4 2 Discuss the Adjustment Process and Illustrate Common Types of Adjusting Entries Principles of Accounting, Volume 1: Financial Accounting

The second entry closes expense accounts to the Income Summary account. The third entry closes the Income Summary account to Retained Earnings. The fourth entry closes the Dividends account to Retained Earnings.

The accounts of a Balance Sheet using IFRS might appear as shown here. Figure 3.7 includes information such as the date of the transaction, the accounts required in the journal entry, and columns for debits and credits. Identifying and analyzing transactions is the first step in the process. This takes information from original sources or activities and translates that information into usable financial data. An original source is a traceable record of information that contributes to the creation of a business transaction.

  1. For example,
    you might have a building for which you paid $1,000,000 that
    currently has been depreciated to a book value of $800,000.
  2. In other words, the ongoing business activity brings about changes in account balances that have not been captured by a journal entry.
  3. This allows a bookkeeper to monitor financial positions and statuses by account.
  4. This means that adjustments are needed to reduce the asset account and transfer the consumption of the asset’s cost to an appropriate expense account.
  5. At left below is a “balance sheet approach” for Prepaid Insurance.

Revenue, expense, and dividend accounts affect retained earnings and are closed so they can accumulate new balances in the next period, which is an application of the time period assumption. In the Printing Plus case, the credit side is the higher figure at $10,240. This means revenues exceed expenses, thus giving church accounting software the company a net income. If the debit column were larger, this would mean the expenses were larger than revenues, leading to a net loss. You want to calculate the net income and enter it onto the worksheet. The $4,665 net income is found by taking the credit of $10,240 and subtracting the debit of $5,575.

2 Discuss the Adjustment Process and Illustrate Common Types of Adjusting Entries

Not only did this negatively impact Celadon Group’s stock price and lead to criminal investigations, but investors and lenders were left to wonder what might happen to their investment. For example, a company accrued $300 of interest during the period. One difference is the supplies account; the figure on paper does not match the value of the supplies inventory still available. A company may choose its yearly reporting period to be based on a calendar or fiscal year. If a company uses a calendar year, it is reporting financial data from January 1 to December 31 of a specific year.

Statement of Retained Earnings

Printing Plus has $140 of interest revenue and $10,100 of service revenue, each with a credit balance on the adjusted trial balance. The closing entry will debit both interest revenue and service revenue, and credit Income Summary. The first entry closes revenue accounts to the Income Summary account.

Accrued Rent

The salary the
employee earned during the month might not be paid until the
following month. For example, the employee is paid for the prior
month’s work on the first of the next month. The financial
statements must remain up to date, so an adjusting entry is needed
during the month to show salaries previously unrecorded and unpaid
at the end of the month. Accounts Receivable increases (debit) for $1,500 because the
customer has not yet paid for services completed. Service Revenue
increases (credit) for $1,500 because service revenue was earned
but had been previously unrecorded. Similar to prepaid insurance, rent also requires advanced
payment.

Note that this interest has not been paid at the end of the period, only earned. This aligns with the revenue recognition principle to recognize https://intuit-payroll.org/ revenue when earned, even if cash has yet to be collected. During the year, it collected retainer fees totaling $48,000 from clients.

In these columns we record all asset, liability, and equity accounts. Take a couple of minutes and fill in the income statement and balance sheet columns. To get the numbers in these columns, you take the number in the trial balance column and add or subtract any number found in the adjustment column.

Financial Accounting

The following entries show the initial payment for the policy and the subsequent adjusting entry for one month of insurance usage. Depreciation may also require an adjustment at the end of the period. Recall that depreciation is the systematic method to record the allocation of cost over a given period of certain assets. This allocation of cost is recorded over the useful life of the asset, or the time period over which an asset cost is allocated. The allocated cost up to that point is recorded in Accumulated Depreciation, a contra asset account.

On January 9, the
company received $4,000 from a customer for printing services to be
performed. The company recorded this as a liability because it
received payment without providing the service. Assume that as of
January 31 some of the printing services have been provided.

Note that Insurance Expense and Prepaid Insurance accounts have identical balances at December 31 under either approach. In the previous chapter, tentative financial statements were prepared directly from a trial balance. However, a caution was issued about adjustments that may be needed to prepare a truly correct and up-to-date set of financial statements. In other words, the ongoing business activity brings about changes in account balances that have not been captured by a journal entry.

As such, the beginning- of-period retained earnings amount remains in the ledger until the closing process “updates” the Retained Earnings account for the impact of the period’s operations. Using the table provided, for each entry write down the income statement account and balance sheet account used in the adjusting entry in the appropriate column. Using the table
provided, for each entry write down the income statement account
and balance sheet account used in the adjusting entry in the
appropriate column. In the last section, we took NeatNiks right up to the unadjusted trial balance at the end of the month of October.

This creates a liability
that the company must pay at a future date. You cover more details
about computing interest in
Current Liabilities, so for now amounts are given. For example, a company performs landscaping services in the
amount of $1,500. At
the period end, the company would record the following adjusting
entry. Interest can be earned from bank account holdings, notes
receivable, and some accounts receivables (depending on the
contract).

When depreciation is recorded in an adjusting entry,
Accumulated Depreciation is credited and Depreciation Expense is
debited. The statement of retained earnings shows the period-ending retained earnings after the closing entries have been posted. When you compare the retained earnings ledger (T-account) to the statement of retained earnings, the figures must match. It is important to understand retained earnings is not closed out, it is only updated. Retained Earnings is the only account that appears in the closing entries that does not close.

When depreciation is recorded in an adjusting entry, Accumulated Depreciation is credited and Depreciation Expense is debited. Recall from Analyzing and Recording Transactions that prepaid expenses (prepayments) are assets for which advanced payment has occurred, before the company can benefit from use. As soon as the asset has provided benefit to the company, the value of the asset used is transferred from the balance sheet to the income statement as an expense. Some common examples of prepaid expenses are supplies, depreciation, insurance, and rent.

Deferrals are prepaid expense and revenue accounts that have delayed recognition until they have been used or earned. This recognition may not occur until the end of a period or future periods. When deferred expenses and revenues have yet to be recognized, their information is stored on the balance sheet. As soon as the expense is incurred and the revenue is earned, the information is transferred from the balance sheet to the income statement. Two main types of deferrals are prepaid expenses and unearned revenues.

You have also not incurred any expenses yet for rent, electricity, cable, internet, gas or food. This means that the current balance of these accounts is zero, because they were closed on December 31, 2018, to complete the annual accounting period. The accounts that need to start with a clean or $0 balance going into the next accounting period are revenue, income, and any dividends from January 2019. To determine the income (profit or loss) from the month of January, the store needs to close the income statement information from January 2019. When you prepare a balance sheet, you must first have the most updated retained earnings balance. To get that balance, you take the beginning retained earnings balance + net income – dividends.

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