profit & Loss Account
• Balance Sheet

Simple Definition

Adjustment entries are journal entries made to record incomes or expenses that belong to the current accounting period but are either unpaid, prepaid, earned, or unrecorded.

 

Why Do Adjustment Entries Exist?

This concept mainly exists because of two accounting rules:

1. Matching Concept

Expenses should be matched with related income of the same period.

2. Accrual Concept

Income and expenses are recorded when they are earned or incurred — not when cash is received or paid.

Example

A business uses electricity in March but pays the bill in April.

Should March accounts ignore electricity expense?

No.

Because electricity was used in March itself.

So we pass an adjustment entry.

 

Why This Matters in Real Life

Imagine two businesses:

• Business A records expenses properly using adjustment entries.
• Business B ignores outstanding salaries, prepaid insurance, and accrued income.

Now both calculate profit.

Business B may show fake higher profits simply because some expenses were ignored.

This can create serious problems:

• wrong tax calculation,
• wrong investor decisions,
• poor budgeting,
• incorrect business valuation,
• and even loan rejection by banks.

In real businesses, accurate accounts are not optional.
They directly affect trust, taxation, funding, and survival.

 

Types of Adjustment Entries Explained Simply

Here are the most common adjustment entries students study in Class 11, Class 12, B.Com, CA Foundation, and other commerce courses.

Adjustment Type	Meaning	Effect
Outstanding Expenses	Expense due but unpaid	Expense increases
Prepaid Expenses	Expense paid in advance	Expense decreases
Accrued Income	Income earned but not received	Income increases
Unearned Income	Advance income received	Income decreases
Depreciation	Asset value reduction	Expense increases
Bad Debts Provision	Expected credit loss	Profit decreases

 

What Is Outstanding Expense?

Outstanding expense means:

Expense belongs to current year but payment is still pending.

Example

Salary for March = ₹15,000
Paid in April.

Still, March accounts must include salary expense.

Journal Entry

Salary A/c Dr.          ₹15,000

   To Outstanding Salary A/c      ₹15,000

Logic

• Expense belongs to current year.
• Liability is created because payment is pending.

 

What Is Prepaid Expense?

Prepaid expense means payment is made now, but benefit belongs to future period.

Example

Insurance paid = ₹12,000 for 12 months
Current year uses only 4 months.

Expense for current year:

{12000 x 4} / 12=4000

Remaining ₹8,000 is prepaid insurance.

Journal Entry

Prepaid Insurance A/c Dr.     ₹8,000

    To Insurance A/c                     ₹8,000

 

What Is Accrued Income?

Income earned but not yet received.

Example

Interest on investment earned = ₹5,000
Not yet received from bank.

Journal Entry

Accrued Interest A/c Dr.      ₹5,000

    To Interest Income A/c            ₹5,000

 

What Is Unearned Income?

Advance payment received for future service.

Example

A tuition center receives ₹20,000 advance fees for next year.

This year cannot treat full amount as income.

Journal Entry

Fees Income A/c Dr.           ₹20,000

    To Unearned Fees A/c              ₹20,000

 

Step-by-Step Adjustment Entry Example (Full Illustration)

Let us understand with one complete example.

Scenario

A small stationery shop in Bhopal has:

• Rent paid during year = ₹36,000
• But ₹6,000 relates to next year
• Salaries unpaid = ₹10,000

Now prepare adjustment entries.

 

Step 1: Identify Prepaid Expense

Rent belongs partly to next year.

Current year expense:

36000 – 6000 = 30000

Entry

Prepaid Rent A/c Dr.      ₹6,000

    To Rent A/c                    ₹6,000

 

Step 2: Identify Outstanding Expense

Salary unpaid = liability.

Entry

Salary A/c Dr.              ₹10,000

    To Outstanding Salary A/c      ₹10,000

 

Step 3: Final Effect

Item	Profit & Loss A/c	Balance Sheet
Rent	₹30,000 Expense	₹6,000 Asset
Salary	₹10,000 Expense	₹10,000 Liability

Now accounts become accurate.

 

A Personal Teaching Moment

Once while teaching B.Com students, I asked:

“If you pay school fees for next year today, does that mean next year becomes free?”

Everyone laughed.

But that simple question solved prepaid expense confusion instantly.

Accounting is not about memorizing entries.
It is about understanding time and benefit.

Once students understand that logic, adjustment entries become much easier.

 

Difference Between Cash Accounting and Adjustment-Based Accounting

Basis	Cash Accounting	Accrual Accounting
Recording Time	When cash moves	When income/expense occurs
Adjustment Entries	Usually not needed	Essential
Accuracy	Lower	Higher
Used By	Small informal setups	Businesses & companies
Profit Reliability	Weak	Strong

 

Real-Life Examples of Adjustment Entries

1. Mobile Recharge Distributor

Commission earned in March but received in April.

Still counted in March income.

 

2. Coaching Institute

Advance fees received from students for next session.

Not fully current income.

 

3. Manufacturing Factory

Electricity bill pending at year-end.

Must still record expense.

 

What Happens If Adjustment Entries Are Ignored?

Many students think adjustments are “extra entries for exams.”

No.

Ignoring them can create:

• wrong profit,
• incorrect taxation,
• fake asset values,
• misleading balance sheet,
• investor distrust,
• audit objections.

In companies, this can even create legal issues.

 

Common Mistakes Students Make

1. Confusing Cash Payment With Expense

Payment timing and expense timing are not always same.

 

2. Forgetting Dual Effect

Every adjustment affects:

• one account in P&L,
• and one account in Balance Sheet.

 

3. Memorizing Without Logic

Students try learning journal entries by heart.

Instead ask:

• Is benefit current or future?
• Is amount paid or unpaid?
• Is income earned or received?

Logic becomes easier than memorization.

 

4. Ignoring Closing Adjustments

Some students only post journal entries but forget final accounts effect.

This loses marks in exams.

 

Exam Tip (Important)

In board exams and university exams:

Always remember this rule:

Every adjustment usually appears twice.

Example:

• Outstanding salary → Expense in P&L + Liability in Balance Sheet
• Prepaid insurance → Reduced expense + Asset in Balance Sheet

If you write both effects clearly, presentation becomes strong.

 

Advanced Insight Beginners Usually Miss

Here is something important many beginners never notice:

Adjustment entries are actually timing corrections.

That’s the deeper idea.

Accounting is not just recording money.
It is distributing financial effects into the correct accounting period.

This becomes extremely important in:

• GST filing,
• company audits,
• taxation,
• budgeting,
• startup valuation,
• bank loan analysis.

Professional accountants spend huge time ensuring timing accuracy.

 

Adjustment Entries in Business Decision-Making

Suppose a retail business owner sees ₹8 lakh annual profit.

Looks good.

But after adjustment entries:

• unpaid salaries,
• depreciation,
• pending electricity,
• bad debts

actual profit becomes ₹4.5 lakh.

Now the owner may:

• avoid opening new branch,
• reduce unnecessary expenses,
• postpone loan,
• improve cash management.

This shows adjustment entries influence real business decisions — not just exams.

 

Journal Entry Summary Table

Adjustment	Journal Entry
Outstanding Expense	Expense A/c Dr. → To Outstanding Expense A/c
Prepaid Expense	Prepaid Expense A/c Dr. → To Expense A/c
Accrued Income	Accrued Income A/c Dr. → To Income A/c
Unearned Income	Income A/c Dr. → To Unearned Income A/c
Depreciation	Depreciation A/c Dr. → To Asset A/c

 

Are Adjustment Entries Important for Indian Exams?

Absolutely.

This topic is highly important in:

• CBSE Class 11 Accountancy
• CBSE Class 12 Accountancy
• State Boards
• B.Com
• CA Foundation
• CMA Foundation
• CS Foundation
• MBA basic accounting subjects

Questions commonly asked:

• journal entries,
• adjustment treatment,
• final accounts,
• rectification,
• theory explanation.

 

Practice Questions

Question 1

Salary outstanding ₹12,000 at year-end. Pass adjustment entry.

 Question 2

Insurance paid ₹24,000 for 12 months. Only 9 months belong to current year. Find prepaid amount and pass entry.

 Question 3

Interest earned ₹5,500 but not received. Pass adjustment entry and state its effect.

 

Frequently Asked Questions (FAQs)

What is the main purpose of adjustment entries?

The main purpose is to show correct profit and financial position by recording incomes and expenses in the proper accounting period.

 

Are adjustment entries compulsory?

In accrual accounting, yes. They are essential for accurate final accounts.

 

Why are adjustment entries passed at year-end?

Because businesses need updated and accurate financial statements before closing books.

 

Do adjustment entries affect cash?

Not always. Many adjustments happen without immediate cash movement.

 

What is the difference between outstanding and prepaid expense?

Outstanding expense is unpaid current expense.
Prepaid expense is future expense paid in advance.

 

Is depreciation also an adjustment entry?

Yes. Depreciation adjusts asset value and records usage expense.

 

Why do students find adjustment entries difficult?

Mostly because they focus on memorizing entries instead of understanding timing and benefit logic.

 

References & Concept Sources

This article is based on widely accepted accounting principles and educational frameworks used in:

• Financial Accounting concepts
• Accrual Accounting System
• Matching Principle
• Indian commerce curriculum (CBSE, universities, professional courses)
• Standard accounting treatment followed in business practice

 

Guidepost Topics  

• What Is Accrual Accounting and Why Is It Important?
• Difference Between Capital Expenditure and Revenue Expenditure
• How to Prepare Final Accounts With Adjustments?

 

Final Understanding

Adjustment entries may look technical at first, but their core idea is simple:

Record income and expenses in the correct time period.

Once students understand this logic, most accounting confusion disappears.

This topic is not only important for exams — it is one of the foundations of real financial accuracy in business.

 

Author Bio

Hi, I’m Manoj Kumar.
I hold an MBA and have practical exposure to accounting, taxation, and business concepts. Along with this, I’ve spent time guiding and explaining these subjects to students in a way that actually makes sense to them.

In my experience, most students don’t find commerce difficult — they just don’t get the right explanation. That’s where I focus. I break down concepts into simple, logical steps so they are easier to understand and remember.

Through Learn with Manika, I aim to make commerce learning clear, practical, and useful — whether you’re preparing for exams or trying to understand how things work in real life. When I explain a concept, I always focus on the logic behind it, because once that becomes clear, confidence automatically follows.

 

Disclaimer

This article is for educational purposes only and should not be considered professional advice.