What is an adjusting entry and why is it necessary at period end?

• A. It records only cash transactions
• B. An adjusting entry updates account balances to reflect accrued or deferred items so financial statements are accurate.
• C. It closes temporary accounts
• D. It computes depreciation

Answer: (B)

Adjusting entries are made at the end of a period to bring the accounts up to date so the financial statements reflect what actually happened during that period. They ensure revenues and expenses are recorded in the period they are earned or incurred, not just when cash changes hands, which is essential for accrual accounting and the matching principle.

These entries typically address items that aren’t captured by routine daily transactions, such as revenues earned but not yet billed, expenses incurred but not yet paid, or costs that have to be allocated over multiple periods. Common examples include recognizing accrued revenues, recording accrued expenses, adjusting prepaid expenses to show the portion actually used, and recognizing depreciation for assets over their useful life. Depreciation is a classic adjusting entry because it spreads the cost of a tangible asset over the periods that benefit from its use, affecting both the expense on the income statement and the accumulated depreciation on the balance sheet.

Why it’s needed at period end is straightforward: it ensures the income statement shows the true profitability for the period by matching revenues with the expenses that generated them, and the balance sheet shows accurate asset and liability balances. Without these adjustments, financial statements could misstate earnings and resource levels.

The other ideas don’t fully capture why adjusting entries are made. They aren’t limited to recording only cash transactions, they aren’t the step that closes temporary accounts, and depreciation, while a common example, is just one type of adjustment aimed at aligning items with the correct period.