1. Adjustments, Financial Statements, and Financial Results
Chapter 4
Adjustments, Financial Statements, and Financial Results
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2. Why Adjustments are Needed
Adjusting entries are made at the end of every accounting period to report revenues and expenses in the proper period and assets and liabilities at appropriate amounts.
Adjusting journal entries record the effects of each period’s adjustments in a debits-equal-credits format
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Revenues must be recorded when earned.
Expenses must be recorded in the same period as the revenues to which they relate.
Assets must be reported at amounts that represent the economic benefits that remain at the end of the current period.
Liabilities must be reported at amounts owed at the end of the current period.
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4. 1. Deferral Adjustments
An expense or revenue had been deferred if we have postponed reporting it on the income statement until a later period.
Use-up rent benefits
Sept. 1
Sept. 30
Cash paid for rent in advance
Adjustment needed
Jan. 1
Deliver subscription service
Jan. 31
Cash received for subscription in advance
Adjustment needed
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Deferral adjustments decrease balance sheet accounts and increase corresponding income statement accounts.
Each deferral adjustment involves one asset and one expense account, or one liability and one revenue account.
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6. Cash paid for income taxes Cash received for interest
2. Accrual Adjustments
Accrual adjustments are needed when revenue is earned or an expense incurred in the current period, but the transaction has not been recorded yet because the cash will be paid or received in a future period.
Incur income taxes
Sept. 1
Sept. 30
Dec. 31
Adjustment needed
Cash paid for income taxes
Jan. 1
Earn interest
Jan. 31
Mar. 31
Adjustment needed
Cash received for interest
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Accrual adjustments are used to record revenue or expenses when they occur prior to receiving or paying cash, and to adjust corresponding balance sheet accounts.
Each accrual adjustment involves one asset and one revenue account, or one liability and one expense account.
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8. Making Required Adjustments
Adjustments are not made every day because it is more efficient to do them all at once at the end of each period.
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Let’s try it
E4-3
E4-8
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The unadjusted trial balance is a key starting point for the adjustment process.
Compare the unadjusted balance with the desired balance to determine the required adjusting entry.
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Accumulated Amortization is a balance sheet account and Amortization Expense is an income statement account.
The Accumulated Amortization account allows you to report both the original cost of equipment and a running total of the amount that has been amortized.
The normal balance in a contra-account is always the opposite of the account it offsets.
The amount of amortization depends on the method used for determining it.
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Adjusting journal entries never involve cash.
Adjusting journal entries always include one balance sheet account and one income statement account.
Dividends are not expenses; they are a reduction of retained earnings.
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13. Adjusted Trial Balance
An Adjusted Trial Balance is prepared to check that the accounting records are still in balance after all adjusting entries have been posted.
Accounts are listed in the order they appear on the balance sheet, statement of retained earnings, and income statement.
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14. Prepare Financial Statements
Use the Adjusted Trial Balance to prepare the Income Statement and Statement of Retained Earnings
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15. Use the Adjusted Trial Balance to prepare the Balance Sheet
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16. Closing Temporary Accounts
Closing temporary accounts is the last step in the accounting process.
It is done at the end of the year.
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Temporary accounts track financial results for a limited period of time. Their balances are zeroed at the end of each accounting year.
Revenue, expense and dividends declares accounts are temporary accounts.
Permanent accounts track financial results from year to year. Their ending balances carry forward to the next year.
Balance sheet accounts are permanent accounts.
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The closing process:
Transfers net income (or loss) and dividends to Retained Earnings.
Establishes zero balances in all income statement and dividend accounts.
Two closing entries are needed:
1. Dr Revenues xx
Cr Expenses xx
Cr Retained Earnings xx
2. Dr Retained Earnings xx
Cr Dividends Declared xx
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Closing entries:
The amount credited (or debited) to Retained Earnings in the first journal entry must equal Net Income (or Net Loss) on the Income Statement.
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Let’s try it
E4-10
E4-13
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21. Post-Closing Trial Balance
The post-closing trial balance is an internal report prepared as the last step in the accounting cycle to check that debits equal credits and all temporary accounts have been closed.
Permanent accounts
(balance sheet accounts)
have balances.
Temporary accounts
(dividend and income statement accounts)
do not have balances.
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22. The Accounting Process
Analyze Transactions
Prepare Journal Entries & Post to Accounts
Prepare Unadjusted Trial Balance
Prepare Post-Closing Trial Balance
Prepare Adjusting Journal Entries & Post to Accounts
Prepare Closing Journal Entries & Post to Accounts
Prepare Financial Statements
Prepare Adjusted Trial Balance
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23. Adjusted Financial Results
Adjusting entries help ensure that a company’s financial statements faithfully represent the company’s financial position.
Without adjusting entries, the financial statements can present an incomplete and misleading picture.
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