Adjustments before a Financial Statement
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Four different types of adjustments that are frequently necessary before financial statements are prepared at the end of an accounting period:
a)The conversion of liabilities to revenues
b)The accruing of revenues that are not recorded.
c)The accruing expenses that is unrecorded.
d)The conversion of assets to expenses
The conversion of liabilities to revenues is achieved by recognizing the earned part of unearned revenue as revenues.
For example: On Oct. 1, 2008, Smash Inc. signed an agreement for giving a certain service to Koni. Smash received $500000 for that service that would be performed. At the end of the year 2008 half of the services under the contract have been proved to Koni. Smash should therefore make the below entries so as to record the revenue that had been earned .
The adjusting entry therefore be:
Dr. Unearned Revenue 250000
Cr. Service Revenue 250000
The accruing of revenues that are not recorded is to accrue the revenues that are present as well as recording the related assets. Due to the fact that the revenues are earned in a specific period and the cash received in another period, the adjustment is thus necessary.
For Example: On Jun 1, 2008, Smash Inc. makes an investment of $100,000for a bonds that pays 5% interest every year. Smash Inc. is not going to receive the interest till March 31, 2009. On December 31, 2008, Smash, Inc. need to make the below entry for the earned interest earned at that time.
The try adjusting for the adjustment is therefore:
Dr. Interest Receivable 2916.667
Cr. Interest Revenue 2916.667
The accruing expense that is unrecorded is to accrue the expenses that have been incurred and then record all the liabilities involved.
For Example: On the year-end, Dec. 31, 2008, the employees of Smash Inc.’s have earned a wages that total to $350,000 for the Monday, but Smash Inc. is not going to pay the wages till the 5th of the following month. Therefore, when the accounting period ends, Smash need to create the below entries to accrue the expense of the wages.
The adjusting entry will hence be:
Dr. Wages Expense 350000
Cr. Wages Payable 350000
The conversion of assets to expenses is to charge the part of prepaid expenses that has expired to expense.
For Example: On July 1, 2008, Smash Inc. paid $200000 for year’s rent that was covered from 1st of the month of July to 30th of the month of June. At the end of 2008, $100000 of expenses of rent have occurred and therefore Smash Inc. need to create the below entries so as to transfer the to the expenses the deferrals.
The adjusting entry is therefore:
Dr. Rent Expense 100000
Cr. Prepaid Rent 10000
Types of Accounts Closed at the End of each Accounting Year
At the end of the accounting year, temporary accounts, drawing and the income summary accounts are closed. The Temporary accounts include all the accounts listed in the income statement .These include the revenues, expenses, gains and the loses that the company could have made through the year (Whittington, 1993).
The income of the income account is one of the temporary accounts. This type of an account is used to close expense and revenue accounts. The balance in this account is equal to the amount in the net loss or the net income. The drawing account is also referred to as the contra-account. This is because this account decreases the capital balance.
The Three Major Steps in the Closing Process
At the end of every year the company does it calculation before closing it files ready to open new ones in the next fiscal year. This process takes three steps in order to be completed. The first step to this process is the Posting of the general journal. This step includes the closure of the revenue account which is located in the income summary, closing the expense account .And finally; for this step to be complete , the income summary account to a capital account should be closed .The summary account may either include the net loss or the net income. After finalizing with the above calculations, the drawing account to the owners’ account should be closed. The next step will involve transferring the income statements to their general ledger. Since the permanent accounts are not closed as the year end, their balances are posted on a post -trial closing balance which confirms that the credits are equal to the debits. With all that having being done, the fiscal year is closed.