Adjusting Entry: A journal entry that assigns an amount of revenue or expense to the appropriate accounting period, bringing the balance sheet to it’s true value.

Year end financial statements are superior to interim financial statements

Adjusting entries help to ensure

Accounts are brought up to date
Late transactions are taken into account
Calculations have been made correctly
Accounting principles and standards have been followed

In the Income Statement

Revenue Recognition Principle: Record revenue as soon as it is earned.

Matching Principle: Matching the expenses to the revenue it helps earn.

In the Balance Sheet

Cost Principle: Assets are recorded at the historical cost (record the original cost, even if the value increases).

Principle of Conservatism: Assets cannot be overstated or understated, it is always better to err on the side of caution

TO NOTE:

Every adjusting entry will always affect a balance sheet and an income statement account.

Adjusting Entry Classifications

2 Classifications:

Accruals- accumulate over time
Prepayments- items paid in cash prior to being used/ earned

Accrual Adjusting Entries

Accrued Expenses: Late Purchase Invoice
Accrued Revenue: Revenue earned but not yet recorded

Prepayment Adjusting Entries

Prepaid (Unearned) Revenue: Received payment prior to being earned
Prepaid Expenses: Supplies, Prepaids and Amortization

Adjusting Entries- Supplies

Supplies are used daily during the fiscal period

Taking Inventory: At the end of the fiscal period, supplies that are left over by the business are counted and valued

Example;

Office supplies had a beginning balance of $6,000
Over the fiscal period, 3 purchases were made bringing the balance to $15,000
At the end of the fiscal period, it is discovered that there are actually $3,000 worth of supplies left (inventory count)

Account balance-Inventory count = Amount used

$15,000-3,000= 12,000

Adjusting Entry (Dec 31, 2021)

Supplies Expense $12,000

Supplies $12,000

To adjust for the inventory count of $3,000

Adjusting Entries- Prepaid Expenses

Some expenses are paid in advance and have benefits that exceed beyond the fiscal year
This can include things like prepaid insurance

Example;

Your company paid auto insurance for one year, starting September 1st 2020 at a cost of $1,800
At the end of the fiscal period, the balance of the prepaid insurance is $1,800

(Months not used/ Months paid) x Monthly rate = Ending balance in prepaid insurance

(8/12) x $1,800 =1,200 ending balance in prepaid insurance

Beginning balance-Ending balance = Usage

$1,800-$1,200= $600

(Months used/ Months paid) x Monthly Rate = Usage

(4/12) x $1,800 =$600

Adjusting Entry (December 31, 2021)

Insurance Expense $600

Prepaid Insurance $600

To adjust for the four months of expired insurance

Adjusting Entries- Late Arriving Purchases

Financial statements are prepared after the fiscal period has ended
Late Invoices or bills that arrive must be taken into account for the fiscal period that it affects

Example;

Jan 15 2020, several late arriving invoices have been received that are applicable to the previous fiscal year
Telephone Expense $212
Utilities Expense $315

Adjusting Entry (December 31, 2019)

Telephone Expense $212

Utilities Expense $315

Accounts Payable $527

To record the 2019 invoices that arrived in 2020

Adjusting Entries-Unearned Revenue

Unearned Revenue: Revenue for which the cash has been received, but the good/service has not yet been provided (pending good/service) (Unearned revenue is a liability)

Record the revenue as earned when it is first received
Record the revenue as unearned when it is first received

Example;

Deposited a cheque for $5,000 on December 23, 2020 for work that is to be done in January and February of 2021

Journal Entry (December 23, 2020)

Bank $5,000

Revenue $5,000

To record a cheque deposited for service to be done at a later date, revenue recognized

Adjusting Entry (December 30, 2020)

Revenue $5,000

Unearned Revenue $5,000

To adjust for the cash advance payment received

8.2- Adjusting the Entries and the Worksheet

8 columns on the worksheet:

Trial Balance (DR and CR)
Adjustments (DR and CR)
Income Statement (DR and CR)
Balance Sheet (DR and CR)

When writing the adjustments, write them in the adjustment column as follows:

Eg; Insurance Expense $2494 (in the Adjustment DR column)

Prepaid Insurance $2494 (in the Adjustment CR column)

To complete the worksheet:

Complete the balance sheet and Income Statement column

Balance Sheet: Assets, Liabilities, Capital, Drawings

Income Statement: Revenue and Expenses

A completed worksheet:

8.3- Closing Entries Concepts

Real Accounts and Nominal Accounts

Real Accounts (Permanent Account): Accounts that have balances that continue into the next fiscal period

Asset and Liability and Owner’s Capital Account

Nominal accounts (Temporary Account): Accounts that have balances that do not continue into the next fiscal period

Revenue, Expense and Drawing accounts
All nominal accounts begin each fiscal period with a zero or nil balance
Nominal accounts (except Drawings) are related to the income statement

Income Summary Account:

Special type of nominal account
Used during the closing entry process
Summarizes the revenue and expenses of the fiscal period
The temporary balance of this account represents the net income or net loss

Closing the Accounts: means to cause it to have no balance.

The nominal accounts are closed at the end of the fiscal period.

End-of-the Year Procedure

Bring the accounts up-to-date by journalizing and posting the adjusting entries
Close the nominal accounts to prepare them for the next fiscal period

Transfer the balances of the revenue accounts to the new Income Summary Account

These figures are found on the income statement credit column
Revenue accounts have credit balances, debit balances are needed to close them out

Dec 31 Revenue

Income Summary

Transfer the balances of the expense accounts to the new Income Summary Account

The figures for this closing entry are found in the debit column of the Income Statement
Expense accounts have debit balances, credit balances are needed to close them

Dec 31 Income Summary

Expenses

Transfer the balances of the Income Summary to the Capital Account

If the Income summary account has a credit balance, a debit entry is needed to close it
If the Income summary account has a debit balance, a credit entry is needed to close it

Net Income

Dec 31 Income Summary

Capital

Net Loss

Dec 31 Capital

Income Summary

Transfer the balances of the Drawings account to the capital account

Drawings account always has a debit balance, a credit balance is needed to close the account

Dec 31 Capital

Drawings

R-evenue

E-xpense

I-ncome

D-rawings

When the above procedure is completed, all the nominal accounts will have a zero balance
The Capital account will continue to the next fiscal period and will have an updated balance (this represents the beginning capital for the next fiscal period)

Take off a post-closing trial balance

A trial balance is taken off to ensure that the ledger is still in balance

A post closing trial balance is taken as soon as the closing entries have been posted

8.4- Amortization

Depreciation is also called fixed assets, capital equipment and plant and equipment
Every long term asset is expected to be used up in the course of time (except land)

Depreciation: Refers to an allowance made for the decrease in the value of an asset over time. Also referred to as amortization of an asset.

Amortization: Means to transfer value.