Welcome back! Last time we learned how the accounting cycle transforms transactions into financial statements. But there's a crucial step we need to explore deeper.

Sometimes what actually happens in business doesn't match when cash changes hands!

Engagement Message

Can you think of a situation where you might owe money before actually paying it?

Here's the key insight: businesses often provide services or incur expenses before cash is exchanged. This creates a timing problem.

Your financial records might not reflect economic reality at month-end without some adjustments.

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Why do you think timing differences between economic events and cash flow matter?

Let's see a simple example. Say you provide consulting services in December, but your client won't pay until January.

Did you earn that revenue in December or January? The answer: December, when you did the work!

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Should that consulting revenue be reported on the December or January financial statements?

Here's another example: You use electricity all month, but the bill doesn't arrive until the next month.

You definitely used electricity this month - that's a real expense that happened, even without the bill.

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Should this electricity expense appear on this month's financial statements?

This is where adjusting entries come to the rescue! These special journal entries capture economic events that happened but weren't recorded yet.

They ensure your financial statements show what actually occurred during the period.

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In your own words, what do adjusting entries help us capture?