Final answer:
Adjusting entries are essential in accrual accounting to ensure the proper matching of revenue and expense within the correct accounting period, to present a truthful balance sheet, and to adjust assets and liabilities. Although adjusting to fair market value is less common, the main focus is on reflecting economic events that have taken place but are not yet recorded in the financial statements.
Step-by-step explanation:
Adjusting entries are a fundamental part of accrual accounting and are necessary for several reasons:
- To obtain a proper matching of revenue and expense, which is central to the accrual accounting concept. It ensures that revenues and expenses are recognized in the correct accounting period.
- To achieve an accurate statement of assets and equities, which refers to presenting a truthful picture of a company's financial condition. These are represented in the balance sheet, an accounting tool that lists assets and liabilities.
- To adjust assets and liabilities to their fair market value, though this is typically not the main purpose of adjusting entries. Adjusting entries are more concerned with recording the economic events that have occurred but haven't been properly recognized in the financial statements.
Regarding the specific terms, here is a brief explanation:
- Asset: An item of value that a firm or an individual owns.
- Asset-liability time mismatch: A situation where customers can withdraw a bank's liabilities in the short term while customers repay its assets over the long term.
- Bank capital: A bank's net worth, calculated as assets minus liabilities.
- Barter: Trading one good or service for another without using money.
- Coins and currency in circulation: The coins and bills in an economy that are not held by the U.S. Treasury, Federal Reserve Bank, or in bank vaults.