Adjusting & Closing Entries & Trial Balance Errors Explained in Depth | Complete Accounting Guide

Have you ever prepared a trial balance, felt satisfied seeing both sides tally, and then still been told that the accounts are incomplete? Or wondered why accountants bother recording expenses that haven’t been paid yet or incomes that haven’t been received? These questions trouble almost every accounting student at some point—and the answer lies in adjusting entries and closing entries.

Accounting is not just about recording cash movements. It is about identifying when income is earned and when expenses are incurred. This is exactly where many students lose marks in exams and clarity in practice. A trial balance may agree, yet profits may still be incorrect because adjustments are missing.

This article explains the complete logic of adjusting entries, closing entries, error rectification, and trial balance concepts using exam-oriented explanations and practical illustrations. The focus is on understanding why entries are passed and how they affect final accounts.

Before we dive in, watch this video for a complete breakdown:

Understanding Adjusting Entries – The Foundation of Accurate Accounts

Adjusting entries are passed at the end of the accounting period to ensure financial statements reflect the true performance of the business. These entries arise because accounting follows principles rather than cash timing.

Two fundamental principles govern adjustments:

• Accrual Basis of Accounting
• Matching Concept

Under accrual accounting, incomes and expenses are recorded when they are earned or incurred, not when cash is received or paid. Without adjusting entries, profits may be overstated or understated.

Outstanding Expenses – Expenses Incurred but Not Paid

Outstanding expenses are expenses that have been incurred during the accounting period but have not yet been paid.

• Outstanding salaries
• Unpaid electricity bills
• Rent due but unpaid

If employees worked in March but salaries are paid in April, the expense still belongs to March. Hence, it must be recorded in the current year.

Effect:

• Expense increases
• Liability is created

Prepaid Expenses – Paid Now, Used Later

Prepaid expenses occur when payment is made in advance, but the benefit relates to future periods.

• Advance rent
• Insurance premium paid in advance

Only the portion related to the current year should be charged as an expense.

Accounting Impact:

• Expense decreases
• Asset is created

Accrued Income – Earned but Not Received

Accrued income refers to income earned during the accounting period but not yet received.

• Interest accrued on deposits
• Rent due from tenants

Income is recognized when earned, ensuring correct profit measurement and proper recognition of receivables.

Income Received in Advance – Cash Without Earning

Income received in advance arises when money is received before providing goods or services.

• Advance rent received
• Subscription received for future services

Such receipts are liabilities and should not be treated as income of the current period.

Why Adjusting Entries Are Non-Negotiable

Failure to pass adjusting entries results in:

• Incorrect profit or loss
• Misstated assets and liabilities
• Wrong financial decisions

This is why adjusting entries are frequently tested in examinations through MCQs and numerical problems.

Closing Entries – Clearing the Path for the Next Year

Closing entries are passed after adjustments to close income and expense accounts and transfer their balances to Trading and Profit & Loss Account.

They ensure that income and expense accounts start with zero balance in the next accounting period, preventing accumulation of results across years.

Errors in Accounting – Why Trial Balance May Still Tally

A tallied trial balance does not guarantee error-free accounts. Certain errors do not affect trial balance agreement.

• Error of Commission
• Error of Omission
• Error of Principle
• Compensating Error

Compensating errors cancel each other’s effect, making trial balance appear correct despite incorrect accounts.

JAIIB Exam | Advance Financial Management | Chapter 24 | Module C [FREE EPDF]

Trial Balance Systems – Gross vs Net

There are two systems of trial balance preparation:

• Gross Trial Balance System: Totals of debit and credit sides are taken
• Net Trial Balance System: Net balance of each ledger account is taken

Common Trial Balance Confusions Clarified

• Purchases appear on the debit side
• Sales appear on the credit side
• Fixed deposits are shown on the debit side
• Bank overdraft appears on the credit side
• Closing stock does not appear unless adjusted

Suspense Account – The Temporary Solution

When errors are discovered after preparing the trial balance, a suspense account is opened to temporarily balance the books.

• Used for one-sided errors
• Temporary in nature
• Eliminated after rectification

Conclusion

Adjusting entries and closing entries form the backbone of accurate accounting. They ensure profits, assets, and liabilities are correctly stated. This article has explained the logic behind adjustments, error rectification, trial balance systems, and suspense accounts in a structured manner.

To master accounting, focus on understanding principles, identifying account nature, and applying logic consistently. Revisit the video, practice similar questions, and engage actively by sharing doubts and answers to strengthen your accounting fundamentals.