Fundamentals of Accountancy, Business, and Management (FABM) 2 Practice Exam

Adjusting entries are end-of-period journal entries used to record revenues earned and expenses incurred in the period, even if cash hasn't yet moved. They align with accrual accounting, ensuring the revenue recognition and matching principles are satisfied so the income statement and balance sheet show the true economic activity for that period.

In practice, adjusting entries handle items that are not captured by the day-to-day cash transactions: accrued revenues (cash coming later for services already performed), accrued expenses (expenses incurred but not yet paid), deferred (prepaid) revenues or expenses (money received or paid before the earning or usage occurs), and depreciation of fixed assets. For example, interest earned but not yet billed, wages earned by employees but not yet paid, or prepaid insurance that has now expired all require adjustments. These entries update assets, liabilities, revenues, and expenses to reflect the period they relate to, rather than when cash actually changes hands.

That description matches the idea of making entries at period end to record accrued and deferred items to reflect accurate revenues and expenses in the period. The other options describe activities outside this purpose: issuing new stock changes financing rather than adjusting operating accounts; recording only cash transactions ignores non-cash accruals; and adjusting for non-cash gains is too narrow and misses the broader aim of aligning all accruals and deferrals.