Which statement about the purpose of adjusting entries is true?

• A. Adjusting entries ensure revenues and expenses are recorded in the period they are earned or incurred
• B. Adjusting entries are optional and can be omitted without affecting financial statements
• C. Adjusting entries only affect cash accounts
• D. Adjusting entries are recorded after closing the books

Answer: (A)

Adjusting entries keep the books in line with accrual accounting by recognizing revenues and expenses in the period they relate to. Some activities span multiple periods, so without these entries the period’s income would be misstated and assets or liabilities would not reflect current amounts. The process uses deferrals and accruals to bring accounts up to date. For example, revenue that has been earned but not yet billed is recorded by increasing accounts receivable and revenue; an expense that has been incurred but not yet paid is recorded by increasing an expense and a payable. These entries affect both the income statement and the balance sheet, not just cash. They are done before the financial statements are prepared and before closing, so profits and the financial position accurately reflect the period just ended. They aren’t optional, and they don’t concern only cash amounts—the goal is to match revenues to the expenses incurred in the same period.