Adjusting Entries:

Matching Accounting & Timing

 Certain end-of-period adjustments must be
made when you close your books.
 Adjusting entries are made at the end of an
accounting period to account for items that
don't get recorded in your daily
transactions.
 In a traditional accounting system,
adjusting entries are made in a general
journal.
 Some adjusting entries are straightforward.
 Others require judgment and some
accounting knowledge.
Adjusting Entries:
Matching Accounting & Timing
 Some adjusting entries must be made
because there is a journal entry that
“drives” it.
 Some adjusting entries must be made
because of the passage of time: there is
no “driver”.
 Adjusting entries are used to insure that
revenues are reported when earned and
expenses are reported when incurred.
Adjusting Entries:
Matching Accounting & Timing
 Adjustments are necessary because
applicable things have occurred during the
period but have not been recorded.
 Any adjusting entry always increases either
a revenue or an expense (not both in the
same entry).
 Either a revenue will be receiving a credit
or an expense will be receiving a debit.
 The only question for the journal entry then
becomes: What gets the debit (if the
adjustment is to increase revenue) or what
gets the credit (if the adjustment is to
increase an expense)?
Adjusting Entries:
Matching Accounting & Timing
 Adjusting entries to increase revenues are
required either because someone paid you
before you did any work (unearned revenue) or
you did work before you billed or were paid for
it (accounts or interest receivable).
 This tells you your debit entry if the adjustment
is to increase revenue: debit unearned
revenue or debit accounts (interest, etc.)
receivable; credit revenue (of some type).
 Remember: a prepaid expense is an asset,
NOT an expense.
 Remember: an unearned revenue is a liability,
NOT a revenue.
Adjusting Entries:
Matching Accounting & Timing
 Adjusting entries to increase expenses are
required either because you already paid
for them before using them (prepaid
expenses such as insurance, rent,
supplies) or you used them before being
billed or paying for them (accrued wages
payable, accrued interest payable, etc.).
 This tells you your credit entry if the
adjustment is to increase an expense.
 Debit the expense; credit prepaid
insurance, supplies or wages payable, etc.
Closing Entries: Out With The
Old, In With The New
 After financial statements are prepared,
you are ready to get your books ready for
the next accounting period by clearing out
the income and expense accounts in the
general ledger and transferring the net
income (or loss) to your owner's equity
account.
 Closing entries are needed to clear out
your revenue and expense accounts as
you start the beginning of a new accounting
period.
Closing Entries: Out With The
Old, In With The New
 Note the distinction between adjusting
entries and closing entries.
 Adjusting entries are required to update
certain accounts in your general ledger at
the end of an accounting period.
 Adjusting entries must be done before you
can prepare your financial statements and
income tax return.
 Closing entries are done after the financial
statement is constructed.
Closing Entries: Out With The
Old, In With The New
 Preparing your closing entries is a very
simple, mechanical process. Follow these
steps:
 Close the revenue accounts. Prepare one
journal entry that debits all the revenue
accounts. (These accounts will have a credit
balance in the general ledger prior to the
closing entry.) Credit an account called
"income summary" for the total.
 Close the expense accounts. Prepare one
journal entry that credits all the expense
accounts. (These accounts will have a debit
balance in the general ledger prior to the
closing entry.) Debit the income summary
account for the total.
Closing Entries: Out With The
Old, In With The New
 Transfer the income summary balance
to a capital account. Prepare a journal
entry that clears out the income summary
account. This entry effectively transfers the
net income (or loss) of the business to the
owner's equity account.
 Close the dividend account. If your
business is a sole proprietorship or
partnership, close the dividend accounts (if
any) by preparing a journal entry that
credits the dividend account and debits the
owner's equity account.
Closing Entries: Out With The
Old, In With The New
 After all closing entries are made, post the
entry totals to the general ledger.
 All revenue and expense accounts should
have a zero balance.