Chapter 11 — The Trial Balance and Adjusting Entries

Chapter 11 — The Trial Balance and Adjusting Entries

By now you’ve recorded months of transactions: invoices, bills, payroll, deposits, payments. Before those records can become financial statements, they need two things: proof that the books are mathematically sound, and corrections for the things daily recording doesn’t capture. The trial balance provides the proof; adjusting entries provide the corrections.

What the trial balance proves

The trial balance is simply a list of every account in your chart of accounts with its current debit or credit balance, totaled in two columns. If total debits equal total credits, the books are in balance.

Imagine a consulting business’s trial balance showing $70,700 in debits versus $76,100 in credits — out of balance by $5,400. That means an entry error exists: a transaction recorded on only one side, a transposed number, or an account balance pulled incorrectly. The trial balance just did its job — it proved something is wrong before the error could infect the financial statements. A bookkeeper would hunt the $5,400: check for a $2,700 entry recorded once instead of twice (5,400 ÷ 2 = 2,700), or scan for transpositions.

What the trial balance does NOT prove: that every transaction was recorded (a forgotten invoice doesn’t disturb the balance), that amounts are correct ($540 recorded as $450 on both sides still balances), or that accounts were classified properly. The trial balance proves the math, not the truth — the truth comes from reconciliation, review, and the adjustments below.

Why adjusting entries exist

Daily bookkeeping records transactions when cash moves or documents arrive. But business reality doesn’t always line up with cash movement. Adjusting entries fix four kinds of mismatch, typically at month-end or year-end.

1. Prepaid expenses: paid now, used later. You pay $2,400 for a year of liability insurance in January. That’s not a $2,400 January expense — it’s an asset (Prepaid Insurance) representing twelve months of coverage. Each month, one twelfth becomes expense: debit Insurance Expense $200, credit Prepaid Insurance $200. Without the adjustment, January looks $2,200 poorer than it is and the other eleven months look $200 richer. Common prepaids: insurance, rent paid in advance, annual software subscriptions, prepaid advertising.

2. Unearned revenue: collected now, earned later. A client pays you $4,000 in advance for a three-month project. On receipt day, that’s not income — it’s a liability (Unearned Revenue), because you owe the work. Each month as you perform the work: debit Unearned Revenue, credit Service Income. Without the adjustment, the receipt month looks wildly profitable, and your balance sheet hides a real obligation — money you’d have to refund if you didn’t deliver.

3. Accrued expenses: incurred now, paid later. Your employees earn wages through the 31st, but payday isn’t until the 5th of next month. Those wages belong to this month’s expenses. The adjusting entry: debit Wage Expense, credit Wages Payable, for the amount earned but not yet paid. Same logic for interest accumulating between loan payments and utilities used but not yet billed. Accruals keep each period’s profit honest instead of letting expenses slide into whichever month the check clears.

4. Depreciation: the gradual expense. Each period, debit Depreciation Expense and credit Accumulated Depreciation for the period’s share of each fixed asset’s cost. Nobody writes a check for depreciation — it’s the quintessential adjusting entry, converting an asset’s cost into expense a slice at a time.

The adjusted trial balance and what comes next

After posting all adjusting entries, you run the trial balance again — now the adjusted trial balance. If it balances (and the adjustments were correct), your books reflect economic reality, not just cash movement. It’s the direct source for the financial statements: income and expense accounts flow to the profit & loss statement; asset, liability, and equity accounts flow to the balance sheet.

In a small business, the bookkeeper usually proposes the recurring adjustments (depreciation schedules, prepaid amortization, standard accruals) and the CPA reviews or books the trickier ones at year-end. What’s essential is that someone does them, every period, before the statements go out.

An example, finished

Back to the consulting business out of balance by $5,400. The bookkeeper finds the error: a $2,700 equipment purchase recorded only as a debit to Equipment, with the credit to Cash never entered. She records the missing credit, and the trial balance now balances at $76,100 each side.

Then four month-end adjustments:

• Prepaid insurance: one month of the $2,400 policy used — debit Insurance Expense $200, credit Prepaid Insurance $200.
• Unearned revenue: $1,000 of the $4,000 advance now earned — debit Unearned Revenue $1,000, credit Service Income $1,000.
• Accrued wages: $1,500 earned in the last three days of the month — debit Wage Expense $1,500, credit Wages Payable $1,500.
• Depreciation: one month’s share is $200 — debit Depreciation Expense $200, credit Accumulated Depreciation $200.

Each entry balances on its own, so the trial balance stays balanced — now at $79,000 each side. And the picture is truer: income is $1,000 higher (work actually performed), expenses are $1,900 higher (insurance used, wages earned, equipment wearing out), and the balance sheet shows the real obligations.

Reversing entries: a handy shortcut

Many bookkeepers use reversing entries — automatic entries dated the first day of the next month that exactly undo the accrual. That $1,500 accrued wage entry? On the 1st of next month, an automatic reversal credits Wage Expense $1,500 and debits Wages Payable $1,500. When payroll is paid on the 5th, the payroll entry debits Wage Expense for the full amount — and the reversal has already cleared last month’s accrual, so nothing is double-counted. If your software supports automatic reversing entries, use them.

How often to adjust

Monthly: if you produce monthly statements and make decisions from them — which this book recommends — post the monthly adjustments: depreciation, prepaid amortization, wage and interest accruals. Quarterly: the minimum for any business filing quarterly estimated taxes or reporting to a lender. At the very least, adjust before any report leaves the building. Annually: the absolute floor — even the simplest business needs year-end adjustments before the tax return.

Key takeaways

• The trial balance lists every account’s balance; equal debit and credit totals prove the math is sound — not that every transaction is correct or complete.
• Adjusting entries fix timing mismatches: prepaid expenses (paid now, used later), unearned revenue (collected now, earned later), accrued expenses (incurred now, paid later), and depreciation.
• Each adjustment enforces the matching principle: income and expenses belong in the period they were earned or incurred.
• The adjusted trial balance is the source document for the financial statements.
• Have adjustments done every period before relying on any report; let the CPA handle the complex year-end ones.