In what way do adjusting entries improve the accuracy of financial statements?

Adjusting entries enhance the accuracy of financial statements primarily by ensuring that revenues and expenses are correctly matched to the period in which they are incurred or earned. This principle is fundamental to the accrual basis of accounting, which dictates that financial transactions should be recorded when they occur, regardless of when cash is exchanged.

When adjusting entries are made, they align revenues with the expenses that were incurred to generate them, allowing for a more realistic portrayal of a company's financial performance during a specific accounting period. For instance, if a company provides a service in December but does not receive payment until January, an adjusting entry would recognize that revenue in December, accurately reflecting the company's earnings for that month. Similarly, expenses incurred for services or goods received must be recorded in the same period to accurately represent the liabilities and expenses.

This matching of revenues and expenses helps prevent distortion in financial statements, providing stakeholders with a clear picture of the company's profitability and financial health, which is critical for decision-making.