Question

Explain, in your own words, the concepts of adjustments and closing entries. In your explanations, use examples (with numbers) to demonstrate your understanding of the concepts. For this assignment, please include 1-3 sentences discussing the relationship between the two concepts.

Answer 1

Adjusting entries are made at the end of the accounting period (but prior to preparing the financial statements) in order for a company's accounting records and financial statements to be up-to-date on the accrual basis of accounting. For example, each day the company incurs wages expense but the payroll involving workers' wages for the last days of the month won't be entered in the accounting records until after the accounting period ends. Similarly, the company uses electricity each day but receives only one bill per month, perhaps on the 20th day of the month. The electricity expense for the last 10-15 days of the month must get into the accounting records if the financial statements are to show all of the expenses and the amounts owed for the current accounting period. Other adjusting entries involve amounts that the company paid prior to amounts becoming expenses. For examples, the company probably paid its insurance premiums for a six month period prior to the start of the six month period. The company may have deferred the expense by recording the amount in the asset account Prepaid Insurance. During the accounting period some of those premiums expired (were used up) and need to appear as expense in the current accounting period and the asset balance reduced.

Closing entries are dated as of the last day of the accounting period, but they are entered into the accounts after the financial statements are prepared. For the most part, closing entries involve the income statement accounts. The closing entries set the balances of all of the revenue accounts and the expense accounts to zero. This means that the revenue and expense accounts will start the new year with nothing in the accounts—allowing the company to easily report the new year revenues and expenses. The net amount of all of the balances from the revenue and expense accounts at the end of the year will end up in retained earnings (for corporations) or owner's equity (for sole proprietorships). Thanks to accounting software, the closing entries are quite effortless.

General Journal (Adjusting entries)	Debit	Credit
Insurance expense
prepaid insurance
Store supplies expense
store supplies
Office supplies expense
Office supplies
Depreciaiton expense-store equipment
Accumulated depricaition-store equipment
Depreciaiton expense-office equipment
Accumulated depricaition-office equipment
(Closing entries)
Sales
income summary
Income summary
sales discount
sales returns and allowances
cost of good sold
depreciation expense-office eq.
depreciation expense-store eq.
office salaries expense
sales salaries expense
insurance expense
rent expense-office space
rent expense-selling space
office supplies expense
store supplies expense
utilities expense
Income summary
retained earnings

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