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Adjusting Entries
Transactions generally are recorded in a journal in chronological order andthen posted to the ledger accounts. These are based on the best informationavailable at the time of recording enteries.
Although the majority of accounts are up to date at the end of an accountingperiod and their balances can be included in the financial statements, some
accounts require adjustment to reflect current circumstances. In general, these accounts are not updated throughout the period because it is
impractical or inconvenient to make such entries on a daily or weekly basis. Atthe end of each accounting period, necessary adjustments are needed prior topreparing the financial statements.
The entries that reflect these adjustments are called adjusting entries.
Adjusting entries are not made based on transactions; rather, adjusting entriesare recorded based on the circumstances at the close of each accountingperiod.
Each adjusting entry involves at least one income statement account and onebalance sheet account.
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Financial Statements Preparation
After preparing adjusting entries, the entries are posted in respective
ledger accounts. The adjusted balance of ledgers is calculated and is used
to prepare an Adjusted Trial Balance.
Adjusted Trial Balance is used to prepare the Financial Statements.
Financial Statements are prepared by Management and are audited byExternal Auditorswho express opinion on the correctness of the Financial
Statements. External users of Accounts rely on the opinion of the Auditors.
But the story of Financial Accounting does not end on Financial
Statements because the business is a going concern, transactions continue
to occur and the cycle of entries, adjustments, trial balance and financialstatements continue period after period in the organization.
To make the loop / cycle restart, a closing and opening process has to be
carried out in the accounting system.
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Closing Entries
Closing entries are journal entries made at the end of an accounting
period.
They have two purposes:
1. They set the stage for the next accounting period by clearing revenue
and expense accounts and the Drawing account of their balances.2. They summarize a periods revenues and expenses by transferring the
balances of revenue and expense accounts to the Profit and Loss /
Retained earnings / Income Summary account. This account is a
temporary account that summarizes all revenues and expenses for
the period. It is used only in the closing processnever in thefinancial statements. Its balance equals the net income or loss
reported on the income statement. The net income or loss is then
transferred to the owners Capital account.
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Closing Entries
The steps involved in making closing entries are as follows:
Step 1. Close the credit balances on the income statement accounts to the
Retained earnings account.
Step 2. Close the debit balances on the income statement accounts to the
Retained earnings account.
Step 3. Close the Drawing account balance to the owners Capital account.
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Closing Entries
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Closing Entries
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Post-closing Trial BalanceAfter posting closing entry, we can prepare a Post-closing Trial Balance.
There are only Asset, Liability and Equity Accounts in a post-closing trial balance. Why?
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Work Sheet
Preparing the Work Sheet
STEPS:1. Enter and Total the Account Balances in the Trial Balance Columns
2. Enter and Total the Adjustments in the Adjustments Columns
3. Enter and Total the Adjusted Account Balances in the Adjusted Trial Balance
Columns
4. Extend the Account Balances from the Adjusted Trial Balance Columns to the
Income Statement or Balance Sheet Columns5. Total the Income Statement Columns and the Balance Sheet Columns. Enter the Net
Income or Net Loss in Both Pairs of Columns as a Balancing Figure, and Recompute
the Column Totals
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