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Fundamentals of Financial and Cost Accounting · Adjustment Entries and Rectification of Errors

Adjustment Entries: Meaning and Need at Year End

Updated 10 October 2026 · Fact-checked

Adjustment entries are journal entries passed at the end of an accounting year to record items that the day-to-day books have missed or recorded in the wrong period. They follow the accrual concept, so profit and the balance sheet show the true position. To solve questions, identify the item, find its effect on the year, then debit and credit accordingly.

Understand Adjustment Entries: Meaning and Need

Your books record transactions as cash moves or bills are raised. But a year does not end neatly. Rent may be due but unpaid. Insurance may be paid for next year too. Some income may be earned but not yet received.

The accrual concept says you record income when it is earned and expense when it is incurred, whatever the date of cash movement. If you ignore this, profit for the year will be wrong. Adjustment entries are the journal entries that fix this at the year end, before you prepare final accounts.

Common items needing adjustment are outstanding expenses, prepaid expenses, accrued income, income received in advance, depreciation, bad debts, provision for doubtful debts and closing stock. Each one matches the right income and expense to the right year.

Adjustment entries are different from regular journal entries. A regular entry records a transaction that actually happened during the year, such as a sale or a payment. An adjustment entry records no new cash event. It corrects the timing or measures a value, such as depreciation. It is also different from a closing entry, which transfers balances of nominal accounts to the Trading and Profit and Loss Account to close them. Adjustments come first. Closing entries come after.

Adjustment entries also differ from rectification entries. Rectification corrects a mistake. An adjustment is not a mistake. It is a planned year-end step.

Key formulas to remember

Outstanding expense entry
Expense A/c Dr. ; To Outstanding Expense A/c
Expense is incurred but unpaid. It is added to the expense in the P&L and shown as a liability.
Prepaid expense entry
Prepaid Expense A/c Dr. ; To Expense A/c
Part of the amount paid belongs to next year. It is deducted from the expense and shown as an asset.
Accrued income entry
Accrued Income A/c Dr. ; To Income A/c
Income is earned but not received. It is added to income and shown as an asset.
Income received in advance entry
Income A/c Dr. ; To Income Received in Advance A/c
Part of the receipt belongs to next year. It is deducted from income and shown as a liability.
Expense for the year
Expense for the year = Paid + Outstanding at end − Outstanding at start − Prepaid at end + Prepaid at start
Use this to find the amount charged to the P&L.
Adjustment vs closing entry
Adjustment: matches items to the year. Closing: transfers nominal balances to final accounts.
Adjustments are passed first, closing entries later.

How to solve Adjustment Entries: Meaning and Need questions

Use this method for any question asking you to identify, explain or pass an adjustment entry.

  1. 1Read the adjustment and note the period it covers and the period of the accounts.
  2. 2Decide whether the item is an expense or an income, and whether it is due, paid early, earned or received early.
  3. 3Apply the accrual concept: how much of the amount belongs to this year?
  4. 4Choose the accounts: the nominal account (expense or income) and the personal or real account (outstanding, prepaid, accrued or advance).
  5. 5Write the entry with the correct debit and credit.
  6. 6Check the effect: does profit rise or fall, and does the item appear as an asset or a liability in the balance sheet?

Quickest way: Asset or liability, then add or deduct

When to use it: Use this for MCQs that ask which entry, effect or balance sheet position applies to an adjustment.

  1. Ask: is the item still owed by us or to us? Owed by us is a liability. Owed to us is an asset.
  2. Outstanding expense: liability, expense goes up. Prepaid expense: asset, expense goes down.
  3. Accrued income: asset, income goes up. Income in advance: liability, income goes down.
  4. Remember that adjustments change profit. Closing entries do not create new profit, they only transfer it.
  5. Eliminate options that debit a personal account wrongly or that treat these items as cash entries.

Common mistakes in Adjustment Entries: Meaning and Need

  • Treating adjustment entries as corrections of errors

    Both are passed in the journal near the year end, so they look alike.

    Fix: Adjustments are planned and follow the accrual concept. Rectification corrects a mistake already made.

  • Confusing adjustment entries with closing entries

    Both are year-end entries.

    Fix: Adjustment entries fix timing and valuation. Closing entries transfer nominal account balances to the final accounts.

  • Showing prepaid expense as a liability

    Students link any 'unpaid' wording to liability.

    Fix: Prepaid means you have paid for a benefit yet to come. It is an asset.

  • Adding prepaid and subtracting outstanding in the P&L

    The direction is memorised, not understood.

    Fix: Outstanding adds to the expense because more was incurred. Prepaid is deducted because part belongs to next year.

  • Thinking adjustment entries involve cash

    Regular entries mostly involve cash or bank.

    Fix: Adjustment entries do not move cash. They only record dues, advances or valuations.

Worked examples

Example 1

Rent paid during the year ended 31 March 2027 is ₹60,000. Rent for March 2027 of ₹5,000 is still unpaid. What is the adjustment entry and the rent charged to the P&L?

Show the solution
  1. Rent for March is incurred in this year but unpaid, so it is an outstanding expense.
  2. Entry: Rent A/c Dr. ₹5,000 ; To Outstanding Rent A/c ₹5,000.
  3. Rent charged = ₹60,000 + ₹5,000 = ₹65,000.
  4. Outstanding rent of ₹5,000 is shown as a liability in the balance sheet.

Answer: Rent A/c Dr. ₹5,000 to Outstanding Rent A/c ₹5,000; rent charged to P&L is ₹65,000.

Example 2

Which statement correctly describes an adjustment entry?
(a) It records a sale made on credit during the year
(b) It is passed at year end to match income and expenses to the right year
(c) It transfers the balance of the Rent account to the P&L Account
(d) It corrects a debit posted to the wrong account

Show the solution
  1. Option (a) is a regular journal entry for a transaction.
  2. Option (c) describes a closing entry.
  3. Option (d) describes rectification of an error.
  4. Option (b) matches the accrual concept and is the meaning of an adjustment entry.

Answer: (b)

Exam tips

  • Link every adjustment to the accrual concept. Many MCQs ask for the reason, and this is the answer.
  • Memorise the four core entries and whether each is an asset or a liability.
  • Questions on difference ask you to pick between adjustment, closing and rectification entries. Recall the purpose of each.
  • Be ready for 'which appears in the balance sheet' questions. Outstanding and advance items are liabilities. Prepaid and accrued items are assets.
  • There is no negative marking, so attempt every question after eliminating wrong options.

Practice questions from Adjustment Entries and Rectification of Errors

Adjustment Entries: Meaning and Need in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Adjustment Entries: Meaning and Need: frequently asked questions

What are adjusting entries in simple words?

They are year-end journal entries that record items missed or placed in the wrong period during the year. Examples are outstanding rent, prepaid insurance and depreciation. They make profit and the balance sheet accurate.

Why are adjustment entries required at year end?

Under the accrual concept, income and expenses belong to the year in which they are earned or incurred, not when cash moves. Day-to-day entries often follow cash. Adjustments bring the books in line with the accrual concept.

What is the difference between adjusting entries and closing entries?

Adjusting entries match income and expenses to the correct year and are passed first. Closing entries transfer the balances of nominal accounts to the Trading and P&L Account so they start the next year at zero.

Do adjustment entries affect profit?

Yes. Items such as outstanding expenses, prepaid expenses, accrued income and depreciation change the profit for the year. That is the main purpose of passing them.