Please explain the purpose of adjusting entries and closing ✓ Solved

This assignment has 2 parts: Please explain the purpose of adjusting entries and closing entries. In a 1-2-page paper, detail what each accomplishes, and give examples of each. Please journalize the closing entries from the attached 10-column worksheet. Use the attached template to complete your General Journal.

Paper For Above Instructions

In the field of accounting, adjusting entries and closing entries are fundamental concepts that ensure the accuracy and completeness of financial statements. This paper outlines the purpose of these entries, detailing what each accomplishes while providing illustrative examples.

Purpose of Adjusting Entries

Adjusting entries are necessary at the end of an accounting period to ensure that the financial statements accurately reflect the company's financial position and performance for that period. The primary purpose of adjusting entries is to align the revenue earned and expenses incurred with the appropriate accounting period, complying with the accrual basis of accounting.

There are several types of adjusting entries, including:

  • Accrued Revenues: These are revenues that have been earned but not yet recorded. For example, if a company provides services in December but will not receive payment until January, an adjusting entry would recognize the revenue in December. The entry would be a debit to Accounts Receivable and a credit to Service Revenue.

  • Accrued Expenses: These are expenses that have been incurred but not yet recorded. For instance, if a company has employees working in December but pays their salaries in January, it must accrue the wages. The adjusting entry would involve debiting Wage Expense and crediting Wages Payable.

  • Deferred Revenues: Also known as unearned revenues, these amounts are collected before the services are performed. If a customer pays in advance for services to be delivered in the next period, an adjusting entry is required to recognize the revenue when earned. The entry would debit Unearned Revenue and credit Service Revenue.

  • Deferred Expenses: These are payments made for expenses that will be recognized in future periods, such as prepaid insurance. An adjusting entry is made to allocate the expense over time by debiting Insurance Expense and crediting Prepaid Insurance.

Examples of Adjusting Entries

Consider a company that pays $1200 for a one-year insurance policy on January 1. Each month, the company recognizes one-twelfth of the cost as an expense. Hence, at the end of each month, an adjusting entry is recorded as follows:



Date: [Last day of the month]


Debit: Insurance Expense $100


Credit: Prepaid Insurance $100

This entry ensures that the insurance expense is accurately matched with the revenue for each month.

Another example involves accrued revenues. If a company has earned $500 in interest on a loan by the end of the accounting period but has not yet booked the interest revenue, the adjusting entry would be:



Date: [Last day of the accounting period]


Debit: Interest Receivable $500


Credit: Interest Revenue $500

This entry recognizes the revenue that has been earned but not yet received.

Purpose of Closing Entries

Closing entries serve a different purpose than adjusting entries. Their main function is to transfer the balances from temporary accounts to permanent accounts, effectively resetting the temporary accounts for the new accounting period. These temporary accounts include revenues, expenses, and dividends, which need to be closed at the end of each accounting period to reflect zero balances for the new period.

The process of closing involves five steps:

  1. Close revenue accounts: All revenue accounts are debited, and the Income Summary account is credited for the total amount of revenues.

  2. Close expense accounts: All expense accounts are credited, and the Income Summary account is debited for the total amount of expenses.

  3. Close the Income Summary account: The difference between total revenues and total expenses is recorded in the Income Summary. If revenues exceed expenses, the Income Summary is debited, and Retained Earnings is credited (and vice versa if expenses exceed revenues).

  4. Close dividends accounts: Any dividends declared are transferred from retained earnings by debiting Retained Earnings and crediting the Dividends account.

Examples of Closing Entries

For example, suppose a company has the following closing balances:

  • Revenue: $10,000

  • Expenses: $7,000

  • Dividends Declared: $1,500

The closing entries would be recorded as follows:



1. Close Revenue Accounts:


Debit: Service Revenue $10,000


Credit: Income Summary $10,000


2. Close Expense Accounts:


Debit: Income Summary $7,000


Credit: Rent Expense $2,500


Credit: Wages Expense $4,500


3. Close Income Summary:


Debit: Income Summary $3,000


Credit: Retained Earnings $3,000


4. Close Dividends:


Debit: Retained Earnings $1,500


Credit: Dividends $1,500

This process ensures the company's temporary accounts reflect zero balances as it begins the new accounting period.

Conclusion

In conclusion, adjusting entries are crucial for aligning income and expenses with the relevant accounting period, thus ensuring the integrity of financial statements. Closing entries are vital for resetting temporary accounts and ensuring that the financial records are ready for the new accounting period. Understanding both types of entries is essential for effective financial reporting and compliance with accounting principles.

References

  • Horngren, C. T., Sundem, G. L., & Elliott, J. A. (2013). Introduction to Financial Accounting. Pearson.

  • Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2020). Financial Accounting. Wiley.

  • Youll, J. (2022). Accounting Principles. Cengage Learning.

  • Shannon, D. M. (2019). Financial Accounting Basics. CreateSpace Independent Publishing Platform.

  • Williams, J. R., Haka, S. F., & Bettner, M. S. (2017). Financial and Managerial Accounting. McGraw-Hill Education.

  • Weetman, P. (2019). Financial Accounting. Pearson Education.

  • Carpenter, T. D., & Sanders, K. S. (2022). Advanced Financial Accounting. Norton & Company.

  • Beal, D. J., & Baker, J. D. (2018). Managerial Accounting: An Introduction to Concepts. South-Western Cengage Learning.

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  • Needles, B. E., Powers, M., & Crosson, S. (2018). Principles of Accounting. Cengage Learning.