4.1 Explain the Concepts and Guidelines Affecting Adjusting Entries
- The next three steps in the accounting cycle are adjusting entries (journalizing and posting), preparing an adjusted trial balance, and preparing the financial statements. These steps consider end-of-period transactions and their impact on financial statements.
- Accrual basis accounting is used by US GAAP or IFRS-governed companies, and it requires revenues and expenses to be recorded in the accounting period in which they occur, not necessarily where an associated cash event happened. This is unlike cash basis accounting that will delay reporting revenues and expenses until a cash event occurs.
- Companies need timely and consistent financial information presented for users to consider in their decision-making. Accounting periods help companies do this by breaking down information into months, quarters, half-years, and full years.
- A calendar year considers financial information for a company for the time period of January 1 to December 31 on a specific year. A fiscal year is any twelve-month reporting cycle not beginning on January 1 and ending on December 31.
- An interim period is any reporting period that does not cover a full year. This can be useful when needing timely information for users making financial decisions.
4.2 Discuss the Adjustment Process and Illustrate Common Types of Adjusting Entries
- Incorrect balances: Incorrect balances on the unadjusted trial balance occur because not every transaction produces an original source document that will alert the bookkeeper it is time to make an entry. It is not that the accountant made an error, it means an adjustment is required to correct the balance.
- Need for adjustments: Some account adjustments are needed to update records that may not have original source documents or those that do not reflect change on a daily basis. The revenue recognition principle, expense recognition principle, and time period assumption all further the need for adjusting entries because they require revenue and expense reporting occur when earned and incurred in a current period.
- Prepaid expenses: Prepaid expenses are assets paid for before their use. When they are used, this asset’s value is reduced and an expense is recognized. Some examples include supplies, insurance, and depreciation.
- Unearned revenues: These are customer advanced payments for product or services yet to be provided. When the company provides the product or service, revenue is then recognized.
- Accrued revenues: Accrued revenues are revenues earned in a period but have yet to be recorded and no money has been collected. Accrued revenues are updated at the end of the period to recognize revenue and money owed to the company.
- Accrued expenses: Accrued expenses are incurred in a period but have yet to be recorded and no money has been paid. Accrued expenses are updated to reflect the expense and the company’s liability.
4.3 Record and Post the Common Types of Adjusting Entries
- Rules for adjusting entries: The rules for recording adjusting entries are as follows: every adjusting entry will have one income statement account and one balance sheet account, cash will never be in an adjusting entry, and the adjusting entry records the change in amount that occurred during the period.
- Posting adjusting entries: Posting adjusting entries is the same process as posting general journal entries. The additional adjustments may add accounts to the end of the period or may change account balances from the earlier journal entry step in the accounting cycle.
4.4 Use the Ledger Balances to Prepare an Adjusted Trial Balance
- Adjusted trial balance: The adjusted trial balance lists all accounts in the general ledger, including adjusting entries, which have nonzero balances. This trial balance is an important step in the accounting process because it helps identify any computational errors throughout the first five steps in the cycle.
4.5 Prepare Financial Statements Using the Adjusted Trial Balance
- Income Statement: The income statement shows the net income or loss as a result of revenue and expense activities occurring in a period.
- Statement of Retained Earnings: The statement of retained earnings shows the effects of net income (loss) and dividends on the earnings the company maintains.
- Balance Sheet: The balance sheet visually represents the accounting equation, showing that assets balance with liabilities and equity.
- 10-column worksheet: The 10-column worksheet organizes data from the trial balance all the way through the financial statements.
- 10-column worksheet
- all-in-one spreadsheet showing the transition of account information from the trial balance through the financial statements
- accounting period
- breaks down company financial information into specific time spans and can cover a month, quarter, half-year, or full year
- type of adjusting entry that accumulates during a period, where an amount was previously unrecorded
- accrued expense
- expense incurred in a period but not yet recorded, and no money has been paid
- accrued revenue
- revenue earned in a period but not yet recorded, and no money has been collected
- adjusted trial balance
- list of all accounts in the general ledger, including adjusting entries, which have nonzero balances
- adjusting entries
- update accounting records at the end of a period for any transactions that have not yet been recorded
- book value
- difference between the asset’s value (cost) and accumulated depreciation; also, value at which assets or liabilities are recorded in a company’s financial statements
- calendar year
- reports financial data from January 1 to December 31 of a specific year
- contra account
- account paired with another account type that has an opposite normal balance to the paired account; reduces or increases the balance in the paired account at the end of a period
- prepaid expense and revenue accounts that have delayed recognition until they have been used or earned
- fiscal year
- twelve-month reporting cycle that can begin in any month, and records financial data for that twelve-month consecutive period
- interim period
- any reporting period shorter than a full year (fiscal or calendar)
- modified accrual accounting
- commonly used in governmental accounting and combines accrual basis and cash basis accounting
- tax basis accounting
- establishes the tax effects of transactions in determining the tax liability of an organization
- useful life
- time period over which an asset cost is allocated