Why do we need to make adjusting entries? Some business transactions may start and end in the same accounting period; however, many other transactions begin in one accounting period but are completed in another. When this happens, it is important to make an adjusting entry at the end of the accounting period to determine the appropriate amount of revenues and expenses that are applicable to the current accounting period. In short, adjusting entries
Therefore, an income statement and balance sheet will properly contain the actual amounts of each and will accurately reflect net income, assets, liabilities, and equity.
Example : If the business pays $1,200 in cash to purchase a one-year insurance policy, the cost of the insurance policy in this transaction would be recorded as an asset (prepaid insurance) by debiting prepaid insurance and crediting cash. At the end of each month, an adjustment would be made by transferring one month's expired insurance to an expense account and reducing the amount in the prepaid insurance account. The company has used one month of insurance.