Adjusting Journal Entries

• Adjusting journal entries update accounts before financial statements, affecting multiple periods and adhering to the accrual principle.
• These entries are made at the end of each accounting period.

Accrual Basis of Accounting

• Businesses prepare adjusting entries to recognize revenues when earned and expenses when incurred.

Revenue Recognition

• Accounting standards mandate revenue recognition when earned and reliably measured.

Sources of Adjusting Entries

• Prepayment of Expenses
• Unearned Income/ Deferred Income
• Accrual Expenses
• Accrual Income
• Provision for Bad Debts
• Depreciation

Adjustment for the Expiration of Prepayment Expenses

• Prepaid expenses are expenses paid in advance, becoming expenses as they are used.

Two Methods for Prepayment Expenses

• Asset Method: Charges the initial payment to an asset account.
• Expense Method: Charges the initial payment to an expense account.

Adjustment for Unearned Income or Deferred Income

• Unearned income occurs when payment is received before delivering goods or services rendered.
• These are initially recorded as liabilities, becoming income over time.

Two Methods for Unearned Income

• Income Method: Credits an income account upon cash receipt.
• Liability Method: Credits a liability account upon cash receipt.

Accrual of Expenses

• Accrued expenses are incurred during the period but not yet paid or recorded
• Debit an expense and credit a liability (accrued expense)

Accrued Income

• Accrued income arises when goods are delivered or services rendered without payment.
• Debit an asset (Accrued Income or Accounts Receivable) and credit an income account

Provisions for Bad Debts

• A percentage of collectibles may become uncollectible.
• Losses from uncollectible accounts are termed "Bad Debts".
• Debit Bad Debts Expense or Doubtful Accounts Expense and credit Allowance for Bad Debts or Allowance for Doubtful Accounts

Depreciation Expense

• Depreciation is the allocated cost of an asset already used or consumed.

Factors in Computing Depreciation Expense

• Cost: Purchase price of the depreciable asset
• Salvage Value: Asset's value at the end of its useful life
• Estimated Useful Life: Estimated number of years the asset can be used
• Debit Depreciation Expense and credit Accumulated Depreciation

Application of Adjusting Entries

• Adjusting entries ensure accurate recording of business activities.
• They match income and expenses and facilitate precise revenue tracking.
• Adjusting entries are essential for asset depreciation reporting.

Worksheet

• A worksheet gathers data for adjusting entries, financial statements, and closing entries.

Preparing the Financial Statements

• Income Statement (or Statement of Comprehensive Income): Prepared first, showing financial performance (revenues less expenses).
• Statement of Changes in Equity: Prepared after the income statement, using the net income figure.
• Statement of Financial Position: Prepared after the statement of changes in equity, using the ending capital. Also known as the balance sheet.

Forms of Statement of Financial Position

• Account Form: Horizontal presentation
• Report Form: Vertical presentation

Journalizing and Posting of Closing Entries

• Nominal (temporary) accounts (income, expenses) and drawing accounts are closed to zero by transferring balances to income summary.
• Closing entries are responsible for closing nominal & drawing accounts to zero balances.

Steps in Closing the Accounts

• Close Income Accounts: Debit revenue accounts to zero out and credit income summary.
• Close Expense Accounts: Credit expense accounts to zero out and debit income summary for the total.
• Close Income Summary Account: Transfer the balance (net income or loss) to the capital account.
• Close Drawing Account: Transfer the debit balance of the drawing account to capital accounts.

Preparing the Post Closing Trial Balance

• Only real accounts (assets, liabilities, and equity) remain after closing.
• Verifies the equality of debits and credits.

Journalizing and Posting of Reversing Entries (Optional)

• Only certain adjusting entries can be reversed.

Entries that can be reversed

• Accrued expense
• Accrued income
• Deferred income under the income method
• Prepaid expense under the expense method

Inventory Systems

• Perpetual Systems: Continuously update records, providing a running balance of available goods and cost of goods sold; no purchases account.
• Periodic Systems: Update records at the end of the accounting period to reflect the quantity and cost of available and sold goods.

Purchases (debit)

• Acquisition of merchandise for resale on cash, credit, or note.

Purchases Returns and Allowances (PRA) (credit)

• When a customer returns goods to the supplier for refund.

Purchase Discount (credit)

• Reduction in price granted for early payment within the discount period.

Freight-In (debit)

• Records the transport cost of purchased goods.

Trade Discounts

• A deduction from the list price to encourage bulk purchases.
• It is not recorded in accounting books.

SALES (credit)

• An income account for gross proceeds from merchandise sales.

Freight-Out (debit)

• Records transport costs of goods sold to customers, also called Delivery Expense.

Sales Returns and Allowances

• A debit account for returns of merchandise by dissatisfied customers.

Sales Discounts

• A debit account for price reductions offered for early payment.

Accounting for Freight Costs

• The sales agreement dictates who pays for transportation costs.

FOB Shipping Point

• Ownership transfers to the buyer when goods leave the seller's premises.
• The buyer pays freight costs and Freight-In is debited.

FOB Destination

• Ownership transfers when goods are delivered to the buyer.
• The seller pays freight costs, and Freight-Out is debited.

Statement of Comprehensive Income

• Net Income/Loss=Net Sales-COGS-Operating Expenses
• Gross Profit=Net Sales–COGS
• Net Cost of Purchases=Purchases-Purchase Returns-Purchase Discount+Freight In
• COGS = Beginning Merchandise Inventory + Net Cost of Purchases - Ending Merchandise Inventory
• TGAFS = Beginning Merchandise Inventory + Net Cost of Purchases