Journal Entries and Adjusting Entries

• Journal entries record financial transactions using the double-entry accounting system.
• Each transaction affects at least two accounts: debits and credits.

Key Accounting Concepts

• Debits increase assets/expenses.
• Credits increase liabilities/equity/revenues.
• General Journal: Where transactions are first recorded.
• T-Accounts: Visual representations of debits and credits for each account.
• Example: A business purchases supplies worth $500 on credit with a debit: Supplies (Asset) $500; and credit: Accounts Payable (Liability) $500.

Adjusting Entries

• Adjusting entries update account balances before financial statements to ensure accuracy.

Key Types of Adjusting Entries

• Accrued Revenues: Revenue earned but not yet received.
• Accrued revenue example: A lawyer provides services in December but gets paid in January.
  • The entry includes a debit to: Accounts Receivable; and credit to: Service Revenue.
• Accrued Expenses: Expenses incurred but not yet paid.
• Accrued expenses example: A company owes salaries for December but pays in January.
  • The entry includes a debit to: Salaries Expense; and credit to: Salaries Payable.
• Deferred (Unearned) Revenues: Cash received in advance, service not yet performed.
• Deferred revenue example: A school receives tuition fees for the next semester.
  • The entry includes a debit to: Unearned Revenue; and credit to: Service Revenue.
• Prepaid Expenses: Expenses paid in advance, used over time.
• Prepaid expenses example: A company pays $12,000 for a one-year insurance policy.
  • Monthly Adjusting Entry (after 1 month): Debit: Insurance Expense $1,000; Credit: Prepaid Insurance $1,000
• Depreciation: Spreading asset cost over its useful life.
• Depreciation example: A truck costing $50,000 depreciates by $5,000 per year.
  • The entry includes a debit to: Depreciation Expense $5,000; and credit to: Accumulated Depreciation $5,000.

Annual Checking in T-Accounts

• T-Accounts help visualize how transactions affect account balances.
• Accountants review T-accounts at year-end to ensure accuracy before financial statements are finalized.

Steps for Annual Checking

• Verify Opening Balances: Ensure last year's closing balances match this year's opening balances.
• Check Adjusting Entries: Ensure necessary year-end adjustments (e.g., accruals, deferrals) are recorded.
• Review Ledger Totals: Verify debits and credits in each T-account balance.
• Prepare the Trial Balance: Compare ledger totals before financial statements are created.

Example Problem: Year-End Checking of a T-Account

• A company's Prepaid Rent account had transactions in January: Paid $12,000 for one-year rent; December: Adjusting entry to recognize rent expense for the year.
• T-Account for Prepaid Rent:
  • Prepaid Rent (Asset Account)
  • Jan 1: $12,000 (Dr)
  • Dec 31: ($12,000) (Cr) → Rent Expense
  • Ending Balance: $0
• Annual Checking: Since the balance is $0, it confirms that all rent expense has been correctly recorded for the year.

Preparing Financial Statements

• Once adjusting entries are recorded and T-accounts are checked, financial statements can be prepared.
• Income Statement: Summarizes revenues and expenses.
• Balance Sheet: Reports assets, liabilities, and equity.
• Statement of Cash Flows: Shows cash inflows and outflows.

Closing Entries (End-of-Year Adjustments)

• Closing entries reset temporary accounts (revenues, expenses, and dividends) to prepare for the next period.

Key Closing Entries

• Close Revenue to Income Summary.
  • Debit: Revenue
  • Credit: Income Summary
• Close Expenses to Income Summary.
  • Debit: Income Summary
  • Credit: Expenses
• Close Income Summary to Retained Earnings.
  • Debit: Income Summary
  • Credit: Retained Earnings
• Close Dividends to Retained Earnings.
  • Debit: Retained Earnings
  • Credit: Dividends
• Example: A company had $100,000 in revenue and $60,000 in expenses.
  • Closing Revenue:
    • Debit: Revenue $100,000
    • Credit: Income Summary $100,000
  • Closing Expenses:
    • Debit: Income Summary $60,000
    • Credit: Expenses $60,000
  • Closing Net Income ($40,000) to Retained Earnings:
    • Debit: Income Summary $40,000
    • Credit: Retained Earnings $40,000

Real-Life Examples of Journal Entries & Adjustments

• Personal Finance: Paying rent in advance (Prepaid Expense).
• Business Transactions: A store receives payments before delivering products (Unearned Revenue).
• Freelancing: A photographer completes a shoot in December but gets paid in January (Accrued Revenue).