Learn the four adjustment types with step-by-step worked examples
The Four Adjustment Types
In Phase 1 you felt the tension: cash timing and work timing do not match. GAAP solves this with adjusting entries—journal entries made at month-end to move revenue and expenses into the correct period.
There are exactly four types. Each one answers a simple question:Did cash move before or after the work?
The Rule:
Adjusting entries never involve Cash. They only reclassify amounts that are already on the books or add amounts that should be on the books but are not yet recorded. Cash was already recorded (or will be recorded later) in a separate transaction.
What happened: Sarah completed a $500 social media campaign for the fitness studio on March 28. She will not invoice until April 5. Cash will arrive in mid-April.
Why it matters: Without an adjustment, March revenue is missing $500 of work that actually happened. The income statement understates performance.
The Adjusting Entry (March 31):
Debit: Accounts Receivable — $500
Credit: Service Revenue — $500
What changed: Accounts Receivable (asset) goes up by $500. Service Revenue (equity) goes up by $500. The accounting equation stays balanced. March now shows the revenue it actually earned.
Signal to use this entry: You completed work this period but have not yet billed or been paid.
What happened: Sarah's freelance designer completed $350 of graphic work in the last week of March. The designer will invoice in April. Sarah will pay in April.
Why it matters: Without an adjustment, March expenses are missing $350. Net income looks higher than it really was.
The Adjusting Entry (March 31):
Debit: Design Expense — $350
Credit: Accounts Payable — $350
What changed: Design Expense (reduces equity) goes up by $350. Accounts Payable (liability) goes up by $350. March expenses now reflect the cost that was actually incurred.
Signal to use this entry: A cost was incurred this period but no bill has arrived and no cash has been paid.
What happened: A client paid Sarah $1,200 on March 15 for a six-month social media package. By March 31, Sarah has delivered about half a month of service.
What was already recorded: When the cash arrived, Sarah recorded:
Debit: Cash — $1,200
Credit: Deferred Revenue — $1,200
Why an adjustment is needed: Deferred Revenue is a liability—Sarah owes future service. By March 31 she has earned a portion. She must move that portion from the liability into actual revenue.
The Adjusting Entry (March 31):
Debit: Deferred Revenue — $100
Credit: Service Revenue — $100
Calculation: $1,200 ÷ 6 months = $200/month. Half of March = ~$100.
What changed: Deferred Revenue (liability) decreases by $100. Service Revenue (equity) increases by $100. The liability now reflects only the work still owed.
Signal to use this entry: Cash was received in advance and some (or all) of the work has now been completed.
What happened: Sarah paid $600 on March 1 for a three-month insurance policy covering March, April, and May.
What was already recorded: When cash was paid:
Debit: Prepaid Insurance — $600
Credit: Cash — $600
Why an adjustment is needed: Prepaid Insurance is an asset—it represents future coverage. By March 31, one month of coverage has been "used up." That portion must move from the asset into an expense.
The Adjusting Entry (March 31):
Debit: Insurance Expense — $200
Credit: Prepaid Insurance — $200
Calculation: $600 ÷ 3 months = $200/month.
What changed: Prepaid Insurance (asset) decreases by $200. Insurance Expense (reduces equity) increases by $200. The asset now reflects only the two months of coverage remaining.
Signal to use this entry: Cash was paid in advance for something that provides benefit over multiple periods, and some of that benefit has now been used.
1. Accrual accounting records revenue when:
2. A client pays Sarah $1,200 upfront for six months of service. On the day cash is received, Sarah should record:
3. An accrued expense means:
Summary: The Four Types at a Glance
| Type | Cash Timing | Adjustment Moves |
|---|---|---|
| Accrued Revenue | Cash comes after work | A/R up, Revenue up |
| Accrued Expense | Cash goes after cost | Expense up, A/P up |
| Deferred Revenue | Cash comes before work | Deferred Rev down, Revenue up |
| Deferred Expense | Cash goes before cost | Expense up, Prepaid down |