Future Business Leaders of America (FBLA) Accounting Practice Test

What do adjusting entries typically affect in accounting?

1. Permanent accounts

2. Equity accounts

3. Liability accounts

4. Expense and revenue accounts

The correct answer is: Expense and revenue accounts

Adjusting entries are crucial in the accounting process, particularly because they ensure that financial statements present an accurate picture of a company's financial position at the end of an accounting period. These entries are primarily made to adjust the balances of revenue and expense accounts to adhere to the accrual basis of accounting. Under this system, revenues need to be recognized when they are earned, and expenses when they are incurred, regardless of when cash transactions occur. For instance, if services are provided in one accounting period but the payment is received in the next, an adjusting entry must be made to reflect the revenue in the period it was earned. Similarly, expenses that have been incurred but not yet recorded must also be adjusted to match the revenues they help generate. Thus, the role of adjusting entries is to align the revenue and expense accounts with the actual economic activities of the company during a reporting period. In contrast, permanent accounts—typically representing assets, liabilities, and equity—carry their balances over from one accounting period to the next without needing adjustments for the same reasons. Therefore, the focus on expense and revenue accounts highlights the essence of adjusting entries in presenting an accurate and complete view of financial performance over time.