Adjusting entries are accounting entries which are designed to compensate for transactions which may not be recorded in the general ledger either because they span multiple accounting periods, or because the transaction did not trigger anything to record. These entries are added at the end of the accounting period before closing the books. Handling adjusting entries can be tricky, and sometimes they can require a judgment call, with some people preferring to leave them to an accountant.
There are two types of adjusting entries. Accruals are expenses or income which occurred before the end of the accounting period, and deferrals are expenses or income which will happen after the accounting period is over. A simple example of an accrual is interest which is earned on a bank account. If the interest is not recorded in an accounting ledger, a false picture of the company's financial health is created, making it necessary to add an adjusting entry to indicate that the interest has been earned, even if it has not yet been paid out.
Another example of an accrual is services which have been rendered, but not yet paid. It is important to note that people performed X amount of services in a given month, even if funds have not yet been received. Likewise, paychecks can be entered as an adjusting entry, indicating that the company will owe money to employees on the basis of the amount of work they have done, even if the paychecks are not yet been issued. For example, if the pay period runs from the 15th to the 15th, but the accounting period closes on the last day of the month, an adjusting entry is needed to reflect the wages earned between the 15th and the last day of the month.
Adjusting entries can be used to account for things like interest earned and paid, paychecks, prepaid expenses, unearned revenue, and so forth. Another example of an adjusting entry is an entry which is designed to account for depreciation and other changes in assets. When a company buys office supplies, for example, the expense is debited, but the supplies are considered an asset, because they have value and the company controls them. As the office supplies are used up, however, the value of the asset drops, and this can be recorded with an adjusting entry. Likewise, appreciation of assets could be recorded with the use of adjusting entries.