Week 8 - Adjusting entries

Question 1

Why are adjusting entries required at the end of the accounting period?

Answer 1

Because financial accounting uses the accrual basis there will be a number of adjustments required at the end of the accounting period.

Question 2

What are the 5 types of adjustments required?

Answer 2

1. Income earned but not received
2. Expenses incurred but not yet paid
3. Income received in advance
4. Prepayments
5. Depreciation

Question 3

How is the adjusting entry “Income earned but not yet received” transacted?

Answer 3

When Income has not yet been recorded or received, then it is recognised through the adjusting journal entry.

Increase Asset (i.e. Accounts receivable)
Increase Equity (i.e. Income)

Example = Interest revenue

Question 4

How is the adjusting entry “ Expenses incurred but not yet paid” transacted?

Answer 4

When expense has not yet been recorded or paid, then it is recognised through the adjusting journal entry.

Decrease equity (i.e. expense)
Increase liability (i.e. accounts payable)

Question 5

How is the adjusting entry “Income received in advance” transacted?

Answer 5

If a business receives cash before performing a service, then they are liable for that service or cash:
Increase Asset (i.e. cash)
Increase Liability (i.e. revenue received in advance)

However when the business earns the income, then an adjusting journal entry is required.
Decrease liability (i.e. revenue received in advance)
Increase equity (i.e. Income)

Question 6

How is the adjusting entry “Prepayment” transacted?

Answer 6

Business pays cash for a service before receiving it:
Increase asset (i.e. prepaid expense)
Decrease asset (i.e cash)

At the end of the accounting period the business needs to determine how much of the prepaid asset has been used up/consumed and add an adjusting entry:
Decrease equity (i.e. expense)
Decrease asset (i.e. prepaid expense)

Question 7

How is the adjusting entry “depreciation” transacted?

Answer 7

Is the recognition that non-current assets do not last forever and it allocates the cost of the asset over the time period that the economic benefits are expected to be delivered.

Adjusting entries are:
Decrease equity (i.e. depreciation expense)
Decrease asset (i.e. accumulated depreciation - contra asset)

Question 8

What is a contra asset?

Answer 8

It is part of the depreciation process.
Paired with and follows its related account.

Normal balance is opposite of the balance of the related account.

Question 9

How are the closing entries for “ Income and expense” prepared?

Answer 9

Income and expense accounts should start each new period with a zero balance.

They require closing entries to be recorded in the journal and posted to the ledger:
Closed with a P&L summary entry added to the opposite normal balance.
ie. expense = debit balance, P&L = credit balance.

Question 10

What happens to entries make in the journal for “profit and loss summary” & “drawings”?

Answer 10

They are closed off to owner capital.

Question 11

What happens to the asset and liability accounts at the end of the accounting period?

Answer 11

The balances are carried forward to the next period.

i.e. closing balance for one period is the opening balance for the next period.

Question 12

What is the whole account process?

Answer 12

1. Initial journal entries, posting to ledger and trial balance.
2. Adjusting entries (at end of accounting period), posted to the ledger.
3. Second trial balance prepared & Income statement prepared
4. Closing entries prepared and posted to ledgers.
5. Third trial balance prepared.
6. Balance sheet.