Meaning of the hadeeth which says that Allah created Adam in His Image
Question

I am asking about the correct understanding of the hadith, “Adam was created in the Image of the Most Merciful”?.
Praise be to Allah.It was narrated from Abu Hurayrah that the Prophet (peace and blessings of Allah be upon him) said: “Allah created Adam in His Image…” Narrated by al-Bukhari, 6227; Muslim, 2841. 
With regard to the hadith, “Do not (insult one another) and say ‘May Allah make your face ugly’, because Adam was created in the Image of the Most Merciful,” this was classed as da’eef (weak) by al-Albani in al-Silsilah al-Da’eefah, no. 1176. 
Perhaps the questioner is confused by this hadith because of the verse in which Allah says (interpretation of the meaning): 
“There is nothing like Him”
[al-Shoora 42:11]
The scholars answered this problem in two ways: a brief answer and a detailed answer. 
The brief answer is that it is impossible for this hadith to contradict the words of Allah (interpretation of the meaning): 
“There is nothing like Him”
[al-Shoora 42:11]
If we find a way to reconcile between them, all well and good, otherwise we should say, 
“ ‘We believe in it; the whole of it (clear and unclear Verses) are from our Lord.’ And none receive admonition except men of understanding”
[Aal ‘Imraan 3:7 – interpretation of the meaning]
We believe that there is nothing like unto Allah and thus we will be on the safe side before Allah. These are the words of Allah, and these are the words of His Messenger; both are true and it is impossible for one of them to belie the other. So we say that the verse shows that His creation cannot resemble Allah, and the hadith affirms that Allah has an Image. Both are true and we believe in them; we say that both are from our Lord, and remain silent thereafter. This is all that we can do. 
See Sharh al-Waasitiyyah by Ibn ‘Uthaymeen. 
With regard to the detailed answer: 
This hadith proves that Allah has an Image, and that Allah created Adam in His Image. 
But there is nothing in this hadith to indicate that the image of Adam (peace be upon him) resembles the Image of Allah, rather this meaning is absolutely false and was not meant by the Prophet (peace and blessings of Allah be upon him), because Allah says (interpretation of the meaning): 
“There is nothing like Him”
[al-Shoora 42:11]
The fact that one thing is likened to another does not mean that it is identical to it in all aspects, rather they are likened to one another because they share some attributes, but that does not means that every attribute is identical. 
This is indicated by the words of the Prophet (peace and blessings of Allah be upon him): “The first group to be admitted to Paradise will be in the image of the moon on the night when it is full.” Narrated by al-Bukhari, 3327; Muslim, 2834. 
This hadith does not mean that they will enter Paradise in a form that is exactly like the moon in all regards, otherwise that would mean that they will enter Paradise with no eyes or mouths, or as rocks.  
Rather what the hadith means is that they will be like the moon in beauty and brightness, with shining faces, and so on. 
So if you say: what is the Image that belongs to Allah and in which Adam was created? We say that Allah has a Face and Eyes and Hands and Feet, but that does not mean that because of these things He resembles man. There may be some similarity but that does not mean that these things are identical, just as the first group of the people of Paradise to enter Paradise are likened to the moon, but that does not mean that they resemble the moon. This confirms the belief of Ahl al-Sunnah wa’l-Jamaa’ah, that none of the attributes of Allah can be likened to the attributes of created beings, and they do not misinterpret the Divine attributes or deny them, and they do not liken them to the attributes of human beings. 
See Sharh al-‘Aqeedah al-Waasitiyyah by Shaykh Muhammad ibn Saalih al-‘Uthaymeen, part 1, p. 107-110.