Question

Why do companies make adjusting entries?

Answer 1

Adjusting entries are prepared at the end of the accounting period in order to adjust the accounts for accrual of expenses and incomes etc.

For example, rent for one year is prepaid in the first month at $1,200 so cash is credited and prepaid rent is debited with $1,200 and at the end of the first month, the adjusting entry is required to be paid for the accrual of one month rent because the first month is over so the rent expense is debited with $100 ($1,200/12 months) and prepaid rent is credited with the same amount.

In this case, the adjusting entry is required to be paid to show the rent expense in the income statement of the first month and as per US GAAP (U.S Generally Accepted Accounting Principles), the books should be maintained based on the accrual basis so when the first month is over, the rent expense of $100 is accrued so it should be recorded through the adjusting entry.

It is one of the examples, as there are many instances to prepare the adjusting entries in order to have correct and accurate balances of accounts which are required to prepare the financial statements like Income statement, balance sheet etc.