What Is Adjustment? Meaning, Types, Examples & Why Every Business Owner Needs to Get It Right

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Adjustment is the process of updating accounting records so that income and expenses are recognized in the correct accounting period. Businesses typically record adjustment entries at the end of each accounting period to comply with accrual accounting principles. The five primary adjustment types are accrued revenue, accrued expenses, prepaid expenses, deferred revenue, and depreciation.

A business records a sale during March but gets the payment in April. The rent is paid for the whole year in advance in January. The loan is raised in February and earns interest every month; however, the first EMI payment is to be made at the end of each month. In none of these cases will the correct figures appear in the company’s balance sheet without adjustment.

As far as business owners keeping track of accounting for themselves or with the help of a professional accountant, there is a fundamental difference between knowing what an adjusting entry is and not having that knowledge. This knowledge can make the difference between proper and improper accounting entries. The sections below break down the types of adjustments, how they work, and where they show up in everyday business finance.

What Is Adjustment in Accounting?

An adjustment in accounting is the process of modifying financial records to ensure that income, expenses, assets, and liabilities are recognised in the correct accounting period. These modifications are recorded through adjusting journal entries, allowing financial statements to accurately reflect the business’s actual financial performance rather than simply its cash transactions.

Adjustments are a fundamental part of accrual accounting, where transactions are recognised when they are earned or incurred, regardless of when payment is received or made. This approach provides a more accurate representation of a company’s profitability and financial position than cash-based accounting.

Businesses typically record adjustment entries at the end of every accounting period-monthly, quarterly, or annually – before preparing financial statements such as the income statement and balance sheet.

Why Are Adjustments Necessary in Accounting?

Financial transactions don’t always occur in a single step. A business may earn revenue before issuing an invoice, receive customer payments before delivering a service, or pay expenses that benefit multiple future periods.

If these timing differences aren’t adjusted, financial statements can become misleading.

Adjustments help businesses:

Match revenue with the period in which it is earned.
Record expenses when they are incurred rather than when they are paid.
Present accurate balances for assets and liabilities.
Prepare reliable financial statements for lenders, investors, auditors, and management.
Calculate taxable income more accurately and support regulatory compliance.

For example, if a company prepays an annual insurance premium of ₹1,20,000 in April, recording the entire amount as an expense immediately would understate profits for April and overstate expenses. Instead, an adjustment allocates ₹10,000 as an expense each month over the policy period, providing a more accurate view of business performance.

Also read: What is Trading and Profit & Loss Account and How to Prepare It?

How Do Adjustment Entries Work?

Adjustment entries are recorded at the end of an accounting period to account for transactions that have occurred but have not yet been fully recorded in the books.

The process typically involves four simple steps:

Review all accounts before closing the books.
Identify transactions that require adjustments because of timing differences.
Record the appropriate adjusting journal entries.
Prepare the final financial statements using the updated balances.

This ensures that the income statement, balance sheet, and related financial reports present an accurate view of the business’s financial health.

Example of an Adjustment

A consulting firm completes a project worth ₹50,000 on 30 March, but invoices the client on 5 April.

Without an adjustment:

March revenue appears lower than it actually is.
April revenue appears higher.
Financial statements become inaccurate.

With an adjusting entry:

Revenue of ₹50,000 is recognised in March.
Accounts Receivable is created until payment is received in April.

This adjustment follows the accrual accounting principle, ensuring that revenue is recognised when it is earned rather than when cash is collected.

Also read: What is Trial Balance? Format, Types, Example & Preparation Steps

Types of Adjustment Entries Every Business Should Know

Adjusting entries generally fall into five recognised categories. Each one corrects a specific timing mismatch between when a transaction is recorded and when cash actually moves.

Type of Adjustment	What It Corrects	Example
Accrued Revenue	Income earned but not yet billed or received	Services delivered in March, invoiced in April
Accrued Expenses	Costs incurred but not yet paid	Salaries for the last week of March, paid in April
Prepaid Expenses	Payments made in advance for future periods	Annual insurance premium paid upfront
Deferred Revenue	Payment received before goods or services are delivered	Advance payment for a subscription
Depreciation	Allocation of asset cost over its useful life	Office equipment expensed over 5 years

A closer look at each:

Accrued revenue is entered as revenue because it represents revenue earned during the accounting period but has not yet been billed or cash collected from the customer.

Accrued expense is the reverse. In other words, an expense is recorded for the period it was incurred, despite any subsequent invoices being received. Utility charges, salaries, and loan interest are examples of accrued expenses.

Prepaid expenses must be allocated across multiple accounting periods to reflect the true benefit from the expense payment made once at the beginning. For example, insurance covering a year’s worth of coverage is paid out in April.

Deferred revenue occurs in situations where the consumer pays for something before he or she receives it. The revenue is held on the books as liabilities until the item is delivered, after which time it is recorded as revenue.

Depreciation allocates the cost of a fixed asset, such as machinery or computers, across its useful life rather than expensing the full purchase cost in the year of purchase.

How Adjustment Entries Affect Financial Statements

Every adjustment entry directly influences the accuracy of a company’s financial statements. Without these adjustments, revenues, expenses, assets, and liabilities may be recorded in the wrong accounting period, resulting in misleading financial reports.

Whether you’re preparing monthly accounts, filing taxes, or presenting financial statements to investors, accurate adjustments ensure your books reflect the true financial position of the business.

Below is how adjustment entries affect different aspects of financial reporting.

Impact on the Income Statement: Adjusting entries affect revenue and expenses during the year, thus influencing the net gain or loss
Impact on the Balance Sheet: Entries for accrued items give rise to liabilities/receivables, while those for prepaid items generate assets
Tax impact: Profit figures used for tax computation depend on correctly adjusted income and expenses, not just cash movements
Investor and lender impact: Financial statements shared with banks or investors for loan approvals or funding rounds need adjustments reflected accurately to avoid misrepresenting business performance

Note: A business that skips adjustments might show a healthy cash balance while actually carrying unrecorded liabilities, creating a false sense of financial stability.

Adjustment in Payments and Transaction Processing

The term adjustment is not limited to accounting. It is also widely used in payment processing, where transaction values may change after the original payment has been authorised or settled.

For businesses accepting digital payments, these adjustments play an important role in payment reconciliation and settlement reporting.

Unlike accounting adjustments, which align revenues and expenses with the correct accounting period, payment adjustments correct or modify settlement amounts after payment processing.

Common payment-related adjustments include:

Refund adjustments: When a customer-initiated refund is processed, the settlement amount for that batch gets adjusted downward
Fee corrections: If a transaction was charged an incorrect processing fee, a subsequent adjustment corrects the merchant’s settlement
Chargeback adjustments: Disputed transactions that get reversed appear as adjustments against future settlements
Currency conversion adjustments: For cross-border transactions, exchange rate differences between the transaction date and settlement date may require an adjustment entry

Adjustment vs Correction: What Is the Difference

While business proprietors might often find themselves using the concepts of adjustment and correction as synonyms, this is actually not the case in accounting practices.

Adjustment: An intentional, systematic journal entry that is done in order to match revenue or expenditures with the appropriate accounting period according to accruals accounting rules.
Correction: A one-time fix for an error, a wrong amount entered, a transaction recorded twice, or a misclassified expense

Adjustments are expected and built into the closing process of every accounting period. Corrections happen only when something went wrong and needs to be fixed retroactively, sometimes requiring a restatement of prior financial statements.

Common Mistakes Businesses Make With Adjustments

These are the common mistakes that happen when adjustment entries are not made or done incorrectly:

Not accruing the expense for the last month of the year: The company pays salaries on the 5th day of the following month, yet it does not make an adjusting entry for the last month of the previous year, causing expenses to be understated while profits are overstated.
Recording all prepaid expenses as expenses when incurred: Buying a year’s subscription to software and making a single adjusting entry that charges all the costs as expenses for that month.
Ignoring depreciation on fixed assets: This happens in small companies since the accounting process is manual, thus failing to update fixed assets.
Mixing up payment adjustments with accounting adjustments: Treating a payment gateway settlement adjustment as if it were an accounting correction, leading to reconciliation mismatches between bank statements and books.

Conclusion

Adjustments in accounting are made to ensure that the financial statements record reality during a particular period rather than merely reflecting cash flows. There are mainly five types: accrued revenues, accrued expenses, prepaid expenses, deferred revenues, and depreciation. In payment processing, adjustments are made differently, depending on various scenarios such as refunds, fees adjustment, or settlement adjustments.

Being able to do adjustments accurately ensures that the company’s financial statements remain true and accurate and that tax filing processes are done correctly. It also ensures proper reconciliation between records and bank account statements. Cashfree payments provides settlement reports for their users to keep track of any payment adjustments.

Get started with Cashfree to bring more clarity to your payment reconciliation process!

FAQs

1. What is adjustment in accounting?

An adjustment in accounting is the process of updating financial records so that income, expenses, assets, and liabilities are recognised in the correct accounting period. Businesses record adjustment entries before preparing financial statements to ensure they accurately reflect financial performance.

2. Why are adjustment entries important?

Adjustment entries ensure that revenues and expenses are recorded in the period in which they are earned or incurred. This improves the accuracy of financial statements, supports tax compliance, and helps businesses make informed financial decisions.

3. What are the five common types of adjustment entries?

The five major types of adjustment entries are:

Accrued revenue
Accrued expenses
Prepaid expenses
Deferred revenue
Depreciation

Each type addresses a different timing difference between accounting records and cash movement.

4. When should businesses record adjustment entries?

Businesses generally record adjustment entries at the end of every accounting period—monthly, quarterly, or annually—before preparing financial statements. Regular adjustments help maintain accurate books throughout the year.

5. What is the difference between an adjustment and a correction?

An adjustment is a planned accounting entry that aligns revenues and expenses with the appropriate accounting period. A correction fixes an accounting error, such as an incorrect amount, duplicate transaction, or wrong account classification.

6. Do adjustment entries affect cash flow?

No. Adjustment entries mainly affect accounting records and financial statements rather than the actual movement of cash. However, they influence reported profits, assets, liabilities, and equity.

7. What happens if adjustment entries are not recorded?

If businesses fail to record necessary adjustments, they may experience:

Incorrect profit or loss reporting.
Inaccurate tax calculations.
Misstated assets and liabilities.
Reconciliation issues.
Misleading financial statements.

These inaccuracies can affect business decisions and regulatory compliance.

8. How are payment adjustments different from accounting adjustments?

Accounting adjustments ensure financial transactions are recorded in the correct accounting period. Payment adjustments relate to transaction processing and settlement activities such as refunds, chargebacks, fee corrections, settlement revisions, or currency conversion differences.

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