Adjusting and Closing Process Address the topics below in your essay Discuss the

Question

Adjusting and Closing Process Address the topics below in your essay Discuss the adjusting process and provide at least three examples of adjustments including the journal entries to record them. Also explain the differences and similarities between the unadjusted and the adjusted trial balances 1. Explain the objectives of the closing process and list the steps required to complete it for a corporation, further elaborating on the account that, while affected by the closing process, is not closed. Also explain the differences and similarities between the adjusted and the post-closing trial balances. 2.

Explanation / Answer

A caution was issued about adjustments that may be needed to prepare a truly correct and up-to-date set of financial statements. This occurs because of multi-period items (revenue and expense items that relate to more than one accounting period) and accrued items (revenue and expense items that have been earned or incurred in a given period, but not yet entered into the accounting records). In other words, the ongoing business activity brings about changes in account balances that have not been captured by a journal entry. Time brings about change, and an adjusting process is needed to cause the accounts to appropriately reflect those changes. These adjustments typically occur at the end of each accounting period, and are akin to temporarily cutting off the flow through the business pipeline to take a measurement of what is in the pipeline. This is consistent with the revenue and expense recognition rules.

There is simply no way to catalog every potential adjustment that a business may need to make. What is required is a firm understanding of a particular business’s operations, along with a good handle on accounting measurement principles.

Multi Period Items: Prepaid Insurance, Prepaid Rent, Unearned revenue etc;

Accrued Items: Accrued Salaries, Accrued Rent, Accrued revenues etc;

Examples for adjustments with situations and entries:

Insurance policies are usually purchased in advance. Cash is paid up front to cover a future period of protection. Assume a three-year insurance policy was purchased on January 1, 20X1, for $9,000. By December 31, 20X1, $3,000 of insurance coverage would have expired (one of three years, or 1/3 of $9,000). The following entries would be needed to record the transaction on January 1 and the adjustment on December 31:

       

To Cash9000

(Prepaid a three year insurance policy)

To Prepaid expense3000

(To adjust prepaid insurance to reflect portion expired ($9000/3=$3000)

As a result of the above entry and adjusting entry, the income statement for 20X1 would report insurance expense of $3,000, and the balance sheet at the end of 20X1 would report prepaid insurance of $6,000 ($9,000 debit less $3,000 credit). The remaining $6,000 amount would be transferred to expense over the next two years by preparing similar adjusting entries at the end of 20X2 and 20X3.

Assume a two-month lease is entered and rent paid in advance on March 1, 20X1, for $3,000. By March 31, 20X1, half of the rental period has lapsed, and financial statements are to be prepared. The following entries would be needed to record the transaction on March 1, and adjust rent expense and prepaid rent on March 31:

(Prepared a two month lease)

To prepaid rent1500

(To adjust prepaid rent for portion lapsed i.e.; $3000/2=$1500)

Accrued rent is the opposite of prepaid rent discussed earlier. Recall that prepaid rent related to rent that was paid in advance. In contrast, accrued rent relates to rent that has not yet been paid, even though utilization of the asset has already occurred.

For example, assume that office space is leased, and the terms of the agreement stipulate that rent will be paid within 10 days after the end of each month at the rate of $400 per month. During December of 20X1, Cabul Company occupied the lease space, and the appropriate adjusting entry for December follows:

To Rent Payable400

(To record accrued rent)

When the rent is paid on January 10, 20X2, this entry would be needed:

               01-10-X2    Rent Payable     400

                                        To Cash               400

                               (To record payment of accrued rent).

Differences between an unadjusted trial balance and an adjusted trial balance

The differences between an unadjusted trial balance and adjusted trial balances are the amounts recorded as part of the adjusting entries.

Adjusting entries include the accrual of revenues that were earned but were not yet recorded, and the accrual of expenses that were incurred but were not yet recorded. Accrued expenses and the related liabilities often involve wages, utilities, repairs and maintenance, commissions, interest, and more.

Adjusting entries also include depreciation and the deferral of or an adjustment of prepayments including prepaid insurance, unearned revenues, customer deposits, and more.

The remaining same are similarities between unadjusted and unadjusted trail balances.

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