What is an adjusting entry?

An adjusting entry is a crucial aspect of the accounting process that ensures the financial statements reflect the accurate financial position of a business for a specific accounting period. It serves to allocate income and expenses to their appropriate periods according to the accrual accounting principle, which dictates that revenues and expenses should be recognized when they are earned or incurred rather than when cash is exchanged.

By making adjusting entries, businesses can align their financial records with the actual performance and condition of the entity over time. This typically involves adjusting entries for accrued items, such as unrecorded revenues earned that have not yet been received in cash or expenses incurred that have not been paid in cash.

As a result, selecting the first option captures the essence of what adjusting entries accomplish in the accounting cycle, emphasizing their vital role in ensuring that financial statements provide a true and fair view of a company's financial activity for each reporting period.