It is necessary to record adjusting entries in the preparation of final accounts because the process of determining income and financial position is based on the accrual basis of accounting. This basis emphasises that while ascertaining profitability, revenues must be considered on an earned basis (not receipt basis) and expenses on an incurred basis (not paid basis).

Many items need adjustment such as outstanding expenses, prepaid expenses, accrued income, income received in advance, depreciation, interest on capital, and other items not recorded on a day-to-day basis. The purpose of making these adjustments is to ensure that the final accounts reveal the true profit or loss and the true financial position of the business.