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What is the importance of adjusting entries in accounting?

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Quick Answer

Companies use adjustment entries to align expenses and revenues to the accounting period where they occurred. The process ensures that all income, expense, asset and liability accounts reflect their true values when reported in financial statements and that the reported results closely align with the requirements of an accounting framework such as IFRS or GAAP.

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Full Answer

Adjusting entries of the closing stock determine the correct value of gross profit and the cost of goods sold. These entries enable businesses to calculate the actual profit or loss made within a given accounting period.

Adjusting entries reduces errors in income and expenditure records, making the records more accurate. The entries enable companies to settle the accrued financial transactions by determining unpaid income as well as expenses incurred but not yet paid. They indicate the correct amount payable to third parties and capture any income and expense information not entered in the accrual system.

Adjusting entries for the depreciation of fixed assets enables companies to determine the correct value of the assets as well as the net profit and financial position of the company for the specified period of the year. The entries are also important in updating financial statements as they help organizations to eliminate obsolete inventory and adjust cash balances for any items noted in the bank reconciliation.

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