An adjusting journal entry, or AJE, is an accounting entry made at the end of a reporting period to update revenue, expense, asset, and liability accounts so the financial statements reflect what actually happened economically, not just what moved through the bank account. In accounting, AJEs are the bridge between the raw ledger and accrual-basis financial statements. They record obligations already incurred, revenue already earned, and value already consumed, even when no cash has changed hands yet.
Without these entries, a month-end or year-end balance sheet and income statement would show only the transactions where money moved. Wages earned in the last week of December but paid in January would disappear from December. A twelve-month insurance premium paid in July would look like a giant July expense and nothing after. AJEs correct those distortions.
Why AJEs Exist
Under Generally Accepted Accounting Principles, revenues and expenses belong in the period when the economic event occurs, not when the cash moves. A consulting firm that finishes a $50,000 project in December but doesn’t get paid until January still earned that revenue in December, and an AJE records it there. The matching concept pairs expenses with the revenues they helped produce in the same period.
Federal tax law pushes many businesses toward this approach. IRC Section 446 requires every taxpayer to use an accounting method that clearly reflects income.1Office of the Law Revision Counsel. 26 USC 446 – General Rule for Methods of Accounting IRC Section 448 goes further: C corporations and partnerships with C corporation partners generally must use the accrual method unless their average annual gross receipts over the prior three years fall below an inflation-adjusted threshold.2Office of the Law Revision Counsel. 26 USC 448 – Limitation on Use of Cash Method of Accounting For tax years beginning in 2026, that threshold is $32 million.3Internal Revenue Service. Revenue Procedure 2025-32 Any business on the accrual method will need AJEs at each period close.
The Three Main Types of Adjusting Journal Entries
AJEs fall into three categories: accruals, deferrals, and non-cash estimates. Each fixes a different mismatch between economic activity and cash movement.
Accruals
Accruals capture economic events that have already happened but haven’t hit the ledger yet because no invoice arrived and no cash changed hands. Wages earned during the final days of a pay period that straddles two months are the classic example. The AJE debits wages expense and credits wages payable. Interest building on a loan works the same way: it grows daily even if the lender only bills quarterly.
Accrued revenue is the mirror image. If your company completed work for a client but hasn’t sent an invoice, or earned interest on a deposit that hasn’t posted, an AJE debits accounts receivable and credits the appropriate revenue account. The purpose is to avoid understating what you’ve earned or what you owe at the reporting date.
Deferrals
Deferrals handle the opposite situation: cash moved before the economic event was complete. Prepaid insurance is the textbook case. A business that pays $1,200 on July 1 for twelve months of coverage records the full amount as a prepaid asset. Each month, an AJE moves $100 from the prepaid asset to insurance expense. By year-end, six months of expense has been recognized and six months of prepaid value remains on the balance sheet.
Unearned revenue works from the other side. When a client pays $10,000 upfront for a project delivered over five months, the initial receipt is a liability because the work is still owed. Each month, an AJE shifts $2,000 from unearned revenue to earned revenue. Without these entries, liabilities are overstated and income is understated.
Non-Cash Estimates
Some AJEs involve no past or future cash movement at all. Depreciation is the most familiar. Rather than expensing a $60,000 delivery truck the day you buy it, you spread the cost over its useful life. IRS Publication 946 provides recovery periods and methods for different asset classes, and most businesses use the Modified Accelerated Cost Recovery System (MACRS) for tax purposes.4Internal Revenue Service. Publication 946, How To Depreciate Property Each period, the AJE debits depreciation expense and credits accumulated depreciation. Amortization applies the same logic to intangible assets like patents or software licenses.
Bad debt estimates also live here. If your business extends credit, some receivables won’t be collected. GAAP requires an estimate at period-end rather than waiting to see which accounts go bad. Two common methods apply: a historical percentage against total credit sales, or aging receivables and applying different loss rates to each bucket. Either way, the AJE debits bad debt expense and credits an allowance for doubtful accounts, reducing the net receivable balance to a more realistic figure.
Adjusting Entries Are Not Correcting Entries
One point worth clearing up early: an AJE is not a correcting entry. AJEs deal with timing. They record events that have genuinely occurred but haven’t been booked because the period hasn’t closed. A correcting entry fixes an outright mistake, like posting a payment to the wrong account or recording an invoice for the wrong amount. Correcting entries can happen any time. AJEs are made at period-end as part of the close. Treating them as the same thing leads to sloppy documentation and audit problems.
How an AJE Gets Recorded
The starting point is the unadjusted trial balance, a report listing every general ledger account and its balance before period-end adjustments. Accountants scan this report for accounts that look stagnant or incomplete. A prepaid insurance balance that hasn’t moved in six months is a signal that nobody has been recording the monthly expense.
From there, the accountant pulls supporting documents. Bank statements confirm interest earned or charged. Loan amortization schedules show principal and interest for the current period. Payroll reports for the final days of the period establish wages earned but unpaid. Vendor contracts reveal service periods that don’t align with billing dates. Fixed-asset registers provide the depreciation method, recovery period, and placed-in-service date needed to compute depreciation.4Internal Revenue Service. Publication 946, How To Depreciate Property
Each entry follows standard double-entry mechanics. One account gets debited, another gets credited, and the entry carries a short description explaining the adjustment. Something like “accrue December wages, paid January 5” gives anyone reviewing the ledger later the context they need. After posting, the software produces an adjusted trial balance, which is the verified basis for the income statement and balance sheet.
Every AJE should have a paper trail linking the entry to its source document, whether that’s a bank statement, amortization schedule, depreciation register, or calculation worksheet. During an audit, the first request is usually the support behind each manual adjustment. Missing documentation gets the entry flagged.
Reversing Entries
Some AJEs create a bookkeeping problem the next period. Suppose you accrued $5,000 in wages payable at the end of December. When the actual payroll runs in January, the full paycheck gets recorded as wages expense. Without an intervening step, part of that expense has been counted twice: once in December’s accrual, again in January’s payroll entry.
A reversing entry solves this. On the first day of the new period, the accountant posts the mirror image of the original accrual, debiting wages payable and crediting wages expense for $5,000. That zeroes out the liability and gives wages expense a temporary credit balance. When the actual payroll entry hits, the two offset and the expense lands in the right period.
Not every AJE gets reversed. Reversals fit accrued expenses, accrued revenues, and certain deferrals. Depreciation, bad debt provisions, and other non-cash estimates are never reversed, because no “real” transaction is arriving next period to cause double-counting.
Materiality and Why Getting AJEs Right Matters
Not every discrepancy between the ledger and reality warrants a formal AJE. Accountants apply a materiality filter: would a reasonable person’s view of the financial statements change if the item were included or corrected? A $15 timing difference on office supplies probably wouldn’t. A $200,000 unrecorded liability almost certainly would.
A percentage benchmark, often around 5% of a relevant financial measure, is a common starting screen, but only a screen. The SEC’s Staff Accounting Bulletin No. 99 states that even quantitatively small misstatements can be material when qualitative factors are present, such as a misstatement that turns a reported loss into a gain, hides a failure to meet loan covenants, or increases management compensation.5U.S. Securities & Exchange Commission. SEC Staff Accounting Bulletin No. 99 – Materiality Materiality is a judgment, not a math problem.
The consequences of skipping or botching AJEs are real. On the tax side, if incorrect adjustments cause an understatement of tax owed, the IRS imposes an accuracy-related penalty of 20% on the underpayment attributable to negligence or a substantial understatement of income. For individuals, a substantial understatement means tax liability was understated by the greater of 10% of the correct tax or $5,000.6Internal Revenue Service. Accuracy-Related Penalty For public companies, material misstatements in SEC filings can trigger enforcement actions, restatements, and personal liability for officers who certified the reports. And because many loan agreements require specific financial ratios, missed AJEs that overstate assets or understate liabilities can put a borrower in technical default once the lender catches the discrepancy.
Manual journal entries are also a common vehicle for financial statement fraud, because they bypass the automated controls built into purchasing, payroll, and billing systems. The basic control is segregation of duties: the person who calculates and proposes an adjusting entry shouldn’t be the same person who approves and posts it. For public companies, Section 404 of the Sarbanes-Oxley Act requires management to assess and report annually on internal controls over financial reporting, including controls around journal entries, with the external auditor independently attesting to that assessment.7U.S. Securities & Exchange Commission. Study of the Sarbanes-Oxley Act of 2002 Section 404