You close the books for the year,
total the Trial Balance, and everything looks perfect. Debits match credits.
Numbers look clean. Then someone says, "Salary for March is still
unpaid."
Suddenly the balance sheet that
looked complete no longer feels complete.
I remember explaining this to a
learner preparing for an accounting interview. He said, "If Trial Balance
already matches, why change anything?" Fair question. Matching totals can
create a dangerous feeling — like the work is finished.
But accounting has a habit of asking
one uncomfortable question:
"Did you record everything that
actually belongs to this year?"
That single question is the reason
adjusting entries exist. Accounts do not only need mathematical accuracy; they
need timing accuracy too. Revenue should belong to the correct period. Expenses
should belong to the correct period. Assets and liabilities should show the
true position of the business.
That takes us directly to the core idea.
What
are Adjusting Entries in Final Accounts?
Adjusting entries in final accounts
are journal entries passed at the end of an accounting period to record incomes
and expenses that belong to the current year but have not yet been properly
recorded. Their purpose is to ensure that financial statements show the correct
profit and true financial position.
Examples include outstanding
expenses, prepaid expenses, accrued income, income received in advance,
depreciation, bad debts, and provision for doubtful debts.
Adjusting
Entries Explained Simply
Think of accounting like recording a
cricket match score.
Suppose a batsman hits a six before
the innings ends, but the scorer forgets to add it. The match happened
correctly, but the scoreboard does not reflect reality.
Adjusting entries perform the same
correction in accounting.
The purpose is not to create new
transactions. The purpose is to capture transactions that already economically
belong to the period.
Let's see the logic step by step:
Step 1: Identify whether something
is missing.
Maybe salary expense has arisen but
payment has not yet happened. Maybe rent for next year has already been paid.
Maybe depreciation on machinery has not been charged.
Step 2: Determine whether the item
affects income or expense.
Every adjustment ultimately affects
profit calculation.
Step 3: Record the journal entry.
The adjusting journal entry updates
ledger balances before preparing Trading Account, Profit and Loss Account, and
Balance Sheet.
Step 4: Show the item in the proper
financial statement.
This is where many lose marks.
Passing the journal entry alone is not enough.
A beginner usually notices only the
journal entry.
A professional also asks:
"Where will this appear in
final accounts?"
That second question changes
everything.
For example:
Outstanding Salary:
- Expense increases in Profit & Loss Account
- Liability increases in Balance Sheet
Prepaid Insurance:
- Expense decreases in Profit & Loss Account
- Asset increases in Balance Sheet
A small adjustment can affect both
profit and financial position simultaneously.
One teaching moment stays with me. A
learner once calculated profit correctly but forgot to place outstanding salary
in liabilities. Half the marks disappeared even though the journal entry was
correct.
Accounting sometimes rewards
complete thinking more than partial accuracy.
LSI terms naturally connected here
include:
- adjustment entries
- year-end adjustments
- accrued expenses
- prepaid expenses
- final account treatment
- closing entries
Key
Rules of Adjusting Entries
- Follow the matching principle.
Revenue and expenses should belong
to the same accounting period.
- Record unpaid expenses.
Expenses incurred but unpaid must
still be recognized.
- Remove future-period expenses.
Prepaid amounts should not increase
current year expense.
- Recognize earned income.
Income earned but not received
should still be recorded.
- Show dual effect.
Most adjustments affect both Profit
& Loss Account and Balance Sheet.
Adjusting
Entries Solved Example
A stationery business in Gwalior
prepared accounts on 31 March 2026. The accountant found the following
information:
- Outstanding Salary = ₹8,000
- Prepaid Insurance = ₹5,000
- Depreciation on Furniture = ₹10,000
Let's record the adjustments.
Step 1: Outstanding Salary
Journal Entry:
Salary A/c Dr. ₹8,000
To Outstanding Salary A/c ₹8,000
Thinking:
Salary belongs to the current year
even though payment is pending.
Effect:
Profit & Loss Account:
Salary expense increases by ₹8,000
Balance Sheet:
Outstanding Salary shown under
liabilities.
Step 2: Prepaid Insurance
Journal Entry:
Prepaid Insurance A/c Dr. ₹5,000
To Insurance A/c ₹5,000
Thinking:
Amount belongs to next year's
benefit.
Effect:
Profit & Loss Account:
Insurance expense decreases.
Balance Sheet:
Prepaid Insurance shown under
current assets.
Step 3: Depreciation on Furniture
Journal Entry:
Depreciation A/c Dr. ₹10,000
To Furniture A/c ₹10,000
Thinking:
Furniture loses value due to usage.
Effect:
Profit & Loss Account:
Depreciation shown as expense.
Balance Sheet:
Furniture value reduces.
Final interpretation:
Without these entries, profit would
be overstated and the Balance Sheet would not reflect the true position.
Common
Mistakes to Avoid
Wrong: "If payment is not made,
expense should not be recorded."
Right: "Expenses are recorded
when incurred, not when cash moves."
Wrong: "Adjustment items affect
only Profit & Loss Account."
Right: "Many adjustments create
a dual effect in both Profit & Loss Account and Balance Sheet."
How
to Think About Adjusting Entries in Real Life
Imagine you own a coaching institute
in India.
March fees are earned but ₹50,000 is
still pending from students. Electricity expense of ₹7,000 is unpaid. Insurance
for six future months has already been paid.
Now ask yourself:
Should profit show only cash
movement?
No.
A business owner wants answers like:
- How much did I genuinely earn?
- What amount do I still owe?
- What amount belongs to the future?
Professionals think beyond cash
received and cash paid.
They think about economic reality.
Financial statements are valuable
only when they describe what actually happened.
Exam
Tip
Examiners frequently combine
adjusting entries with final accounts. After passing the journal entry, pause
for five seconds and ask:
"Where is the second
effect?"
Many questions become easy when you
consciously look for the Balance Sheet impact after writing the Profit &
Loss effect.
Quick
Recap
• Adjusting entries record missing
year-end items.
• They ensure matching of revenue
and expenses.
• Outstanding expenses increase
liabilities.
• Prepaid expenses create assets.
• Depreciation reduces asset value.
• Forgetting the dual effect causes
unnecessary mark loss.
Frequently
Asked Questions
Q: What are adjusting entries in
final accounts?
A: Adjusting entries are year-end
journal entries passed to record accrued, prepaid, or unrecorded items so
financial statements show correct profit and position.
Q: Why are adjusting entries
necessary?
A: They ensure that expenses and
revenues belong to the correct accounting period and prevent incorrect profit
calculation.
Q: How do adjusting entries affect
final accounts?
A: They usually affect both Profit
& Loss Account and Balance Sheet through expenses, income, assets, or
liabilities.
Q: What is the difference between
adjusting entries and closing entries?
A: Adjusting entries update account
balances before preparing statements, while closing entries transfer balances
and close temporary accounts.
Q: How do I identify adjusting
entries in accounting problems?
A: Look for words like outstanding,
prepaid, accrued, provision, depreciation, or income received in advance.
Related
Terms
→ Outstanding Expenses
→ Prepaid Expenses
→ Accrued Income
→ Income Received in Advance
→ Depreciation
Related
Guides
→ How do outstanding expenses affect
Profit and Loss Account and Balance Sheet?
The strongest accountants are not
the ones who record the most transactions; they are the ones who notice what
everyone else forgot.
AUTHOR BIO: Hi, I'm Manoj Kumar —
MBA, with hands-on experience in accounting, taxation, and business concepts.
Most students don't struggle with commerce itself; they struggle because no one
breaks it down properly. That's what I focus on with Learn with Manika: simple,
logical steps that make concepts stick, whether you're prepping for exams or
just want to understand how things actually work.
DISCLAIMER: This article is for
educational purposes only and is not a substitute for official study material
or professional advice. Tax laws, accounting standards, and exam patterns
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