Key Points
- Adjusting entries translate cash-basis records into accrual-basis financial statements at each period-end.
- Most mid-market entities post between 30 and 80 manual adjusting entries per year-end close, each carrying higher inherent risk than routine automated postings.
- Auditors must test adjusting entries as part of their mandatory fraud-response procedures, separate from routine journal entry testing.
- A missing or miscalculated adjusting entry directly misstates the reported profit because it bypasses the normal transaction cycle.
What is Adjusting Entry?
IAS 1.27 requires financial statements to be prepared on the accrual basis, meaning transactions are recognised when they occur, not when cash moves. Adjusting entries bridge the gap between what the accounting system recorded during the period and what the accrual basis demands at the reporting date.
Four categories cover virtually all adjusting entries. Accruals record expenses incurred or revenue earned but not yet invoiced (a December electricity bill received in January). Deferrals spread cash already received or paid across the periods it relates to (prepaid insurance allocated month by month). Estimates update balances that require judgment, such as the allowance for doubtful accounts or depreciation charges. Reclassifications move amounts between line items to achieve the presentation required by IAS 1.29.
IAS 10.8 adds a second trigger: events after the reporting period that provide evidence of conditions existing at the balance sheet date require adjusting entries even though they occur after year-end. The auditor's responsibility under ISA 560.6 is to perform procedures designed to identify such events up to the date of the auditor's report. Because adjusting entries are manual, posted by experienced staff at the point in the reporting cycle when management faces the strongest incentive to shape results, ISA 240.32(a) requires the auditor to include them in journal entry testing as "other adjustments made in the preparation of the financial statements."
Worked example
Client: Italian food production company, FY2025, revenue EUR 67M, IFRS reporter. The financial controller is preparing December 2025 year-end adjusting entries.
Step 1 — Accrue December utilities and services
Rossi received a EUR 145,000 gas and electricity bill on 8 January 2026 covering December 2025 consumption. The financial controller posts an adjusting entry at 31 December 2025: debit production overheads EUR 145,000, credit accrued expenses EUR 145,000. The auditor verifies the amount against the January invoice.
Documentation note: record the accrual period, the supporting invoice (received January 2026), and the IAS 1.27 basis. Attach the invoice.
Step 2 — Defer prepaid insurance
Rossi paid EUR 360,000 on 1 October 2025 for a 12-month product liability insurance policy. At year-end, three months have elapsed. The adjusting entry recognises EUR 90,000 as insurance expense (3/12 of EUR 360,000) and leaves EUR 270,000 as a prepaid asset.
Documentation note: record policy dates, premium amount, allocation calculation (EUR 360,000 / 12 x 3), and the remaining prepaid balance. Cross-reference the policy document.
Step 3 — Adjust the provision for doubtful receivables
The trade receivables balance at 31 December 2025 is EUR 11.2M. Rossi applies a provision matrix based on historical loss rates. The model produces an expected credit loss of EUR 392,000. The existing allowance is EUR 310,000, so the adjusting entry increases the allowance by EUR 82,000: debit bad debt expense EUR 82,000, credit allowance for doubtful receivables EUR 82,000.
Documentation note: record the receivables ageing, loss rates by bucket, calculation output (EUR 392,000), prior allowance, and the net adjustment per IFRS 9.5.5.15. Retain the provision matrix workbook.
Step 4 — Recognise an adjusting event after the reporting period
On 15 January 2026, a key customer (owing EUR 480,000 at year-end) entered insolvency proceedings. IAS 10.9(b)(i) classifies this as an adjusting event because the customer's financial difficulties existed at the balance sheet date. The financial controller posts an additional specific allowance of EUR 384,000 (80% of the outstanding balance, based on legal counsel's recovery estimate).
Documentation note: record the event date, the IAS 10.8–9 classification rationale, evidence that the condition existed at the balance sheet date (deteriorating payment history in Q4 2025), and the basis for the 80% write-down. Attach the insolvency notice and legal counsel's opinion per ISA 560.6.
Conclusion: the four adjusting entries convert Rossi's cash-basis balances to an accrual-basis result, with each entry traceable to a supporting document and a specific standard paragraph.
Why it matters in practice
- Adjusting entries for post-balance-sheet events are frequently posted without documenting why the event qualifies as "adjusting" rather than "non-adjusting" under IAS 10.3. The distinction turns on whether the event provides evidence of a condition that existed at the reporting date. When the classification is not documented, the auditor under ISA 560.7(a) cannot evaluate whether the entity applied the standard correctly. Reviewers flag entries where the conclusion is stated but the supporting analysis is absent.
- Teams sometimes exclude adjusting entries from the ISA 240.32 journal entry testing population because they view them as a separate category from "journal entries." ISA 240.32(a) explicitly refers to "journal entries recorded in the general ledger and other adjustments made in the preparation of the financial statements." The adjusting entries are the "other adjustments." Omitting them from the testing population leaves the highest-risk entries untested.
Adjusting entry vs. correcting entry
| Dimension | Adjusting entry | Correcting entry |
|---|---|---|
| Purpose | Updates balances for accruals, deferrals, estimates, and reclassifications to achieve accrual-basis reporting | Fixes an error in a previously recorded transaction (wrong account, wrong amount, wrong period) |
| Timing | Posted at period-end as part of the normal close process | Posted whenever the error is discovered, which may be mid-period or at year-end |
| Frequency | Recurring: the same types of adjusting entries recur each period | Non-recurring: each correcting entry addresses a specific, one-off mistake |
| Audit risk | Higher inherent risk because of judgment involved (estimates, IAS 10 classification) and manual posting at a pressure point in the cycle | Risk depends on the nature of the error; pattern of correcting entries may indicate control weaknesses |
The distinction matters because a recurring adjusting entry (the monthly depreciation charge, for instance) follows a predictable pattern the auditor can test by recalculation. A correcting entry signals that something went wrong. A high volume of correcting entries may indicate control deficiencies, which the auditor evaluates under ISA 315 when assessing control risk.
Related terms
Frequently asked questions
How do I distinguish an adjusting entry from a closing entry?
An adjusting entry updates balances to reflect accrual-basis amounts before the financial statements are prepared. A closing entry zeroes out temporary accounts and transfers the net result to retained earnings after the statements are finalised. Adjusting entries affect reported numbers; closing entries reset the books for the next period. IAS 1.27 drives adjusting entries; closing entries have no specific IFRS paragraph.
When should adjusting entries be posted for a mid-year interim close?
IAS 34.28 requires interim financial statements to apply the same recognition and measurement principles as annual statements. Adjusting entries for accruals, deferrals, estimates, and reclassifications are therefore required at each interim reporting date, not only at year-end. The auditor performing a review under ISRE 2410 should evaluate whether the entity posted the necessary adjustments at the interim date.
Do adjusting entries need separate approval from routine journal entries?
ISA 240.32(a) does not prescribe a specific approval process, but ISA 315.26(a) requires the auditor to understand the entity's controls over journal entries, including adjusting entries. Most firms expect a second approval by someone senior to the preparer because of the manual nature and direct impact on reported results. The absence of a review trail is a finding the engagement quality reviewer will flag.