Final answer:
Adjusting journal entries ensure financial statements are accurate and include deferrals, accruals, and estimates. They help in recognizing revenue and expenses in the correct accounting period, in line with the accrual accounting principles.
Step-by-step explanation:
Adjusting journal entries are necessary for three situations: deferrals, accruals, and estimates. Adjusting entries are a key part of the accrual accounting system and are used to recognize revenue and expenses in the correct accounting period. These adjustments ensure that the financial statements present a company's financial position and results of operations accurately.
There are three main types of adjusting entries:
- Deferrals: These are adjustments for payment or receipt of money in advance for services or products to be provided in the future. It helps in matching revenues with expenses in the period in which they are incurred.
- Accruals: These entries involve revenues that have been earned or expenses that have been incurred but haven't been recorded yet. Accruals ensure that income statements reflect the revenues earned and expenses incurred during the period.
- Estimates: This third type involves adjusting for items that are a matter of judgment or estimate, such as depreciation or bad debts. This is where a company will record expenses or revenues that are anticipated, based on reasonable estimates.
Each of these adjusting entry types is crucial for keeping accounting records up to date and for ensuring that the financial statements are accurate and comply with the generally accepted accounting principles (GAAP).