Adjusting and Closing Process Accounting Cycle Basic steps 1 Record transactions in the journal 2 Post from the journal to the ledger 3 Prepare an unadjusted trial balance 4 Record past year end adjusting entries 5 Prepare an adjusted trial balance 6 From the adjusted trial balance prepare financial statements Accrual Accounting Revenues recorded when earned Expenses are recorded in the same period they help to earn revenues o Realization principle o Matching concept Adjusting entries matching concept are followed are needed to ensure that the realization principle and o 1 Revenues are recorded in the period earned o 2 Expenses are recognized in the period incurred Regardless as to when cash is received or paid Adjusting entries update account balances journal entries made at the end of the accounting period to o These are required because of accrual accounting and are required each time financial statements are prepared Two main categories of adjustment o 1 Deferral transaction where cash has been received or paid while the related revenue or expense has not been recorded o 2 Accruals transactions for which cash has not yet been received or paid but the related revenue or expense has been earned or incurred and thus must be recorded Deferred expense company pays for expense item in advanced o Recorded as an asset o Becomes an expense when asset is used up o Ex Prepaid insurance prepaid rent supplies Adjusting entries for deferred prepaid expenses are required to the recorded the portion of the prepayment representing the expense incurred which is the amount of the asset used up o The Adjusting entry results in a debt to an expense account and a credit to an asset account Problem 1 Deferred revenue or delivered later company receives cash in advance for services to performed o This cash received is a liability o Becomes a revenue when service is performed or good is delivered transactions for which cash has not been received or paid Accruals o Accrued revenue and expense o Ex Salary Adjusting entries for accruals are required to record revenues earned and expenses incurred in the current period but not yet received or paid in cash o Accrued Revenue debit is an asset and credit is a revenue o Accrued expense debit an expense and credit liability Depreciation expense over useful life systematic allocation of the rest of the cost of a plant asset to o The using up of P P E o AJE is needed every year o Depreciation has nothing to do with value of an asset we don t depreciate and asset because its value is decreasing Matching concept Record expense when asset used up Debit depreciation expense Credit accumulated depreciation Depreciation expenses o Classified as an expense o Found on income statement o Reduces net income o Represents the amount of the building or equipment used up in the current year Accumulated Depreciation o Causes decreases in assets o Classified as a contra asset o Normal balance is a credit o Found on the balance sheet directly underneath the asset being depreciated was acquired o Represents the total amount of the building or equipment used up since it Interest comes about either when a company borrows money and must repay it with interest or when a company lends money to someone and is repaid with interest o Interest principal rate time 4 Key Points o 1 The rate is always expressed as an annual rate o 2 Time is always a fraction and is always over 12 numerator of months used up o 3 Interest can be computed for any time period less than or equal to one year but never for a period of more than one year o 4 For now we will assume all interest is paid at the end of the loan rather than have monthly payments that include interest An adjusted trial balance prepared after all AJE s have been journalized and posted o Its purpose is to prove the equality of the total debit and credit balances in the ledger after all adjustments have been made o It is the same thing as the unadjusted trial balance except it includes the effects of adjusting entries o Financial statements can be prepared directly from the adjusted trial Nominal temporary account are closed to a zero balance at the end of every balance year o Ex revenues expenses dividends Permanent real account are never closed to zero as part of the year and The purpose of the closing entries is to transfer a net income or net loss and closing process o Assets liabilities equity dividends to retained earnings 3 Closing Entries 1 Close revenue into retained earnings 2 Close expenses into retained earnings 3 Close dividends into retained earnings Debit each revenue and credit retained earnings for total revenue o Debit retained earnings and credit expense for total expense o Debit retained earning and credit dividends for dividends account Example 2 After closing entries have been posted 1 All temporary accounts have a zero balance 2 Balance in retained earnings represents the accumulated and undistributed earnings at the and of the accounting period o The balance in retained earning represents net income for dividends o Permanent accounts not closed