Adjusting entries are made to recognize revenue as earned or expenses as incurred, even if no cash has changed hands yet. They do not always involve cash, as shown by the example of accruing interest on a loan for the month of March before the interest is actually paid in August. Adjusting entries may decrease balance sheet accounts like prepaid expenses while increasing income statement accounts like revenue or expenses. The only incorrect statement about adjusting entries is that they always involve cash.

1. Which of the following statements regarding adjusting entries is not correct?
1) Adjusting entries nearly always involve the cash account and either a revenue or expense
account.
2) Adjusting entries may reduce amounts on the balance sheet and increase corresponding
revenue or expense accounts on the income statement.
3) Adjusting entries may be used to recognize revenue as earned and expenses when incurred
prior to the receipt or payment of cash.
4) Adjusting entries are often made for interest revenue earned and interest expense incurred.
Solution
The answer is option (1)
Adjusting entries may not always involve cash. Suppose a loan was taken on February 1, and the
loan is repayable on August 1. The accounting year closes on 31st March. The actual interest will
be payable on August 1, but an adjusting entry will have to be made on 31st March for the
interest amount accrued for the month of March.
Here no cash account is involved, as it is accrual basis of accounting.