Adjusting Entries Company A Exercises

Journal Entries
Analysing transactions and recording them as journal entries is the first step in the accounting
cycle. It begins at the start of an accounting period and continues throughout the period.
Transaction analysis is a process that determines whether a particular business event has an
economic effect on the assets, liabilities or equity of the business. It also involves ascertaining
the magnitude of the transaction i.e. its currency value.
After analysing transactions, accountants classify and record the events having an economic
effect via journal entries according to debit-credit rules. Frequent journal entries are usually
recorded in specialized journals, for example, sales journal and purchases journal. The rest are
recorded in a general journal.
The following example illustrates how to record journal entries:
Example
Company A was incorporated on January 1, 20X0 with an initial capital of 5,000 shares of
common stock having Php20 par value. During the first month of its operations, the company
engaged in the following transactions:
Date Transaction
Jan 2 An amount of Php 36,000 was paid as advance rent for three months.
Paid Php 60,000 cash on the purchase of equipment costing Php 80,000. The remaining
Jan 3
amount was recognized as a one year note payable with an interest rate of 9%.
Jan 4 Purchased office supplies costing Php 17,600 on account.
Jan 13 Provided services to its customers and received Php 28,500 in cash.
Jan 13 Paid the accounts payable on the office supplies purchased on January 4.
Jan 14 Paid wages to its employees for the first two weeks of January, aggregating Php 19,100.
Provided Php 54,100 worth of services to its customers. They paid Php 32,900 and
Jan 18
promised to pay the remaining amount.
Jan 23 Received Php 15,300 from customers for the services provided on January 18.
Jan 25 Received Php 4,000 as an advance payment from customers.
Jan 26 Purchased office supplies costing Php 5,200 on account.
Jan 28 Paid wages to its employees for the third and fourth week of January: Php 19,100.
Jan 31 Paid Php 5,000 as dividends.
Jan 31 Received an electricity bill of Php 2,470.
Jan 31 Received a telephone bill of Php ,494.
Jan 31 Miscellaneous expenses paid during the month totaled Php 3,470
The following table shows the journal entries for the above transactions.
The following table shows the journal entries for the above transactions.
Date Account Debit Credit
Jan 1 Cash 100,000
Common Stock 100,000
Jan 2 Prepaid Rent 36,000
Cash 36,000
Jan 3 Equipment 80,000
Cash 60,000
Notes Payable 20,000

Jan 4 Office Supplies 17,600
Accounts Payable 17,600
Jan 13 Cash 28,500
Service Revenue 28,500
Jan 13 Accounts Payable 17,600
Cash 17,600
Jan 14 Wages Expense 19,100
Cash 19,100
Jan 18 Cash 32,900
Accounts
21,200
Receivable
Jan 23 Cash 15,300
Accounts
15,300
Receivable
Jan 25 Cash 4,000
Unearned Revenue 4,000
Jan 26 Office Supplies 5,200
Jan 28 Wages Expense 19,100
Cash 19,100
Jan 31 Dividends 5,000
Cash 5,000
Jan 31 Electricity Expense 2,470
Utilities Payable 2,470
Jan 31 Telephone Expense 1,494
Jan 31 Miscellaneous Expense 3,470
Cash 3,470
At the end of the period, all the journal for the period are posted to the ledger accounts.
The second step of accounting cycle is to post the journal entries to the ledger accounts.
The journal entries recorded during the first step provide information about which accounts are to be
debited and which to be credited and also the magnitude of the debit or credit (see debit-credit-rules).
The debit and credit values of journal entries are transferred to ledger accounts one by one in such a
way that debit amount of a journal entry is transferred to the debit side of the relevant ledger account
and the credit amount is transferred to the credit side of the relevant ledger account.
After posting all the journal entries, the balance of each account is calculated. The balance of an asset,
expense, contra-liability and contra-equity account is calculated by subtracting the sum of its credit side
from the sum of its debit side. The balance of a liability, equity and contra-asset account is calculated
the opposite way i.e. by subtracting the sum of its debit side from the sum of its credit side.
Example
The ledger accounts shown below are derived from the journal entries of Company A.
Asset Accounts
Cash Accounts Receivable

$100,00
$36,000 $21,200 $15,300
0
28,500 60,000
32,900 17,600
15,300 19,100
4,000 19,100
5,000
3,470
$20,430 $5,900
Office Supplies Prepaid Rent
$17,60 $36,00
0 0
5,200
$22,80 $36,00
0 0
Equipment
$80,000
$80,000
Liability Accounts
Accounts Payable Notes Payable

$17,600 $17,600 $20,000
5,200
$5,200 $20,000
Utilities Payable Unearned Revenue
$2,470 $4,000
1,494
$3,964 $4,000
Equity Accounts
Common Stock
$100,000
$100,000
Revenue, Dividend and Expense Accounts
Service Revenue Dividend

$28,500 $5,000
54,100
$82,600 $5,000
Wages Expense Miscellaneous Expense
$19,10
$3,470
0
19,100
$38,20 $3,470
0
Electricity Expense Telephone Expense
$2,470 $1,494
$2,470 $1,494
The ledger accounts step of accounting cycle completes here.
The next step is the preparation of unadjusted trial balance
Unadjusted Trial Balance

An unadjusted trial balance is a trial balance which is created before any adjusting
entries are made in the ledger accounts.
A trial balance is a list of the balances of ledger accounts of a business at a
specific point of time usually at the end of a period such as month, quarter or
year.
The preparation of a trial balance is very simple. All we have to do is to list the
balances of all the ledger accounts of a business.
Example
The following unadjusted trial balance has been prepared from the ledger
accounts of Company A.
Company A
Unadjusted Trial Balance
January 31, 20X0
Debit Credit
Cash $20,430
Accounts Receivable 5,900
Office Supplies 22,800
Prepaid Rent 36,000
Equipment 80,000
Accounts Payable $5,200
Notes Payable 20,000
Unearned Revenue 4,000
Common Stock 100,000
Wages Expense 38,200
Miscellaneous
3,470
Expense
Electricity Expense 2,470
Telephone Expense 1,494
Dividend 5,000
Total $215,764 $215,764
Since, in double entry accounting we record each transaction with equal debit and credit
effect, therefore the total of debit and credit balances of the trial balance are always
equal. Any difference shall indicate some mistake in the recording process or in the
calculations. Although each unbalanced trial balance indicates mistake, this does not
mean that a trial balance which is balanced is always correct. It is quite possible for
incorrect journal entries to not unbalance the trial balance and they may escape un-
noticed if individual journals and ledgers are not reviewed carefully. Examples of such
errors are: to omit an entry, to record a transaction twice, to record an expense in the
wrong expense account, etc.
After the preparation of an unadjusted trial balance, the next step in the accounting
cycle is to pass adjusting entries.
Adjusting Entries
Adjusting entries are journal entries recorded at the end of an accounting period to adjust income
and expense accounts so that they comply with the accrual concept of accounting. Their main
purpose is to match incomes and expenses to appropriate accounting periods.
The transactions which are recorded using adjusting entries are not spontaneous but are spread
over a period of time. Not all journal entries recorded at the end of an accounting period are
adjusting entries. For example, an entry to record a purchase on the last day of a period is not an
adjusting entry. An adjusting entry always involves either income or expense account.
Types
There are following types of adjusting entries:
 Accruals:
These include revenues not yet received nor recorded and expenses not yet paid nor
recorded. For example, interest expense on loan accrued in the current period but not yet
paid.
 Prepayments:
These are revenues received in advance and recorded as liabilities, to be recorded as
revenue and expenses paid in advance and recorded as assets, to be recorded as expense.
For example, adjustments to unearned revenue, prepaid insurance, office supplies,
prepaid rent, etc.
 Non-cash:
These adjusting entries record non-cash items such as depreciation expense, allowance
for doubtful debts etc.
Example
This example is a continuation of the accounting cycle problem we have been working on. In the
previous step we prepared an unadjusted trial balance. Here we will pass adjusting entries.
Relevant information for the preparation of adjusting entries of Company A

Office supplies having original cost $4,320 were unused till the end of the period. Office
supplies having original cost of $22,800 are shown on unadjusted trial balance.
Prepaid rent of $36,000 was paid for the months January, February and March.
The equipment costing $80,000 has useful life of 5 years and its estimated salvage value is
$14,000. Depreciation is provided using the straight line depreciation method.
The interest rate on $20,000 note payable is 9%. Accrue the interest for one month.
$3,000 worth of service has been provided to the customer who paid advance amount of $4,000.
The adjusting entries of Company A are:

Jan 31 Supplies Expense 18,480
Office Supplies 18,480
Supplies Expense = $22,800 − $4,320 = $18,480
Jan 31 Rent Expense 12,000
Prepaid Rent 12,000
Rent Expense = $36,000 ÷ 3 = $12,000
Jan 31 Depreciation Expense 1,100
Accumulated
1,100
Depreciation
Depreciation Expense = ($80,000 − $14,000) ÷ (5 × 12) = $1,100
Jan 31 Interest Expense 150
Interest Payable 150
Interest Expense = $20,000 × (9% ÷ 12) = $150
Jan 31 Unearned Revenue 3,000
An adjusted trial balance is prepared in the next step of accounting cycle.
Adjusted Trial Balance

An adjusted trial balance is a trial balance which is prepared after the preparation of adjusting
entries. Adjusted trial balance contains balances of revenues and expenses along with those of
assets, liabilities and equities. Adjusted trial balance can be used directly in the preparation of the
statement of changes in stockholders' equity, income statement and the balance sheet. However it
does not provide enough information for the preparation of the statement of cash flows.
The format of an adjusted trial balance is same as that of unadjusted trial balance.
Example
The following adjusted trial balance was prepared after posting the adjusting entries of Company
A to its general ledger and calculating new account balances:
Company A
January 31, 20X0
Debit Credit
Cash $20,430 −
Accounts Receivable 5,900 −
Office Supplies 4,320 −
Prepaid Rent 24,000 −
Equipment 80,000 −
Accumulated Depreciation − $1,100
Accounts Payable − 5,200
Utilities Payable − 3,964
Unearned Revenue − 1,000
Interest Payable − 150
Notes Payable − 20,000
Common Stock − 100,000
Service Revenue − 85,600
Wages Expense 38,200 −
Supplies Expense 18,480 −
Rent Expense 12,000 −
Miscellaneous Expense 3,470 −
Electricity Expense 2,470 −
Telephone Expense 1,494 −
Depreciation Expense 1,100 −
Interest Expense 150 −
Dividend 5,000 −
Total $217,014 $217,014
The totals of an adjusted trial balance must be equal. Any difference indicates that there
is accounting error in the journal entries or in the ledger or in the calculations.
The next step of accounting cycle is the preparation of closing entries.
by Irfanullah Jan, ACCA and last modified on May 14, 2019
Related Topics
 Adjusting Entries
 Unadjusted Trial Balance
Post-Closing Trial Balance
Closing Entries
Closing entries are journal entries made at the end of an accounting period which
transfer the balances of temporary accounts to permanent accounts. Closing entries are
based on the account balances in an adjusted trial balance.
Temporary accounts include:
1. Revenue, Income and Gain Accounts

2. Expense and Loss Accounts
3. Dividend, Drawings or Withdrawals Accounts
4. Income Summary Account
The permanent account to which balances are transferred depend upon the type of
business. In case of a company, retained earnings account, and in case of a firm or a sole
proprietorship, owner's capital account receives the balances of temporary accounts.
Income summary account is a temporary account which facilitates the closing process.
Closing entries are better explained via an example.
Example
The following example shows the closing entries based on the adjusted trial balance of
Company A.
Note Date Account Debit Credit

1 Jan 31 Service Revenue 85,600
Income Summary 85,600
2 Jan 31 Income Summary 77,364
Wages Expense 38,200
Supplies Expense 18,480
Rent Expense 12,000
Miscellaneous
3,470
Expense
Electricity Expense 2,470
Telephone Expense 1,494
Depreciation
1,100
Expense
Interest Expense 150
3 Jan 31 Income Summary 8,236
Retained Earnings 8,236
4 Jan 31 Retained Earnings 5,000
Note Date Account Debit Credit
Dividend 5,000
Notes
1. Service revenue account is debited and its balance it credited to income summary
account. If a business has other income accounts, for example gain on sale
account, then the debit side of the first closing entry will also include the gain on
sale account and the income summary account will be credited for the sum of all
income accounts.
2. Each expense account is credited and the income summary is debited for the sum
of the balances of expense accounts. This will reduce the balance in income
summary account.
3. Income summary account is debited and retained earnings account is credited for
the an amount equal to the excess of service revenue over total expenses i.e. the
net balance in income summary account after posting the first two closing
entries. In this case $85,600 − $77,364 = $8,236. Please note that, if the balance in
income summary account is negative at this stage, this closing entry will be
opposite i.e. debit to retained earnings and credit to income summary.
4. The last closing entry transfers the dividend or withdrawal account balance to the
retained earnings account. Since dividend and withdrawal accounts are contra to
the retained earnings account, they reduce the balance in the retained earnings.
The last step of an accounting cycle is to prepare post-closing trial balance.
Post-Closing Trial Balance

A post-closing trial balance is a list of balances of ledger accounts prepared after closing
entries have been passed and posted to the ledger accounts. Since the closing entries transfer the
balances of temporary accounts (i.e. expense, revenue, gain, dividend and withdrawal accounts)
to the retained earnings account, the new balances of temporary accounts are zero and therefore
they are not listed on a post-closing trial balance. However, all the other accounts having non-
negative balances are listed including the retained earnings account.
The preparation of post-closing trial balance is the last step of the accounting cycle and its
purpose is to be sure that sum of debits equal the sum of credits before the start of new
accounting period. It provides the openings balances for the ledger accounts of the new
accounting period.
Example
The following post-closing trial balance was prepared after posting the closing entries of
Company A to its general ledger and calculating new account balances:
Company A
January 31, 2010
Debit Credit
Cash $20,430 −
Accounts Receivable 5,900 −
Office Supplies 4,320 −
Prepaid Rent 24,000 −
Equipment 80,000 −
Accumulated Depreciation − $1,100
Accounts Payable − 5,200
Utilities Payable − 3,964
Unearned Revenue − 1,000
Interest Payable − 150
Notes Payable − 20,000
Common Stock − 100,000
Retained Earnings − 3,236
Total $134,650 $134,650
This is the end of the accounting cycle. In the next accounting period, the accounting cycle will
be repeated again starting from the preparation of journal entries i.e. the first step of accounting
cycle.
t Chapter
 Accounting Cycle
 Journal Entries
 Ledger Accounts
 Trial Balance
 Adjusted Trial Balance
 Closing Entries
 Post-Closing Trial Balance
 Income Summary Account
 Reversing Entries
 Compound Entries
 Accounting Errors
 Accounting Worksheet
 Accruals and Prepayments
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Income Summary Account

Income summary account is a temporary account used in the closing stage of the accounting
cycle to compile all income and expense balances and determine net income or net loss for the
period. The net balance of the income summary account is closed to the retained
earnings account.
In the closing stage, balances in all income accounts are transferred to the income summary
account by debiting the individual income accounts by their closing balance and crediting the
corresponding balance to the income summary account. Similarly, balances in all expense
accounts are transferred to the income summary account by crediting the individual accounts by
their closing balance and debiting the corresponding balance to the income summary account.
If the income summary account has a net credit balance i.e. when the sum of the credit side is
greater than the sum of the debit side, the company has a net income for the period. Conversely,
if the income summary account has a net debit balance i.e. when the sum of the debit side is
greater than the sum of the credit side, it represents a net loss.
An income summary account is effectively a T-account of the income statement. Since it is a

temporary ledger account, it does not appear on any financial statement.
A net income is closed/transferred to retained earnings by debiting income summary account and
crediting retained earnings account while a net loss is transferred by crediting income summary
account and debiting retained earnings account. Once this process is complete, a post-closing
trial balance is prepared which helps in preparation of the balance sheet.
Example
In the financial year 2012, PC Ltd. had total revenues of $20 million. It used three expense
accounts with the following balances:
Cost of goods sold $8 million

Selling expense $4 million
Administrative expense $2 million
Finance cost $1 million
Post the transactions to the income summary account and close the income summary account.
Solution
Income Summary Account
Cost of goods sold 8,000,000 Revenues 20,000,000
Selling expense 4,000,000
Administrative expenses 2,000,000
Finance cost 1,000,000
Balance 5,000,000
In this case, the income summary account has a net credit balance which means that the company
has a net income of $5 million.
The income summary account is closed by taking the net balance to retained earnings as follows:
$5
Income summary account
million
$5
Retained earnings
million
All Chapters in Accounting
Current Chapter
 Journal Entries
 Ledger Accounts
 Trial Balance
 Closing Entries
Reversing Entries
Reversing entries are passed at the beginning of an accounting period as an optional
step of accounting cycle to cancel the effect of previous period adjusting entries
involving future payments or receipts of cash. The benefit of reversing those adjusting
entries is that this eliminates the need to identify what part, if any, of a particular
payment or receipt made or received in the period relates to the previous period
expense or revenue.
When reversing entries are not made, the accountant needs to remember last period
adjusting entries and account for any expense/revenue previously recognized relating to
current period payments or receipts. This is done using compound journal entries.
Reversing entries are best explained using an example:
Example
Two of the adjusting entries recorded by a company on year ending Dec 31, 20X2 are
shown below:

Dec 31 Interest Expense $1,500
Interest Payable $1,500
Dec 31 Rent Receivable $29,000
Rent Revenue $29,000
Interest was accrued during the months of November and December on loan of
$100,000 obtained on Nov 1, 20X2. Interest is payable after every three months. Rent
receivable is related to a building given on rent on Dec 1, 20X2. Rent is payable after
every 2 months.
Pass the journal entries recording the actual payment of interest and receipt of rent first
without reversing entries and then with reversing entries.
Solution
Interest Rate on Loan

= (1,500 ÷ 2) × 12 / $100,000
= 9%
Total Interest Payment on Feb 1, 20X3 (a)

= 9% × 3/12 × $100,000
= $2,250
Rent Payable on Feb 1 (b)

= 29,000 × 2
= $58,000
Without Using Reversing Entries:
Under this method, each payment is apportioned between expense and payable and
each receipt between a revenue and a receivable. Thus:
Interest Expense in 20X3 resulting from (a)

= $2,250 − $1,500
= $750
Rent Expense in 20X3 resulting from (b)

= $58,000 − $29,000
= $29,000
Feb
Interest Expense $750
1
Cash $2,250
Feb
Cash $58,000
1
Rent Receivable $29,000
Using Reversing Entries:
This method involves two steps, first, the last period adjusting entries which involve
future payments or receipts are reversed as shown below:

Jan
1
Interest Expense $1,500
Jan
1
Rent Receivable $29,000
At the time of actual payment or receipt, a simple journal entry is used to record them
without any regard to the part of the payment or receipt which may relate to last period.
Thus,

Feb
Interest Expense $2,250
1
Cash $2,250
Feb
Cash $58,000
1
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Related Topics
 Journal Entries
 Closing Entries
 Debit and Credit
 Accounting Equation
Compound Journal Entries

Compound journal entry is an accounting entry which affects three or more account
heads. A simple journal entry has just two rows i.e. one debit and one credit, whereas a
compound journal entry has three or more rows.
A compound entry is actually a combination of two or more simple journal entries but
instead of recording numerous separate journal entries, it is better to merge multiple
journal entries of a single accounting event into a single compound entry because it
saves time and keeps the related debits and credits in one place in the journal.
Example
The following examples illustrate the format of a compound journal entry:
Example 1
On Jan 1, 20X3 Company T purchased a computer costing $1,000 from a supplier and
issued a check of $3,400. The excess amount fully settles a previous amount owed by
the company to the supplier.
Since the total payment of $3,400 comprised of $1,000 for computer and the remaining
$2,400 for past payable, this transaction may be recorded in two separate journal
entries:
 Debit Equipment and Credit Cash for $1,000 each; and

 Debit Payables and Credit Cash for $2,400 each.
Alternatively, it is much faster and intuitive if we record the above transaction as a single
compound entry as follows:

Jan 1, 20X3 Equipment 1,000
Cash 3,400
Example 2
FGH Company obtained a loan of $10,000 @12% interest on July 1, 20X2. The loan was
repaid on Dec 31, 20X2, the year-end of FGH Company.
Interest expense on loan

= $10,000 × 6/12 × 12%
= $600.
The repayment can be recorded using the following compound journal entry:

Dec 31, 20X2 Loan Payable 10,000
Interest
600
Expense
Cash 10,600
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Related Topics
 Journal Entries
 Closing Entries
 Debit and Credit
 Accounting Equation
Current Chapter
 Journal Entries
 Ledger Accounts
 Trial Balance
 Closing Entries
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Accounting Errors
Accounting errors are unintentional mistakes in book-keeping of transactions. Accounting errors
are different from accounting fraud because in fraud an intentional mistake is made to
misrepresent financial information or to conceal misappropriation of assets.
Accounting errors are easier to identify when they cause a difference between debit and credit
totals of a trial balance. However accounting errors may not always cause a trial balance to
imbalance, in which case they are relatively difficult to identify. Where a trial balance is
imbalanced by accounting errors, the difference between the debit and credit totals of the trial
balance is temporarily kept in suspense account until the errors are corrected.
Types
Accounting errors can be broadly classified into the following types. Please note that different
types of errors may have overlapping characteristics.
Errors of Principle
Errors that involve violation of accounting principles, misinterpretation of facts, unintentional
unrealistic estimates or incorrect method of calculation. These errors are usually caused due to
insufficient accounting knowledge.
Clerical Errors
It is in human nature to make mistakes. For example, an accountant may inadvertently enter an
incorrect figure in accounts. Such errors are known as clerical errors. Clerical errors may be
minimized with experience. Clerical errors have following sub-types:
 Arithmetic: Errors in calculations other than incorrect method of calculation.

 Input Errors: Incorrect figures input into accounting records. Most common input error is
a transposition error in which a number is input with incorrect order of digits.
 Omissions: Forgetting to enter a transaction in accounting records.
 Misplacement: Entering a transaction in wrong account.
Examples
 Errors of Principle: Recognizing expense in wrong accounting period, recognizing
unearned revenue as income instead of a liability, inconsistent application of accounting
principles, etc.
 Arithmetic: Calculations such as 3+2×6 may be incorrectly done by performing addition
before multiplication, thus arriving at 30 as the answer. However the correct answer is 15
because we have to perform multiplication before addition.
 Input Errors: Entering 120000 as 12000 or 2389 as 3289. These errors may be minimized
by using comma as a separator i.e. formatting 120000 as 120,000.
 Omissions: Forgetting to record a purchase transaction.
 Misplacement: Recording amount receivable from Customer A in Customer B’s account.
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Current Chapter
 Journal Entries
 Ledger Accounts
 Trial Balance
 Closing Entries
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About
Accounting Worksheet

An accounting worksheet is large table of data which may be prepared by accountants as an

optional intermediate step in an accounting cycle. The main purpose of a worksheet is that it
reduces the likelyhood of forgeting an adjustment and it reveals arithmatic errors. A worksheet
acts as a tool for an accountant and it is not usually intented to be used by third parties. It is an
informal document.
A typical worksheet consists of a column on the left showing main account titles and 10 more
columns of debits and credits showing trial balance, adjustments, adjusted trial balance, incomes
statement and balancesheet.
Example
The following example shows a worksheet based on the data from various pages of this chapter.
Scroll the worksheet to the right to view all columns.
Unadjusted Trial Balance Adjustments Adjusted Trial Balance Income Statement

Account Title
Debit Credit Debit Credit Debit Credit Debit Credit
Cash $20,430 $20,430
Accounts Receivable 5,900 5,900
Office Supplies 22,800 $18,480 4,320
Prepaid Rent 36,000 12,000 24,000
Equipment 80,000 80,000
Accumulated Depreciation 1,100 $1,100
Accounts Payable $5,200 5,200
Notes Payable 20,000 20,000
Utilities Payable 3,964 3,964
Interest Payable 150 150
Unearned Revenue 4,000 $3,000 1,000
Common Stock 100,000 100,000
Service Revenue 82,600 3,000 85,600 $85,600
Wages Expense 38,200 38,200 $38,200
Supplies Expense 18,480 18,480 18,480
Rent Expense 12,000 12,000 12,000
Depreciation Expense 1,100 1,100 1,100
Miscellaneous Expense 3,470 3,470 3,470
Electricity Expense 2,470 2,470 2,470
Telephone Expense 1,494 1,494 1,494
Dividend 5,000 5,000
Interest Expense 150 150 150
Totals $215,764 $215,764 $34,730 $34,730 $217,014 $217,014 $77,364 $85,600
Net Income 8,236
$85,600 $85,600
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Current Chapter
 Journal Entries
 Ledger Accounts
 Trial Balance
 Closing Entries
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Accruals and Prepayments

Accruals are expenses incurred but not yet paid while prepayments are payments for
expenses for that are not yet incurred. Accruals and prepayments give rise to current
liabilities and current assets respectively in accordance with the matching principle and
accrual accounting.
Matching principle requires accountants to record revenues and expenses in the period
in which they are incurred regardless of when the relevant payments are made. In order
to create this 1-on-1 correspondence between revenue and expenses, expenses are
recorded if they are incurred in a particular period even if they are not yet paid, because
they were necessary to earn the revenue for that period. On the other hand,
prepayments are recorded to represent payments related to goods and services that are
to be consumed in future periods. It is this matching principle that differentiates accrual
accounting from cash-basis accounting, which records revenues and expenses when
they are received and not when they are earned or incurred.
Examples
Woodworks, Inc. is a furniture manufacturer and retailer. You are closing the books of
the company for the year ended 30 June 2014. Suggest appropriate accounting
treatment for the following transactions:
1. The company paid salaries of $70,000 for June 2014 on 4 July 2014. Total salaries
for the year 2014 do not already include this figure.
2. On 5 July 2014, the company received utility bills totaling $30,000.
3. Annual rent of $100,000 on Outlet A was paid on 1 January 2014 and it was
recorded as prepaid rent.
4. Semi-annual rent of $30,000 on Outlet B was also paid on 1 April 2014 and the
whole amount was charged to the income statement.
5. On 30 June 2014, $50,000 was paid on account of 5-year premium membership of
relevant business association.
Journal entries
The basic principle behind accrual accounting is to record revenues and expenses
regardless of payment. Following accrual and prepayment adjustments are required for
2014.
1. Though salaries of $70,000 were paid on 4 July 2014, they related to services
provided by employees in June 2014. These salaries are the cost of June 2014
revenue and must be recorded as part of June financial statements even if the
payment is made after 30 June. The following journal entry must be made:
Salaries expense $70,000

Salaries payable $70,000
2. On 4 July 2014, at the time of actual payment is made, the following journal entry is
made:
Salaries payable $70,000

Cash $70,000
3. Utility bills related to utilities consumed in June, so they must be reflected in

financial statements for the year ended 30 June 2014, even if they are paid later.
Utilities expense $30,000

Utilities payable $30,000
4. When the bills are actually paid, the following journal entry reflects the actual
payment:
Utilities payable $30,000

Cash $30,000
5. 12 months of rent was paid on 1 January 2014 and it was recorded as prepaid rent.
Half of this rent is related to the year ended 30 June 2014, so a journal entry should
be made to expense out half of the prepaid rent.
Rent expense ($100,000/2) $50,000

Prepaid rent $50,000
6. In April 2014, $30,000 was paid on account of six months of rent on Outlet B and it
was expensed out. However, only three months of the relevant rent payment
belong to financial year 2014. A journal entry should be made to reduce the
recorded rent expense and create a prepaid rent asset equivalent to three months
of use.
Prepaid rent ($300,000/6×3) $15,000

Rent expense $15,000
7. The payment of $50,000 on 30 June 2014 relates to membership fee due in next 5
year. This payment is a prepayment.
Prepaid membership fee $50,000

Cash $50,000
8. This prepaid membership fee will be expensed out proportionately in next 5 years.
by Obaidullah Jan, ACA, CFA and last modified on Oct 14, 2014
Studying for CFA® Program? Access notes and question bank for CFA ® Level 1 authored by me
at AlphaBetaPrep.com
Current Chapter
 Journal Entries
 Ledger Accounts
 Trial Balance
 Closing Entries
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Journal Entries

The following example illustrates how to record journal entries:

Date Account Debit Credit

Jan 1 Cash 100,000

Common Stock 100,000

Jan 2 Prepaid Rent 36,000

Jan 3 Equipment 80,000

Notes Payable 20,000

Accounts Payable 17,600

Jan 13 Cash 28,500

Service Revenue 28,500

Jan 13 Accounts Payable 17,600

Jan 14 Wages Expense 19,100

Jan 18 Cash 32,900

Service Revenue 54,100

Jan 23 Cash 15,300

Jan 25 Cash 4,000

Unearned Revenue 4,000

Jan 26 Office Supplies 5,200

Accounts Payable 5,200

Jan 28 Wages Expense 19,100

Jan 31 Dividends 5,000

Jan 31 Electricity Expense 2,470

Utilities Payable 2,470

Jan 31 Telephone Expense 1,494

Utilities Payable 1,494

Jan 31 Miscellaneous Expense 3,470

Cash Accounts Receivable

Accounts Payable Notes Payable

Revenue, Dividend and Expense Accounts

Service Revenue Dividend

The ledger accounts step of accounting cycle completes here.

The next step is the preparation of unadjusted trial balance

Unadjusted Trial Balance

Relevant information for the preparation of adjusting entries of Company A

The adjusting entries of Company A are:

Date Account Debit Credit

An adjusted trial balance is prepared in the next step of accounting cycle.

Adjusted Trial Balance

by Irfanullah Jan, ACCA and last modified on May 14, 2019

Post-Closing Trial Balance

Temporary accounts include:

1. Revenue, Income and Gain Accounts

Closing entries are better explained via an example.

Note Date Account Debit Credit

The last step of an accounting cycle is to prepare post-closing trial balance.

Post-Closing Trial Balance

Income Summary Account

An income summary account is effectively a T-account of the income statement. Since it is a

Cost of goods sold $8 million

All Chapters in Accounting

Reversing entries are best explained using an example:

Date Account Debit Credit

Interest Rate on Loan

Total Interest Payment on Feb 1, 20X3 (a)

Rent Payable on Feb 1 (b)

Without Using Reversing Entries:

Interest Expense in 20X3 resulting from (a)

Rent Expense in 20X3 resulting from (b)

Date Account Debit Credit