Which of the Following Statements Regarding Adjusting Entries Is Correct?

Adjusting entries are a fundamental part of the accounting process, made at the end of an accounting period to ensure that financial statements are accurate and comply with the accrual basis of accounting. These entries help recognize revenues and expenses in the correct accounting period. Let’s explore the correct statement regarding adjusting entries.

Key Features of Adjusting Entries

1. Adjusting Entries Are Made at the End of the Accounting Period

• Correct: Adjusting entries are typically made at the end of an accounting period to update accounts before preparing financial statements. These entries ensure that revenues and expenses are recognized in the appropriate period, in line with accounting principles such as the matching principle.

2. Adjusting Entries Are Only Made for Revenue Accounts

• Incorrect: Adjusting entries are not limited to revenue accounts. They are made for both revenues and expenses. For example, accrued revenues (revenue earned but not yet billed) and accrued expenses (expenses incurred but not yet paid) both require adjusting entries.

3. Adjusting Entries Are Made Only When Errors Are Discovered

• Incorrect: Adjusting entries are not made to correct errors. They are made to ensure that all transactions that should have been recorded in the current period, but were not, are reflected in the financial statements. Errors are corrected separately, usually through journal entries.

4. Adjusting Entries Always Involve Cash

• Incorrect: Adjusting entries do not always involve cash. In fact, many adjusting entries relate to accrued revenues, accrued expenses, or prepaid expenses that do not involve cash transactions. For example, adjusting entries for depreciation or amortization don’t involve cash but affect the value of assets and expenses.

Conclusion

The correct statement about adjusting entries is that they are made at the end of the accounting period to ensure the accuracy of financial reporting and to comply with accrual accounting principles. These entries ensure that all necessary adjustments for revenues, expenses, and asset/liability balances are properly recorded.