Between the trial balance export from the accounting system and the final tax return, adjustments happen. Some are corrections for bookkeeping errors. Others align book accounting with tax requirements. Some reclassify transactions to match tax form line items.
These adjustments are predictable. The same types of adjustments recur across clients and tax seasons. Knowing what to look for speeds up trial balance preparation and reduces the chance of missing necessary corrections.
This guide covers the most common adjusting entries CPAs make before tax filing, why they're necessary, and how to identify when each adjustment is needed.
Depreciation Adjustments
Book depreciation and tax depreciation are rarely the same. Bookkeepers typically use straight-line depreciation over estimated useful life for financial statements. Tax depreciation uses MACRS, bonus depreciation, and Section 179, which produce different amounts.
When This Adjustment Is Needed
Check for depreciation adjustments when:
• The trial balance shows depreciation expense that doesn't match your prior-year depreciation schedule
• New assets were purchased during the year
• Bonus depreciation or Section 179 elections will be made
• The client uses book depreciation for financial reporting
How to Calculate the Adjustment
Compare book depreciation expense (from trial balance) to tax depreciation (from depreciation software or schedule):
• If tax depreciation is higher: Debit depreciation expense, credit accumulated depreciation (or use a tax depreciation adjustment account)
• If tax depreciation is lower: Credit depreciation expense, debit accumulated depreciation
The adjustment brings the trial balance depreciation to the amount that will be claimed on the tax return.
Meals and Entertainment Reclassification
Meals incurred during business activities get 50% limitation for tax purposes (100% for 2021-2022 under temporary rules). But bookkeepers often code meals into general travel expense, business expense, or other categories where the limitation doesn't get applied.
When This Adjustment Is Needed
Review travel and entertainment accounts for meal expenses that need separation:
• Travel expense account contains hotel, airfare, and meals combined
• Client meetings or entertainment expenses include meals
• Office expense includes meals provided to employees
• Vehicle expense includes meals during travel
How to Calculate the Adjustment
Review expense detail (receipts, transaction descriptions, amounts) to identify meal expenses. Typical indicators:
• Restaurant charges
• Food delivery services
• Grocery store charges for business meals
• Per diem amounts that include meals
Reclassify identified meal amounts:
Debit: Meals and Entertainment
Credit: Travel Expense (or other source account)
Loan Principal vs Interest Separation
Bookkeepers sometimes record entire loan payments as interest expense, or code principal payments to interest. Only the interest portion is deductible. Principal payments reduce the loan liability.
When This Adjustment Is Needed
Check loan accounts when:
• Interest expense seems unusually high relative to loan balance
• Loan liability balance hasn't decreased during the year despite payments
• Total loan payments exceed interest expense by a large amount
How to Calculate the Adjustment
Obtain loan statements or amortization schedules showing principal and interest breakdown for each payment. Calculate total principal and total interest for the year.
Compare to what's recorded:
• If principal was expensed: Credit interest expense, debit loan payable
• If interest is overstated: Credit interest expense, debit loan payable or other appropriate account
Personal Expense Removal
Business clients, particularly sole proprietors and single-member LLCs, often run personal expenses through business accounts. These need to be removed from business expenses and reclassified as owner draws or distributions.
When This Adjustment Is Needed
Watch for personal expenses in:
• Vehicle expense (personal mileage)
• Utilities (residential utilities)
• Insurance (personal insurance premiums)
• Travel (personal trips)
• General expenses (personal purchases)
How to Calculate the Adjustment
Identify personal amounts through:
• Transaction review
• Discussion with client about mixed-use assets
• Comparison to prior-year business/personal split
Reclassify personal portions:
Debit: Owner Draw (sole prop/partnership) or Distribution (S corp/C corp)
Credit: Expense account (wherever personal expense was recorded)
Prepaid Expense Allocation
When expenses are paid for periods extending beyond year-end, the unused portion should be recorded as a prepaid asset, not fully expensed in the current year.
When This Adjustment Is Needed
Common prepaid expenses:
• Insurance premiums covering multiple years or extending into next year
• Rent paid in advance
• Service contracts or subscriptions spanning year-end
• Maintenance agreements
How to Calculate the Adjustment
Determine the period covered by the payment and the portion applicable to the next year:
Example: $12,000 insurance premium paid November 1 for 12 months coverage. Two months apply to current year (Nov-Dec), 10 months to next year.
Adjustment:
Debit: Prepaid Insurance (asset) $10,000
Credit: Insurance Expense $10,000
Accrued Expense Recognition
Expenses incurred but not yet paid or recorded need to be accrued to match them to the correct tax year.
When This Adjustment Is Needed
Common accrued expenses:
• Utilities used but not yet billed
• Credit card charges not yet reflected in accounting system
• Payroll for final pay period of year not processed until next year
• Property taxes assessed but not yet paid
• Professional fees for work done but not yet invoiced
How to Calculate the Adjustment
Estimate the amount owed based on:
• Prior invoices for recurring expenses
• Proration of known annual amounts
• Payroll records showing unpaid wages
Adjustment:
Debit: Expense account
Credit: Accrued expenses payable (liability)
Inventory Adjustments
Businesses that maintain inventory need cost of goods sold to reflect actual inventory used, not just purchases. Beginning inventory plus purchases minus ending inventory equals cost of goods sold.
When This Adjustment Is Needed
Inventory adjustments are required when:
• Physical inventory count differs from book inventory
• Purchases were fully expensed instead of capitalized to inventory
• Ending inventory for tax needs to differ from book inventory
How to Calculate the Adjustment
Based on physical inventory count or inventory records:
If ending inventory is higher than recorded:
Debit: Inventory (asset)
Credit: Cost of goods sold
If ending inventory is lower:
Debit: Cost of goods sold
Credit: Inventory (asset)
Fixed Asset vs Repair Expense Classification
Bookkeepers sometimes expense items that should be capitalized as fixed assets, or capitalize items that should be expensed as repairs. Tax treatment depends on correct classification.
When This Adjustment Is Needed
Review repairs and maintenance expense for:
• Large expenditures (generally over $2,500 or your firm's capitalization threshold)
• Improvements that extend asset life
• Additions or betterments to existing assets
Review fixed asset additions for:
• Routine repairs incorrectly capitalized
• Small tools or supplies that should be expensed
How to Calculate the Adjustment
Determine correct classification based on:
• Amount
• Nature of expenditure (repair vs improvement)
• IRS capitalization rules and safe harbors
If repair was capitalized:
Debit: Repairs expense
Credit: Fixed assets
If asset should have been expensed:
Debit: Repairs or appropriate expense
Credit: Fixed assets
Owner Health Insurance (S Corporations)
S corporation shareholders owning more than 2% cannot receive health insurance as a tax-free fringe benefit. It must be included in W-2 wages and then deducted on the shareholder's personal return.
When This Adjustment Is Needed
Check for this adjustment when:
• S corporation paid health insurance for shareholders
• Insurance was recorded as general employee benefits
• Shareholder W-2 doesn't include health insurance premiums
How to Calculate the Adjustment
Identify health insurance premiums paid for greater-than-2% shareholders. These need to be:
• Reclassified from employee benefits to officer compensation
• Added to shareholder W-2 wages (not done via adjusting entry, but noted for W-2 correction or next year)
Trial balance adjustment:
Debit: Officer compensation
Credit: Employee benefits expense
State Tax Deduction Timing
State income taxes can only be deducted in the year paid (cash basis) or accrued (accrual basis). Bookkeepers sometimes deduct estimated tax payments in the wrong year.
When This Adjustment Is Needed
Review state tax expense when:
• Final payment for prior year was made in current year
• Estimated payments for current year were made in December
• State tax refunds were received
How to Calculate the Adjustment
Match state tax payments to the tax year they apply to:
• Cash basis: Deduct in year paid regardless of which tax year the payment applies to
• Accrual basis: Accrue tax liability at year-end for amount owed but not yet paid
Adjust trial balance to match the method used.
Creating an Adjustment Checklist
To ensure you don't miss common adjustments, create a checklist for trial balance review:
□ Compare depreciation expense to tax depreciation schedule
□ Review travel and entertainment for meals needing reclassification
□ Verify loan payments split correctly between principal and interest
□ Scan expense accounts for personal expenses
□ Check for prepaid expenses extending past year-end
□ Identify expenses incurred but not recorded (accruals)
□ Verify inventory balance matches physical count or records
□ Review repairs expense for items that should be capitalized
□ Review fixed asset additions for items that should be expensed
□ Check S corp shareholder health insurance treatment
□ Verify state tax deduction timing
□ Compare to prior-year adjustments (same issues often recur)
Automate Common Adjusting Entries
If you're making the same types of adjustments for most clients every year, Ledger IQ can automate the detection and suggestion of these entries. The software flags common issues, suggests adjusting entries with calculated amounts, and learns your firm's adjustment patterns. This reduces the time spent on manual trial balance review and ensures adjustments are applied consistently across all clients.