CH 03

C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S P R E N T I C E H A L L


Adjusting and Closing Entries

CHAPTER THREE

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LEARNING OBJECTIVES

Understand the revenue recognition and matching principles

Understand the four types of adjustments and prepare adjusting entries

Prepare financial statements from an adjusted trial balance

Prepare closing entries and a post-closing trial balance

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Accounting Cycle

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1

2

3

4

5

6

7

8

Analyze & journalize

transactions

Post transaction

s to general ledger

Prepare unadjusted

trial balance

Journalize & post

adjusting entries

Prepare adjusted

trial balance

Journalize & post closing entries

Prepare post-closing

trial balance

Prepare financial

statements


Accounting Period

◘ Reporting time frame Month, quarter, or year

◘ Annual accounting period Calendar year Fiscal year Any consecutive 12-month period

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Understand the revenue recognit ion and matching pr inc ip les

LEARNING OBJECTIVE ONE

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Revenue Recognition Principle

◘ Revenues should be recognized, or recorded, when they are earned, regardless of when cash is received.

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Matching Principle

◘ Expenses should be matched with the revenues they helped generate, regardless of when paid.


ACCRUALS

◘ Business has earned revenue before receiving cash from customer

OR

◘ Business has incurred expense before cash is paid

DEFERRALS

◘ Business received cash before providing goods or services to customer

OR

◘ Business paid for expense before it was incurred

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Accruals and Deferrals

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Accruals and Deferrals

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Now Later

Accrued Revenue Revenue is recognized

Cash is received

Accrued Expense Expense is recognized

Cash is paid

Deferred Revenue

Cash is received

Revenue is recognized

Deferred Expense

Cash is paid Expense is recognized

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Understand the four types of adjustments and prepare adjust ing entr ies

LEARNING OBJECTIVE TWO

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Adjusting Entries

◘ Ensures revenue recognition and matching principles are followed

◘ Recorded at the end of the accounting period

◘ Results in accurate, up-to-date financial statements

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ACCRUED REVENUE

◘ Revenue is earned before cash is received

◘ Debit a receivable; credit a revenue

ACCRUED EXPENSE

◘ Expense is incurred before cash is paid

◘ Debit an expense; credit a liability

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Adjustments for Accruals

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Adjustments for Deferrals

◘ Unearned revenue Recorded as liabilities when payment is received from

customer Revenue is recorded when customer receives goods

or services

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◘ Prepaid expense Recorded as assets when paid for Expense is recorded as asset is used up


Accruing Revenues

◘ Business earns revenue before receiving cash

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GENERAL JOURNAL

DATE ACCOUNTS DEBIT CREDIT

Mar.31

Accounts Receivable 250

Service Revenue 250


Accruing Expenses

◘ Business incurs expense before making payment

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GENERAL JOURNAL


Mar.31

Salaries Expense 550

Salaries Payable 550


Summary of Accrual Adjusting Entries◘ For accruals, cash transaction comes

later

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First Dr. Cr. Later Dr.

Cr.

Accrue a revenue and the related asset:Receive cash and decrease the asset:

Accrued Revenue

Accounts Receivable

$$$ Cash $$$

Service Revenue

$$$

Accounts Receivable

$$$

Accrue an expense and the related liability:

Pay cash and decrease the liability:

Accrued Expense

Salaries Expense $$$ Salaries Payable $$$

Salaries Payable

$$$

Cash $$$


Adjusting Deferred Revenues

◘ Business receives cash from customer before earning revenue

Liability Unearned revenue

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GENERAL JOURNAL


Mar.21

Cash 450

Unearned Service Revenue

450

Mar.31

Unearned Service Revenue

150

Service Revenue 150


Adjusting Deferred Expenses

◘ Business pays for items before they are used

◘ Examples: Assets Prepaid Rent Prepaid Insurance Supplies

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Prepaid Rent

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GENERAL JOURNAL


Mar.1 Prepaid Rent 3,000

Cash 3,000

Mar.31

Rent Expense 1,000

Prepaid Rent 1,000


Supplies

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GENERAL JOURNAL


Mar.5 Supplies 900

Cash 900

Mar.31

Supplies Expense 300

Supplies 300


Depreciation of Long-Term Assets

◘ Last for more than one year Land, Buildings, Equipment and Furniture

◘ Used up over time Excluding land

◘ Expense cost of long-term asset over its life

Depreciation

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Depreciation

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GENERAL JOURNAL


Mar.8 Equipment 12,600

Accounts Payable 12,600

$12,600 purchase

price

$4,200 annual

depreciation

3 years

$4,200 annual

depreciation

$350 monthly

depreciation

12 mont

hs


Depreciation

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GENERAL JOURNAL


Mar.31

Depreciation Expense, Equipment 350

Accumulated Depreciation, Equipment

350

Contra-asset


Contra-Accounts

◘ Linked to another account and will appear with it in the financial statements

◘ Normal balance is the opposite of the account to which it is linked

◘ Balance is subtracted from the balance of the linked account to determine the net value

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Book Value

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Equipment 12,600

Less: Accumulated Depreciation, Equipment

350

Book Value, Equipment $12,250


Summary of Deferral Adjusting Entries◘ For deferrals, cash transaction comes

first

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First Dr. Cr. Later Dr.

Cr.

Receive cash and record a liability: Record revenue and decrease liability:

Unearned Revenue

Cash $$$ Unearned Revenue $$$

Unearned Revenue

$$$

Service Revenue $$$

Pay cash and record an asset:Record expense and decrease asset:

Prepaid Expense

Prepaid Rent $$$ Rent Expense $$$

Cash $$$

Prepaid Rent $$$


Problem P3-42A (1 of 3)

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GENERAL JOURNAL Page 1


Dec.31

Insurance Expense 1,500

Prepaid Insurance 1,500

($3,600 x 5/12)

Dec.31

Salaries Expense 6,600

Salaries Payable 6,600

($16,500 x 2/5)



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Dec.31

Interest Receivable 300

Interest Revenue 300

Dec.31

Supplies Expense 3,600

Supplies 3,600

($900 + 4,500 - 1,800)



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Dec.31

Unearned Revenue 5,100

Service Revenue 5,100

Dec.31

Depreciation Expense 4,290

Accumulated Depreciation, Vehicles

2,990

Accumulated Depreciation, Equipment

1,300


Prepare fi nancia l statements from an adjusted tr ia l balance

LEARNING OBJECTIVE

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Preparing the Financial Statements

◘ After adjustments are made and posted, the adjusted trial balance is prepared

◘ The financial statements are prepared using the amount from the adjusted trial balance

Income Statement Statement of Retained Earnings Balance Sheet

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Prepare c los ing entr ies and a post-c los ing tr ia l balance

LEARNING OBJECTIVE FOUR

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Closing Entries

◘ Revenue, expense and dividend account balances are set to zero before starting next accounting period. The accounts are transferred to Retained Earnings

Transferring revenue and expense account balances increases Retained Earnings by the amount of net income (or deceases it by the amount of net loss)

Transferring the dividends account balance decreases Retained Earnings

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TEMPORARY

◘Revenues

◘Expenses

◘Dividends

◘ Closed to Retained Earnings

Begin next period with a zero balance

PERMANENT

◘ Assets ◘ Liabilities ◘ Common Stock ◘ Retained Earnings

◘ Not Closed Balances carry forward

to next period

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Temporary and Permanent Accounts

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Three Closing Entries

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Dr. Cr.

Close Revenues

Revenues $$$

Retained Earnings $$$

Close Expenses


Expenses $$$

Close Dividends


Dividends $$$


Impact of Closing Entries on Retained Earnings

◘ Increased by net income (or decreased by net loss)

Close revenues and expenses

◘ Decreased by dividends

◘ Account balance will match ending balance on Statement of Retained Earnings

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Exercise E3-38B (1 of 3)

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Common Stock $22,000 Accounts Receivable $ 7,000

Service Revenue R 54,000 Retained Earnings 4,200

Unearned Revenue 2,100 Salaries Payable 1,300

Salaries Expense E 20,800 Depreciation Expense E 2,600

Accumulated Depreciation 30,000 Rent Expense E 5,900

Supplies Expense E 1,800 Dividends D 16,000

Interest Revenue R 500 Supplies 1,700

Interest Expense E 2,400



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GENERAL JOURNAL


Apr.30

Service Revenue 54,000

Interest Revenue 500

Retained Earnings 54,500

Apr.30


Salaries Expense 20,800

Supplies Expense 1,800

Interest Expense 2,400

Depreciation Expense 2,600

Rent Expense 5,900



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GENERAL JOURNAL


Apr.30


Dividends 16,000

Jona and Son Electrical, Inc.Statement of Retained Earnings

Month Ended April 30, 2012

Retained Earnings, April 1, 2012 $ 4,200

Add: Net Income for the month

21,000

Subtotal 25,200

Less: Dividends 16,000

Retained Earnings, April 30, 2012 $ 9,200


Post-closing Trial Balance

◘ Final step of the accounting cycle

◘ Includes only assets, liabilities and stockholders’ equity accounts

All temporary accounts have been closed

◘ Provides a starting point for next period’s transactions

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ADJUSTING ENTRIES

◘ Report net income accurately

◘ Reflect correct account balances on balance sheet

◘ Never include cash

CLOSING ENTRIES

◘ Zero out revenue, expenses and dividends

◘ Transfer balances of temporary accounts to Retained Earnings

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Summary of Adjusting Entries and the Closing Process

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CHAPTER SUMMARY

Adjusting entries are necessary to adhere to revenue recognition and matching principles and to generate accurate, up-to-date financial statements.

Closing entries are necessary to prepare temporary accounts for the next accounting period by zeroing them out into Retained Earnings and to ensure the Balance Sheet reflects the ending balance for all permanent accounts.

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?C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S

P R E N T I C E H A L L42

04/08/2023

Questions

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Printed in the United States of America.C O P Y R I G H T © 2 0 1 2 P E A R S O N E D U C AT I O N I N C . P U B L I S H I N G A S

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