Question

• Why are adjusting entries needed?
• What are the four scenarios that lead to the four types of adjusting entries?
• What are the four financial statements, and what does each of them convey about an organization?
• What do closing entries do, and how do they work?

Answer 1

1. Why are adjusting entries needed?
Under accrual system, there may be situations where money has been received but not earned and vice versa. Similarly there may be situations where money has been paid but not incurred and vice versa. Under the accrual method, these transactions should be recorded during the accounting period in which they occur. Thus adjusting entries are needed to adjust these situations. Each adjusting entry generally affects one income statement account (revenue/expense) and one balance sheet account (asset/liability). Adjusting entries are made to ensure that the financial statements follows the and matching concept and revenue recognition concept.

2. What are the four scenarios that lead to the four types of adjusting entries?

Four types of adjusting entries are-

1. accrued revenues, 2. accrued expenses, 3. unearned revenues and 4.prepaid expenses

Four scenarios that lead to the four types of adjusting entries are-
1. Accrued revenues - When revenue/income has been earned but not received then there is need to create adjusting entry for Accrued Revenue

2. Accrued expenses- When expense has been incurred but not paid, then there is need to create adjusting entry for Accrued Expense

3. Unearned revenues- When money has been received but not earned then there is need to create adjusting entry for Unearned Revenue

4. Prepaid expenses - When money has been paid but not incurred, then there is need to create adjusting entry for Prepaid Expense

3. What are the four financial statements, and what does each of them convey about an organization?

Four financial statements are -
1. Balance Sheet/Statement of Financial Position - It shows financial position of the organization or company at a specific point in time. Balance Sheet is prepared for a particular date. It shows balance of assets liabilities and owner's capital on a particular dtae

2. Income Statement/Statement of Profit and Loss- It shows net profit or loss earned by company for a particular period. It shows revenue and expense leading to net profit or loss for a particular period

3. Statement of Cash Flows - It shows Inflow and Ouflow of cash from operating, investing and financing activities. It also reconciles cash changes from the beginning cash balance with the ending cash balance.

4. Statement of Change in Equity - It shows details about movement of owner’s equity over a period of time. It shows changes in retained earnings between the two periods

4. What do closing entries do, and how do they work?

Closing entries are the a journal entries that are made at end of Financial period to transfer balances from the temporary account to the permanent account.

Temporary accounts in the general ledger comprises of income statement accounts like sales or expense accounts. When the income statement is published at the end of the year, the balances of these temporary accounts are transferred to the income summary, which is also a temporary account. The balance of income summary is transferred to the retained earnings, which is a permanent account on the balance sheet.
Steps in closing process are:

1. Closing the revenue accounts—Transfer the balances in the revenue accounts to Income Summary by debiting revenue and crediting income summary.

2. Closing the expense accounts— Transfer the balances in the expense accounts to Income Summary by debiting income summary and crediting the expenses

3. Closing the Income Summary account—Transfer the balance of the Income Summary account to the Retained Earnings account by debiting income summary and crediting retained earnings

4. Closing the Dividends account— Tansferring the balance of the Dividends account to the Retained Earnings account
by debiting retained earnings and crediting dividends.