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4
The Adjustment Process

Chapter Outline
4.1 Explain the Concepts and Guidelines Affecting Adjusting Entries

4.2 Discuss the Adjustment Process and Illustrate Common Types of Adjusting Entries

4.3 Record and Post the Common Types of Adjusting Entries

4.4 Use the Ledger Balances to Prepare an Adjusted Trial Balance

4.5 Prepare Financial Statements Using the Adjusted Trial Balance

Why It Matters
As we learned in Analyzing and Recording Transactions, upon finishing college Mark Summers wanted to start his
own dry-cleaning business called Supreme Cleaners. After four years, Mark finished college and opened Supreme
Cleaners. During his first month of operations, Mark purchased dry-cleaning equipment and supplies. He also hired
an employee, opened a savings account, and provided services to his first customers, among other things.

Mark kept thorough records of all of the daily business transactions for the month. At the end of the month, Mark
reviewed his trial balance and realized that some of the information was not up to date. His equipment and supplies
had been used, making them less valuable. He had not yet paid his employee for work completed. His business
savings account earned interest. Some of his customers had paid in advance for their dry cleaning, with Mark's
business providing the service during the month.
What should Mark do with all of these events? Does he have a responsibility to record these transactions? If so,
how would he go about recording this information? How does it affect his financial statements? Mark will
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have to explore his accounting process to determine if these end-of-period transactions require recording and adjust
his financial statements accordingly. This exploration is performed by taking the next few steps in the accounting
cycle.

4.1 Explain the Concepts and Guidelines Affecting Adjusting Entries

Analyzing and Recording Transactions was the first of three consecutive chapters covering the steps in the
accounting cycle (Figure 4.2).

Figure 4.2 The Basic Accounting Cycle. In this chapter, we examine the next three steps in the accounting cycle—5,
6, and 7—which cover adjusting entries (journalize and post), preparing an adjusted trial balance, and preparing the
financial statements. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license)
In Analyzing and Recording Transactions, we discussed the first four steps in the accounting cycle: identify and
analyze transactions, record transactions to a journal, post journal information to the general ledger, and prepare an
(unadjusted) trial balance. This chapter examines the next three steps in the cycle: record adjusting entries
(journalizing and posting), prepare an adjusted trial balance, and prepare the financial statements (Figure 4.3).
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Figure 4.3 Steps 5, 6, and 7 in the Accounting Cycle. (attribution: Copyright Rice University, OpenStax, under CC
BY-NC-SA 4.0 license)
As we progress through these steps, you learn why the trial balance in this phase of the accounting cycle is referred
to as an “adjusted” trial balance. We also discuss the purpose of adjusting entries and the accounting concepts
supporting their need. One of the first concepts we discuss is accrual accounting.

Accrual Accounting
Public companies reporting their financial positions use either US generally accepted accounting principles (GAAP)
or International Financial Reporting Standards (IFRS), as allowed under the Securities and Exchange Commission
(SEC) regulations. Also, companies, public or private, using US GAAP or IFRS prepare their financial statements
using the rules of accrual accounting. Recall from Introduction to Financial Statements that accrual basis
accounting prescribes that revenues and expenses must be recorded in the accounting period in which they were
earned or incurred, no matter when cash receipts or payments occur. It is because of accrual accounting that we
have the revenue recognition principle and the expense recognition principle (also known as the matching
principle).
The accrual method is considered to better match revenues and expenses and standardizes reporting
information for comparability purposes. Having comparable information is important to external users of
information trying to make investment or lending decisions, and to internal users trying to make decisions about
company performance, budgeting, and growth strategies.
Some nonpublic companies may choose to use cash basis accounting rather than accrual basis accounting to report
financial information. Recall from Introduction to Financial Statements that cash basis accounting is a method of
accounting in which transactions are not recorded in the financial statements until there is an exchange of cash. Cash
basis accounting sometimes delays or accelerates revenue and expense reporting until cash receipts or outlays
occur. With this method, cash flows are used to measure business performance in a given period and can be simpler
to track than accrual basis accounting.
There are several other accounting methods or concepts that accountants will sometimes apply. The first is modified
accrual accounting, which is commonly used in governmental accounting and merges accrual basis and cash basis
accounting. The second is tax basis accounting that is used in establishing the tax effects of transactions in
determining the tax liability of an organization.
One fundamental concept to consider related to the accounting cycle—and to accrual accounting in
particular—is the idea of the accounting period.

The Accounting Period

As we discussed, accrual accounting requires companies to report revenues and expenses in the accounting
period in which they were earned or incurred. An accounting period breaks down company financial information
into specific time spans, and can cover a month, a quarter, a half-year, or a full year. Public companies governed
by GAAP are required to present quarterly (three-month) accounting period financial
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statements called 10-Qs. However, most public and private companies keep monthly, quarterly, and yearly (annual)
period information. This is useful to users needing up-to-date financial data to make decisions about company
investment and growth. When the company keeps yearly information, the year could be based on a fiscal or
calendar year. This is explained shortly.

CONTINUING APPLICATION AT WORK

Adjustment Process for Grocery Stores

In every industry, adjustment entries are made at the end of the period to ensure revenue matches expenses.
Companies with an online presence need to account for items sold that have not yet been shipped or are in the
process of reaching the end user. But what about the grocery industry? At first glance, it might seem that no
such adjustment entries are necessary. However, grocery stores have adapted to the current retail
environment. For example, your local grocery store might provide catering services for a graduation party. If the
contract requires the customer to put down a 50% deposit, and occurs near the end of a period, the grocery
store will have unearned revenue until it provides the catering service. Once the party occurs, the grocery store
needs to make an adjusting entry to reflect that revenue has been earned.

The Fiscal Year and the Calendar Year

A company may choose its yearly reporting period to be based on a calendar or fiscal year. If a company uses
calendar year, it is reporting financial data from January 1 to December 31 of a specific year. This may be
useful for businesses needing to coincide with a traditional yearly tax schedule. It can also be easier to track for
some businesses without formal reconciliation practices, and for small businesses.
fiscal year is a twelve-month reporting cycle that can begin in any month and records financial data for that
consecutive twelve-month period. For example, a business may choose its fiscal year to begin on April 1, 2019, and
end on March 31, 2020. This can be common practice for corporations and may best reflect the operational flow of
revenues and expenses for a particular business. In addition to annual reporting, companies often need or choose to
report financial statement information in interim periods.

Interim Periods
An interim period is any reporting period shorter than a full year (fiscal or calendar). This can encompass monthly,
quarterly, or half-year statements. The information contained on these statements is timelier than waiting for a yearly
accounting period to end. The most common interim period is three months, or a quarter. For companies whose
common stock is traded on a major stock exchange, meaning these are publicly traded companies, quarterly
statements must be filed with the SEC on a Form 10-Q. The companies must file a Form 10-K for their annual
statements. As you’ve learned, the SEC is an independent agency of the federal government that provides oversight
of public companies to maintain fair representation of company financial activities for investors to make informed
decisions.
In order for information to be useful to the user, it must be timely—that is, the user has to get it quickly enough so
it is relevant to decision-making. You may recall from Analyzing and Recording Transactions that
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this is the basis of the time period assumption in accounting. For example, a potential or existing investor wants
timely information by which to measure the performance of the company, and to help decide whether to invest, to
stay invested, or to sell their stockholdings and invest elsewhere. This requires companies to organize their
information and break it down into shorter periods. Internal and external users can then rely on the information that is
both timely and relevant to decision-making.
The accounting period a company chooses to use for financial reporting will impact the types of adjustments they
may have to make to certain accounts.

ETHICAL CONSIDERATIONS

Illegal Cookie Jar Accounting Used to Manage Earnings

From 2000 through the end of 2001, Bristol-Myers Squibb engaged in “Cookie Jar Accounting,” resulting in
$150 million in SEC fines. The company manipulated its accounting to create a false indication of income and
growth to create the appearance that it was meeting its own targets and Wall Street analysts’ earnings
estimates during the years 2000 and 2001. The SEC describes some of what occurred:

Bristol-Myers inflated its results primarily by (1) stuffing its distribution channels with excess
inventory near the end of every quarter in amounts sufficient to meet its targets by making
pharmaceutical sales to its wholesalers ahead of demand; and (2) improperly recognizing $1.5
billion in revenue from such pharmaceutical sales to its two biggest wholesalers. In connection with
the $1.5 billion in revenue, Bristol-Myers covered these wholesalers’ carrying costs and guaranteed
them a return on investment until they sold the products. When Bristol-Myers recognized the $1.5
billion in revenue upon shipment, it did so contrary to generally accepted accounting principles.[1]

In addition to the improper distribution of product to manipulate earnings numbers, which was not enough to
meet earnings targets, the company improperly used divestiture reserve funds (a “cookie jar” fund that is
funded by the sale of assets such as product lines or divisions) to meet those targets. In this circumstance,
earnings management was considered illegal, costing the company millions of dollars in fines.

4.2 Discuss the Adjustment Process and Illustrate Common

Types of Adjusting Entries
When a company reaches the end of a period, it must update certain accounts that have either been left unattended
throughout the period or have not yet been recognized. Adjusting entries update accounting records at the end of a
period for any transactions that have not yet been recorded. One important accounting principle to remember is that
just as the accounting equation (Assets = Liabilities + Owner’s equity/or common stock/or capital) must be equal, it
must remain equal after you make adjusting entries. Also note that in this equation, owner’s equity represents an
individual owner (sole proprietorship), common stock represents a corporation’s owners’ interests, and capital
represents a partnership’s owners’ interests. We discuss the effects of adjusting entries in greater detail throughout
this chapter.
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There are several steps in the accounting cycle that require the preparation of a trial balance: step 4, preparing an
unadjusted trial balance; step 6, preparing an adjusted trial balance; and step 9, preparing a post-closing trial
balance. You might question the purpose of more than one trial balance. For example, why can we not go from the
unadjusted trial balance straight into preparing financial statements for public consumption? What is the purpose of
the adjusted trial balance? Does preparing more than one trial balance mean the company made a mistake earlier in
the accounting cycle? To answer these questions, let’s first explore the (unadjusted) trial balance, and why some
accounts have incorrect balances.

Why Some Accounts Have Incorrect Balances on the Trial Balance

The unadjusted trial balance may have incorrect balances in some accounts. Recall the trial balance from
Analyzing and Recording Transactions for the example company, Printing Plus.

Figure 4.4 Unadjusted Trial Balance for Printing Plus. (attribution: Copyright Rice University, OpenStax, under
CC BY-NC-SA 4.0 license)
The trial balance for Printing Plus shows Supplies of $500, which were purchased on January 30. Since this is a new
company, Printing Plus would more than likely use some of their supplies right away, before the end of the month on
January 31. Supplies are only an asset when they are unused. If Printing Plus used some of its supplies immediately
on January 30, then why is the full $500 still in the supply account on January 31? How do we fix this incorrect
balance?
Similarly, what about Unearned Revenue? On January 9, the company received $4,000 from a customer for printing
services to be performed. The company recorded this as a liability because it received payment without providing the
service. To clear this liability, the company must perform the service. Assume that as of January 31 some of the
printing services have been provided. Is the full $4,000 still a liability? Since a portion of the service was provided, a
change to unearned revenue should occur. The company needs to correct this balance in the Unearned Revenue
account.
Having incorrect balances in Supplies and in Unearned Revenue on the company’s January 31 trial balance is not
due to any error on the company’s part. The company followed all of the correct steps of the accounting cycle up to
this point. So why are the balances still incorrect?
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Journal entries are recorded when an activity or event occurs that triggers the entry. Usually the trigger is from an
original source. Recall that an original source can be a formal document substantiating a transaction, such as an
invoice, purchase order, cancelled check, or employee time sheet. Not every transaction produces an original source
document that will alert the bookkeeper that it is time to make an entry.
When a company purchases supplies, the original order, receipt of the supplies, and receipt of the invoice from the
vendor will all trigger journal entries. This trigger does not occur when using supplies from the supply closet. Similarly,
for unearned revenue, when the company receives an advance payment from the customer for services yet provided,
the cash received will trigger a journal entry. When the company provides the printing services for the customer, the
customer will not send the company a reminder that revenue has now been earned. Situations such as these are why
businesses need to make adjusting entries.

THINK IT THROUGH

Keep Calm and Adjust . . .

Elliot Simmons owns a small law firm. He does the accounting himself and uses an accrual basis for
accounting. At the end of his first month, he reviews his records and realizes there are a few inaccuracies on
this unadjusted trial balance.
One difference is the supplies account; the figure on paper does not match the value of the supplies
inventory still available. Another difference was interest earned from his bank account. He did not have
anything recognizing these earnings.
Why did his unadjusted trial balance have these errors? What can be attributed to the differences in
supply figures? What can be attributed to the differences in interest earned?

The Need for Adjusting Entries

Adjusting entries update accounting records at the end of a period for any transactions that have not yet been
recorded. These entries are necessary to ensure the income statement and balance sheet present the correct, up-to-
date numbers. Adjusting entries are also necessary because the initial trial balance may not contain complete and
current data due to several factors:
The inefficiency of recording every single day-to-day event, such as the use of supplies.
Some costs are not recorded during the period but must be recognized at the end of the period, such as
depreciation, rent, and insurance.
Some items are forthcoming for which original source documents have not yet been received, such as a utility
bill.
There are a few other guidelines that support the need for adjusting entries.

Guidelines Supporting Adjusting Entries

Several guidelines support the need for adjusting entries:

• Revenue recognition principle: Adjusting entries are necessary because the revenue recognition principle
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requires revenue recognition when earned, thus the need for an update to unearned revenues.
Expense recognition (matching) principle: This requires matching expenses incurred to generate the
revenues earned, which affects accounts such as insurance expense and supplies expense.
Time period assumption: This requires useful information be presented in shorter time periods such as years,
quarters, or months. This means a company must recognize revenues and expenses in the proper period,
requiring adjustment to certain accounts to meet these criteria.
The required adjusting entries depend on what types of transactions the company has, but there are some
common types of adjusting entries. Before we look at recording and posting the most common types of adjusting
entries, we briefly discuss the various types of adjusting entries.

Types of Adjusting Entries

Adjusting entries requires updates to specific account types at the end of the period. Not all accounts require
updates, only those not naturally triggered by an original source document. There are two main types of adjusting
entries that we explore further, deferrals and accruals.

Deferrals
Deferrals are prepaid expense and revenue accounts that have delayed recognition until they have been used or
earned. This recognition may not occur until the end of a period or future periods. When deferred expenses and
revenues have yet to be recognized, their information is stored on the balance sheet. As soon as the expense is
incurred and the revenue is earned, the information is transferred from the balance sheet to the income statement.
Two main types of deferrals are prepaid expenses and unearned revenues.

Prepaid Expenses
Recall from Analyzing and Recording Transactions that prepaid expenses (prepayments) are assets for which
advanced payment has occurred, before the company can benefit from use. As soon as the asset has provided
benefit to the company, the value of the asset used is transferred from the balance sheet to the income statement as
an expense. Some common examples of prepaid expenses are supplies, depreciation, insurance, and rent.

When a company purchases supplies, it may not use all supplies immediately, but chances are the company has
used some of the supplies by the end of the period. It is not worth it to record every time someone uses a pencil or
piece of paper during the period, so at the end of the period, this account needs to be updated for the value of what
has been used.
Let’s say a company paid for supplies with cash in the amount of $400. At the end of the month, the company took
an inventory of supplies used and determined the value of those supplies used during the period to be $150. The
following entry occurs for the initial payment.
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Supplies increases (debit) for $400, and Cash decreases (credit) for $400. When the company recognizes the
supplies usage, the following adjusting entry occurs.

Supplies Expense is an expense account, increasing (debit) for $150, and Supplies is an asset account, decreasing
(credit) for $150. This means $150 is transferred from the balance sheet (asset) to the income statement (expense).
Notice that not all of the supplies are used. There is still a balance of $250 (400 – 150) in the Supplies account. This
amount will carry over to future periods until used. The balances in the Supplies and Supplies Expense accounts
show as follows.

Depreciation may also require an adjustment at the end of the period. Recall that depreciation is the systematic
method to record the allocation of cost over a given period of certain assets. This allocation of cost is recorded over
the useful life of the asset, or the time period over which an asset cost is allocated. The allocated cost up to that
point is recorded in Accumulated Depreciation, a contra asset account. A contra account is an account paired with
another account type, has an opposite normal balance to the paired account, and reduces the balance in the paired
account at the end of a period.
Accumulated Depreciation is contrary to an asset account, such as Equipment. This means that the normal balance
for Accumulated Depreciation is on the credit side. It houses all depreciation expensed in current and prior periods.
Accumulated Depreciation will reduce the asset account for depreciation incurred up to that point. The difference
between the asset’s value (cost) and accumulated depreciation is called the book value of the asset. When
depreciation is recorded in an adjusting entry, Accumulated Depreciation is credited and Depreciation Expense is
debited.
For example, let’s say a company pays $2,000 for equipment that is supposed to last four years. The company
wants to depreciate the asset over those four years equally. This means the asset will lose $500 in value each year
($2,000/four years). In the first year, the company would record the following adjusting entry to show depreciation of
the equipment.

Depreciation Expense increases (debit) and Accumulated Depreciation, Equipment, increases (credit). If the
company wanted to compute the book value, it would take the original cost of the equipment and subtract
accumulated depreciation.
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Book value of equipment = $2,000 – $500 = $1,500

This means that the current book value of the equipment is $1,500, and depreciation will be subtracted from this
figure the next year. The following account balances after adjustment are as follows:

You will learn more about depreciation and its computation in Long-Term Assets . However, one important fact that
we need to address now is that the book value of an asset is not necessarily the price at which the asset would sell.
For example, you might have a building for which you paid $1,000,000 that currently has been depreciated to a book
value of $800,000. However, today it could sell for more than, less than, or the same as its book value. The same is
true about just about any asset you can name, except, perhaps, cash itself.
Insurance policies can require advanced payment of fees for several months at a time, six months, for example. The
company does not use all six months of insurance immediately but over the course of the six months. At the end of
each month, the company needs to record the amount of insurance expired during that month.

For example, a company pays $4,500 for an insurance policy covering six months. It is the end of the first month
and the company needs to record an adjusting entry to recognize the insurance used during the month. The
following entries show the initial payment for the policy and the subsequent adjusting entry for one month of
insurance usage.

In the first entry, Cash decreases (credit) and Prepaid Insurance increases (debit) for $4,500. In the second
entry, Prepaid Insurance decreases (credit) and Insurance Expense increases (debit) for one month’s insurance
usage found by taking the total $4,500 and dividing by six months (4,500/6 = 750). The account balances after
adjustment are as follows:

Similar to prepaid insurance, rent also requires advanced payment. Usually to rent a space, a company will need
to pay rent at the beginning of the month. The company may also enter into a lease agreement that requires
several months, or years, of rent in advance. Each month that passes, the company needs to record
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rent used for the month.

Let’s say a company pays $8,000 in advance for four months of rent. After the first month, the company records
an adjusting entry for the rent used. The following entries show initial payment for four months of rent and the
adjusting entry for one month’s usage.

In the first entry, Cash decreases (credit) and Prepaid Rent increases (debit) for $8,000. In the second entry,
Prepaid Rent decreases (credit) and Rent Expense increases (debit) for one month’s rent usage found by taking
the total $8,000 and dividing by four months (8,000/4 = 2,000). The account balances after adjustment are as
follows:

Another type of deferral requiring adjustment is unearned revenue.

Unearned Revenues
Recall that unearned revenue represents a customer’s advanced payment for a product or service that has yet to be
provided by the company. Since the company has not yet provided the product or service, it cannot recognize the
customer’s payment as revenue. At the end of a period, the company will review the account to see if any of the
unearned revenue has been earned. If so, this amount will be recorded as revenue in the current period.
For example, let’s say the company is a law firm. During the year, it collected retainer fees totaling $48,000 from
clients. Retainer fees are money lawyers collect in advance of starting work on a case. When the company collects
this money from its clients, it will debit cash and credit unearned fees. Even though not all of the $48,000 was
probably collected on the same day, we record it as if it was for simplicity’s sake.

In this case, Unearned Fee Revenue increases (credit) and Cash increases (debit) for $48,000.

At the end of the year after analyzing the unearned fees account, 40% of the unearned fees have been earned.
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This 40% can now be recorded as revenue. Total revenue recorded is $19,200 ($48,000 × 40%).

For this entry, Unearned Fee Revenue decreases (debit) and Fee Revenue increases (credit) for $19,200, which is
the 40% earned during the year. The company will have the following balances in the two accounts:

Besides deferrals, other types of adjusting entries include accruals.

Accruals
Accruals are types of adjusting entries that accumulate during a period, where amounts were previously
unrecorded. The two specific types of adjustments are accrued revenues and accrued expenses.

Accrued Revenues
Accrued revenues are revenues earned in a period but have yet to be recorded, and no money has been
collected. Some examples include interest, and services completed but a bill has yet to be sent to the
customer.
Interest can be earned from bank account holdings, notes receivable, and some accounts receivables (depending
on the contract). Interest had been accumulating during the period and needs to be adjusted to reflect interest
earned at the end of the period. Note that this interest has not been paid at the end of the period, only earned.
This aligns with the revenue recognition principle to recognize revenue when earned, even if cash has yet to be
collected.
For example, assume that a company has one outstanding note receivable in the amount of $100,000. Interest on
this note is 5% per year. Three months have passed, and the company needs to record interest earned on this
outstanding loan. The calculation for the interest revenue earned is $100,000 × 5% × 3/12 = $1,250. The following
adjusting entry occurs.

Interest Receivable increases (debit) for $1,250 because interest has not yet been paid. Interest Revenue
increases (credit) for $1,250 because interest was earned in the three-month period but had been previously
unrecorded.
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Previously unrecorded service revenue can arise when a company provides a service but did not yet bill the
client for the work. This means the customer has also not yet paid for services. Since there was no bill to trigger a
transaction, an adjustment is required to recognize revenue earned at the end of the period.
For example, a company performs landscaping services in the amount of $1,500. However, they have not yet
received payment. At the period end, the company would record the following adjusting entry.

Accounts Receivable increases (debit) for $1,500 because the customer has not yet paid for services completed.
Service Revenue increases (credit) for $1,500 because service revenue was earned but had been previously
unrecorded.

Accrued Expenses
Accrued expenses are expenses incurred in a period but have yet to be recorded, and no money has been
paid. Some examples include interest, tax, and salary expenses.
Interest expense arises from notes payable and other loan agreements. The company has accumulated interest
during the period but has not recorded or paid the amount. This creates a liability that the company must pay at a
future date. You cover more details about computing interest in Current Liabilities, so for now amounts are given.

For example, a company accrued $300 of interest during the period. The following entry occurs at the end of the
period.
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Interest Expense increases (debit) and Interest Payable increases (credit) for $300. The following are the
updated ledger balances after posting the adjusting entry.

Taxes are only paid at certain times during the year, not necessarily every month. Taxes the company owes
during a period that are unpaid require adjustment at the end of a period. This creates a liability for the company.
Some tax expense examples are income and sales taxes.
For example, a company has accrued income taxes for the month for $9,000. The company would record the
following adjusting entry.

Income Tax Expense increases (debit) and Income Tax Payable increases (credit) for $9,000. The following are the
updated ledger balances after posting the adjusting entry.

Many salaried employees are paid once a month. The salary the employee earned during the month might not be
paid until the following month. For example, the employee is paid for the prior month’s work on the first of the next
month. The financial statements must remain up to date, so an adjusting entry is needed during the month to show
salaries previously unrecorded and unpaid at the end of the month.
Let’s say a company has five salaried employees, each earning $2,500 per month. In our example, assume that they
do not get paid for this work until the first of the next month. The following is the adjusting journal entry for salaries.

Salaries Expense increases (debit) and Salaries Payable increases (credit) for $12,500 ($2,500 per employee ×
five employees). The following are the updated ledger balances after posting the adjusting entry.
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In Record and Post the Common Types of Adjusting Entries, we explore some of these adjustments specifically for
our company Printing Plus, and show how these entries affect our general ledger (T-accounts).

YOUR TURN

Adjusting Entries

Example Income Statement Account Balance Sheet Account Cash in Entry?

Table 4.1

Review the three adjusting entries that follow. Using the table provided, for each entry write down the
income statement account and balance sheet account used in the adjusting entry in the appropriate column.
Then in the last column answer yes or no.

Solution

Example Income Statement Account Balance Sheet Account Cash in Entry?

1 Supplies expense Supplies No

2 Service Revenue Unearned Revenue No

Table 4.2
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Example Income Statement Account Balance Sheet Account Cash in Entry?

3 Rent Expense Prepaid machine rent no

Table 4.2

YOUR TURN

Adjusting Entries Take Two

Did we continue to follow the rules of adjusting entries in these two examples? Explain.

Example Income Statement Account Balance Sheet Account Cash in Entry?

Table 4.3

Solution

Yes, we did. Each entry has one income statement account and one balance sheet account, and cash
does not appear in either of the adjusting entries.

Example Income Statement Account Balance Sheet Account Cash in Entry?

1 Electricity Expense Accounts Payable no

2 Salaries Expense Salaries Payable no

Table 4.4
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4.3 Record and Post the Common Types of Adjusting Entries

Before beginning adjusting entry examples for Printing Plus, let’s consider some rules governing adjusting
entries:
Every adjusting entry will have at least one income statement account and one balance sheet account.
Cash will never be in an adjusting entry.
The adjusting entry records the change in amount that occurred during the period.

What are “income statement” and “balance sheet” accounts? Income statement accounts include revenues and
expenses. Balance sheet accounts are assets, liabilities, and stockholders’ equity accounts, since they appear on a
balance sheet. The second rule tells us that cash can never be in an adjusting entry. This is true because paying or
receiving cash triggers a journal entry. This means that every transaction with cash will be recorded at the time of
the exchange. We will not get to the adjusting entries and have cash paid or received which has not already been
recorded. If accountants find themselves in a situation where the cash account must be adjusted, the necessary
adjustment to cash will be a correcting entry and not an adjusting entry.
With an adjusting entry, the amount of change occurring during the period is recorded. For example, if the supplies
account had a $300 balance at the beginning of the month and $100 is still available in the supplies account at the
end of the month, the company would record an adjusting entry for the $200 used during the month (300 – 100).
Similarly for unearned revenues, the company would record how much of the revenue was earned during the period.

Let’s now consider new transaction information for Printing Plus.

CONCEPTS IN PRACTICE

Earnings Management
Recording adjusting entries seems so cut and dry. It looks like you just follow the rules and all of the numbers
come out 100 percent correct on all financial statements. But in reality this is not always the case. Just the fact
that you have to make estimates in some cases, such as depreciation estimating residual value and useful life,
tells you that numbers will not be 100 percent correct unless the accountant has ESP. Some companies
engage in something called earnings management, where they follow the rules of accounting mostly but they
stretch the truth a little to make it look like they are more profitable. Some companies do this by recording
revenue before they should. Others leave assets on the books instead of expensing them when they should to
decrease total expenses and increase profit.
Take Mexico-based home-building company Desarrolladora Homex S.A.B. de C.V. This company reported
revenue earned on more than 100,000 homes they had not even build yet. The SEC’s complaint states that
Homex reported revenues from a project site where every planned home was said to have been “built and sold
by Dec. 31, 2011. Satellite images of the project site on March 12, 2012, show it was still largely undeveloped
and the vast majority of supposedly sold homes remained unbuilt.”[2]
Is managing your earnings illegal? In some situations it is just an unethical stretch of the truth easy enough to
do because of the estimates made in adjusting entries. You can simply change your estimate and insist the
new estimate is really better when maybe it is your way to improve the bottom line, for example, changing
your annual depreciation expense calculated on expensive plant assets from assuming a ten-year useful life,
a reasonable estimated expectation, to a twenty-year useful life, not so
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reasonable but you insist your company will be able to use these assets twenty years while knowing that is a
slim possibility. Doubling the useful life will cause 50% of the depreciation expense you would have had. This
will make a positive impact on net income. This method of earnings management would probably not be
considered illegal but is definitely a breach of ethics. In other situations, companies manage their earnings in a
way that the SEC believes is actual fraud and charges the company with the illegal activity.

Recording Common Types of Adjusting Entries

Recall the transactions for Printing Plus discussed in Analyzing and Recording Transactions.

Jan. 3, 2019 issues $20,000 shares of common stock for cash

Jan. 5, 2019 purchases equipment on account for $3,500, payment due within the month

Jan. 9, 2019 receives $4,000 cash in advance from a customer for services not yet rendered

Jan. 10, 2019 provides $5,500 in services to a customer who asks to be billed for the services

Jan. 12, 2019 pays a $300 utility bill with cash

Jan. 14, 2019 distributed $100 cash in dividends to stockholders

Jan. 17, 2019 receives $2,800 cash from a customer for services rendered

Jan. 18, 2019 paid in full, with cash, for the equipment purchase on January 5

Jan. 20, 2019 paid $3,600 cash in salaries expense to employees

Jan. 23, 2019 received cash payment in full from the customer on the January 10 transaction

Jan. 27, 2019 provides $1,200 in services to a customer who asks to be billed for the services

Jan. 30, 2019 purchases supplies on account for $500, payment due within three months On

January 31, 2019, Printing Plus makes adjusting entries for the following transactions.

On January 31, Printing Plus took an inventory of its supplies and discovered that $100 of supplies had
been used during the month.
The equipment purchased on January 5 depreciated $75 during the month of January.
Printing Plus performed $600 of services during January for the customer from the January 9 transaction.
Reviewing the company bank statement, Printing Plus discovers $140 of interest earned during the month of
January that was previously uncollected and unrecorded.
Employees earned $1,500 in salaries for the period of January 21–January 31 that had been previously
unpaid and unrecorded.
We now record the adjusting entries from January 31, 2019, for Printing Plus.

Transaction 13: On January 31, Printing Plus took an inventory of its supplies and discovered that $100 of
supplies had been used during the month.
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Analysis:

$100 of supplies were used during January. Supplies is an asset that is decreasing (credit).
Supplies is a type of prepaid expense that, when used, becomes an expense. Supplies Expense would
increase (debit) for the $100 of supplies used during January.

Impact on the financial statements: Supplies is a balance sheet account, and Supplies Expense is an income
statement account. This satisfies the rule that each adjusting entry will contain an income statement and balance
sheet account. We see total assets decrease by $100 on the balance sheet. Supplies Expense increases overall
expenses on the income statement, which reduces net income.

Transaction 14: The equipment purchased on January 5 depreciated $75 during the month of January.

Analysis:

Equipment lost value in the amount of $75 during January. This depreciation will impact the Accumulated
Depreciation–Equipment account and the Depreciation Expense–Equipment account. While we are not doing
depreciation calculations here, you will come across more complex calculations in the future.
Accumulated Depreciation–Equipment is a contra asset account (contrary to Equipment) and increases
(credit) for $75.
Depreciation Expense–Equipment is an expense account that is increasing (debit) for $75.

Impact on the financial statements: Accumulated Depreciation–Equipment is a contra account to Equipment.

When calculating the book value of Equipment, Accumulated Depreciation–Equipment will be deducted from the
original cost of the equipment. Therefore, total assets will decrease by $75 on the balance sheet. Depreciation
Expense will increase overall expenses on the income statement, which reduces net income.
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Transaction 15: Printing Plus performed $600 of services during January for the customer from the January 9
transaction.
Analysis:

The customer from the January 9 transaction gave the company $4,000 in advanced payment for services. By
the end of January the company had earned $600 of the advanced payment. This means that the company still
has yet to provide $3,400 in services to that customer.
Since some of the unearned revenue is now earned, Unearned Revenue would decrease. Unearned
Revenue is a liability account and decreases on the debit side.
The company can now recognize the $600 as earned revenue. Service Revenue increases (credit) for $600.

Impact on the financial statements: Unearned revenue is a liability account and will decrease total liabilities and
equity by $600 on the balance sheet. Service Revenue will increase overall revenue on the income statement, which
increases net income.

Transaction 16: Reviewing the company bank statement, Printing Plus discovers $140 of interest earned
during the month of January that was previously uncollected and unrecorded.
Analysis:

Interest is revenue for the company on money kept in a savings account at the bank. The company only sees
the bank statement at the end of the month and needs to record interest revenue that has not yet been
collected or recorded.
Interest Revenue is a revenue account that increases (credit) for $140.
Since Printing Plus has yet to collect this interest revenue, it is considered a receivable. Interest Receivable
increases (debit) for $140.

Impact on the financial statements: Interest Receivable is an asset account and will increase total assets by $140
on the balance sheet. Interest Revenue will increase overall revenue on the income statement, which increases net
income.
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Transaction 17: Employees earned $1,500 in salaries for the period of January 21–January 31 that had been
previously unpaid and unrecorded.
Analysis:

Salaries have accumulated since January 21 and will not be paid in the current period. Since the salaries
expense occurred in January, the expense recognition principle requires recognition in January.
Salaries Expense is an expense account that is increasing (debit) for $1,500.
Since the company has not yet paid salaries for this time period, Printing Plus owes the employees this
money. This creates a liability for Printing Plus. Salaries Payable increases (credit) for $1,500.

Impact on the financial statements: Salaries Payable is a liability account and will increase total liabilities and
equity by $1,500 on the balance sheet. Salaries expense will increase overall expenses on the income
statement, which decreases net income.

We now explore how these adjusting entries impact the general ledger (T-accounts).

YOUR TURN

Deferrals versus Accruals

Label each of the following as a deferral or an accrual, and explain your answer.

The company recorded supplies usage for the month.

A customer paid in advance for services, and the company recorded revenue earned after providing
service to that customer.The company recorded salaries that had been earned by employees but were
previously unrecorded and have not yet been paid.
Solution
The company is recording a deferred expense. The company was deferring the recognition of
supplies from supplies expense until it had used the supplies.
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The company has deferred revenue. It deferred the recognition of the

revenue until it was actually earned. The customer already paid the
cash and is currently on the balance sheet as a liability.

In the journal entry, Depreciation Expense–Equipment has a debit of $75. This is posted to the Depreciation
Expense–Equipment T-account on the debit side (left side). Accumulated Depreciation–Equipment has a credit
balance of $75. This is posted to the Accumulated Depreciation–Equipment T-account on the credit side (right side).

Transaction 15: Printing Plus performed $600 of services during January for the customer from the January 9
transaction.
Journal entry and T-accounts:

In the journal entry, Unearned Revenue has a debit of $600. This is posted to the Unearned Revenue T-account on
the debit side (left side). You will notice there is already a credit balance in this account from the January 9 customer
payment. The $600 debit is subtracted from the $4,000 credit to get a final balance of $3,400 (credit). Service
Revenue has a credit balance of $600. This is posted to the Service Revenue T-account on the credit side (right
side). You will notice there is already a credit balance in this account from other revenue transactions in January.
The $600 is added to the previous $9,500 balance in the account to get a new final credit balance of $10,100.
Transaction 16: Reviewing the company bank statement, Printing Plus discovers $140 of interest earned
during the month of January that was previously uncollected and unrecorded.
Journal entry and T-accounts:
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In the journal entry, Interest Receivable has a debit of $140. This is posted to the Interest Receivable T-account on
the debit side (left side). Interest Revenue has a credit balance of $140. This is posted to the Interest Revenue T-
account on the credit side (right side).
Transaction 17: Employees earned $1,500 in salaries for the period of January 21–January 31 that had been
previously unpaid and unrecorded.
Journal entry and T-accounts:

In the journal entry, Salaries Expense has a debit of $1,500. This is posted to the Salaries Expense T-account on the
debit side (left side). You will notice there is already a debit balance in this account from the January 20 employee
salary expense. The $1,500 debit is added to the $3,600 debit to get a final balance of $5,100 (debit). Salaries
Payable has a credit balance of $1,500. This is posted to the Salaries Payable T-account on the credit side (right
side).

T-accounts Summary
Once all adjusting journal entries have been posted to T-accounts, we can check to make sure the accounting
equation remains balanced. Following is a summary showing the T-accounts for Printing Plus including adjusting
entries.
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Figure 4.5 Printing Plus summary of T-accounts with Adjusting Entries. (attribution: Copyright Rice
University, OpenStax, under CC BY-NC-SA 4.0 license)
The sum on the assets side of the accounting equation equals $29,965, found by adding together the final balances
in each asset account (24,800 + 1,200 + 140 + 400 + 3,500 – 75). To find the total on the liabilities and equity side of
the equation, we need to find the difference between debits and credits. Credits on the liabilities and equity side of the
equation total $35,640 (500 + 1,500 + 3,400 + 20,000 + 10,100 + 140). Debits on the liabilities and equity side of the
equation total $5,675 (100 + 100 + 5,100 + 300 + 75). The difference between $35,640 – $5,675 = $29,965. Thus,
the equation remains balanced with $29,965 on the asset side and $29,965 on the liabilities and equity side. Now that
we have the T-account information, and have confirmed the accounting
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equation remains balanced, we can create the adjusted trial balance in our sixth step in the accounting cycle.

LINK TO LEARNING

When posting any kind of journal entry to a general ledger, it is important to have an organized system for
recording to avoid any account discrepancies and misreporting. To do this, companies can streamline their
general ledger and remove any unnecessary processes or accounts. Check out this article “Encourage
General Ledger Efficiency” from the Journal of Accountancy (https://openstax.org/l/ 50JrnAcctArticl) that
discusses some strategies to improve general ledger efficiency.

4.4 Use the Ledger Balances to Prepare an Adjusted Trial Balance

Once all of the adjusting entries have been posted to the general ledger, we are ready to start working on
preparing the adjusted trial balance. Preparing an adjusted trial balance is the sixth step in the accounting cycle.
An adjusted trial balance is a list of all accounts in the general ledger, including adjusting entries, which have
nonzero balances. This trial balance is an important step in the accounting process because it helps identify any
computational errors throughout the first five steps in the cycle.
As with the unadjusted trial balance, transferring information from T-accounts to the adjusted trial balance requires
consideration of the final balance in each account. If the final balance in the ledger account (T-account) is a debit
balance, you will record the total in the left column of the trial balance. If the final balance in the ledger account (T-
account) is a credit balance, you will record the total in the right column.
Once all ledger accounts and their balances are recorded, the debit and credit columns on the adjusted trial
balance are totaled to see if the figures in each column match. The final total in the debit column must be the same
dollar amount that is determined in the final credit column.
Let’s now take a look at the adjusted T-accounts and adjusted trial balance for Printing Plus to see how the
information is transferred from these T-accounts to the adjusted trial balance. We only focus on those general ledger
accounts that had balance adjustments.
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For example, Interest Receivable is an adjusted account that has a final balance of $140 on the debit side. This
balance is transferred to the Interest Receivable account in the debit column on the adjusted trial balance.
Supplies ($400), Supplies Expense ($100), Salaries Expense ($5,100), and Depreciation Expense–Equipment
($75) also have debit final balances in their adjusted T-accounts, so this information will be transferred to the
debit column on the adjusted trial balance. Accumulated Depreciation–Equipment ($75), Salaries Payable
($1,500), Unearned Revenue ($3,400), Service Revenue ($10,100), and Interest Revenue ($140) all have credit
final balances in their T-accounts. These credit balances would transfer to the credit column on the adjusted
trial balance. Once all balances are transferred to the adjusted trial balance, we sum each of the debit and credit
columns. The debit and credit columns both total $35,715, which means they are equal and in balance

After the adjusted trial balance is complete, we next prepare the company’s financial statements.
4.5 Prepare Financial Statements Using the Adjusted Trial Balance

Once you have prepared the adjusted trial balance, you are ready to prepare the financial statements. Preparing
financial statements is the seventh step in the accounting cycle. Remember that we have four financial statements
to prepare: an income statement, a statement of retained earnings, a balance sheet, and the statement of cash
flows. These financial statements were introduced in Introduction to Financial Statements and Statement of Cash
Flows dedicates in-depth discussion to that statement.
To prepare the financial statements, a company will look at the adjusted trial balance for account information. From
this information, the company will begin constructing each of the statements, beginning with the income statement.
Income statements will include all revenue and expense accounts. The statement of retained earnings will include
beginning retained earnings, any net income (loss) (found on the income statement), and dividends. The balance
sheet is going to include assets, contra assets, liabilities, and stockholder equity accounts, including ending retained
earnings and common stock.
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YOUR TURN

Magnificent Adjusted Trial Balance

Go over the adjusted trial balance for Magnificent Landscaping Service. Identify which income statement each
account will go on: Balance Sheet, Statement of Retained Earnings, or Income Statement.
Solution

Balance Sheet: Cash, accounts receivable, office supplied, prepaid insurance, equipment, accumulated
depreciation (equipment), accounts payable, salaries payable, unearned lawn mowing revenue, and
common stock. Statement of Retained Earnings: Dividends. Income Statement: Lawn mowing revenue, gas
expense, advertising expense, depreciation expense (equipment), supplies expense, and salaries expense.

Income Statement
An income statement shows the organization’s financial performance for a given period of time. When preparing an
income statement, revenues will always come before expenses in the presentation. For Printing Plus, the following
is its January 2019 Income Statement.
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Revenue and expense information is taken from the adjusted trial balance as follows:

Total revenues are $10,240, while total expenses are $5,575. Total expenses are subtracted from total revenues
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to get a net income of $4,665. If total expenses were more than total revenues, Printing Plus would have a net loss
rather than a net income. This net income figure is used to prepare the statement of retained earnings.

CONCEPTS IN PRACTICE

The Importance of Accurate Financial Statements

Financial statements give a glimpse into the operations of a company, and investors, lenders, owners, and
others rely on the accuracy of this information when making future investing, lending, and growth decisions.
When one of these statements is inaccurate, the financial implications are great.
For example, Celadon Group misreported revenues over the span of three years and elevated earnings
during those years. The total overreported income was approximately $200–$250 million. This gross
misreporting misled investors and led to the removal of Celadon Group from the New York Stock Exchange.
Not only did this negatively impact Celadon Group ’s stock price and lead to criminal investigations, but
investors and lenders were left to wonder what might happen to their investment.
That is why it is so important to go through the detailed accounting process to reduce errors early on and
hopefully prevent misinformation from reaching financial statements. The business must have strong

internal controls and best practices to ensure the information is presented fairly.[3]

Statement of Retained Earnings

The statement of retained earnings (which is often a component of the statement of stockholders’ equity) shows
how the equity (or value) of the organization has changed over a period of time. The statement of retained
earnings is prepared second to determine the ending retained earnings balance for the period. The statement of
retained earnings is prepared before the balance sheet because the ending retained earnings amount is a required
element of the balance sheet. The following is the Statement of Retained Earnings for Printing Plus.

Net income information is taken from the income statement, and dividends information is taken from the
adjusted trial balance as follows.
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The statement of retained earnings always leads with beginning retained earnings. Beginning retained earnings carry
over from the previous period’s ending retained earnings balance. Since this is the first month of business for Printing
Plus, there is no beginning retained earnings balance. Notice the net income of $4,665 from the income statement is
carried over to the statement of retained earnings. Dividends are taken away from the sum of beginning retained
earnings and net income to get the ending retained earnings balance $4,565 for January. This ending retained
earnings balance is transferred to the balance sheet.
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LINK TO LEARNING

Concepts Statements give the Financial Accounting Standards Board (FASB) a guide to creating
accounting principles and consider the limitations of financial statement reporting. See the FASB’s
“Concepts Statements” page (https://openstax.org/l/50FASBConState) to learn more.

Balance Sheet
The balance sheet is the third statement prepared after the statement of retained earnings and lists what the
organization owns (assets ), what it owes (liabilities), and what the shareholders control (equity) on a specific date.
Remember that the balance sheet represents the accounting equation, where assets equal liabilities plus
stockholders’ equity. The following is the Balance Sheet for Printing Plus.

Ending retained earnings information is taken from the statement of retained earnings, and asset, liability, and
common stock information is taken from the adjusted trial balance as follows.

This OpenStax book is available for free at http://cnx.org/content/col25448/1.4

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Looking at the asset section of the balance sheet, Accumulated Depreciation–Equipment is included as a contra
asset account to equipment. The accumulated depreciation ($75) is taken away from the original cost of the
equipment ($3,500) to show the book value of equipment ($3,425). The accounting equation is balanced, as shown
on the balance sheet, because total assets equal $29,965 as do the total liabilities and stockholders’ equity.

There is a worksheet approach a company may use to make sure end-of-period adjustments translate to the
correct financial statements.
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Review the annual report of Stora Enso (https://openstax.org/l/50StoraEnso2017) which is an international

company that utilizes the illustrated format in presenting its Balance Sheet, also called the Statement of
Financial Position. The Balance Sheet is found on page 31 of the report.
Some of the biggest differences that occur on financial statements prepared under US GAAP versus IFRS
relate primarily to measurement or timing issues: in other words, how a transaction is valued and when it is
recorded.

Ten-Column Worksheets
The 10-column worksheet is an all-in-one spreadsheet showing the transition of account information from the trial
balance through the financial statements. Accountants use the 10-column worksheet to help calculate end-of-period
adjustments. Using a 10-column worksheet is an optional step companies may use in their accounting process.
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Here is a picture of a 10-column worksheet for Printing Plus.

There are five sets of columns, each set having a column for debit and credit, for a total of 10 columns. The five
column sets are the trial balance, adjustments, adjusted trial balance, income statement, and the balance sheet. After
a company posts its day-to-day journal entries, it can begin transferring that information to the trial balance columns
of the 10-column worksheet.
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The trial balance information for Printing Plus is shown previously. Notice that the debit and credit columns both
equal $34,000. If we go back and look at the trial balance for Printing Plus, we see that the trial balance shows
debits and credits equal to $34,000.

Once the trial balance information is on the worksheet, the next step is to fill in the adjusting information from the
posted adjusted journal ent
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The adjustments total of $2,415 balances in the debit and credit columns.

The next step is to record information in the adjusted trial balance columns.
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To get the numbers in these columns, you take the number in the trial balance column and add or subtract any
number found in the adjustment column. For example, Cash shows an unadjusted balance of $24,800. There is no
adjustment in the adjustment columns, so the Cash balance from the unadjusted balance column is transferred over
to the adjusted trial balance columns at $24,800. Interest Receivable did not exist in the trial balance information, so
the balance in the adjustment column of $140 is transferred over to the adjusted trial balance column.

Unearned revenue had a credit balance of $4,000 in the trial balance column, and a debit adjustment of $600 in the
adjustment column. Remember that adding debits and credits is like adding positive and negative numbers. This
means the $600 debit is subtracted from the $4,000 credit to get a credit balance of $3,400 that is translated to the
adjusted trial balance column.
Service Revenue had a $9,500 credit balance in the trial balance column, and a $600 credit balance in the
Adjustments column. To get the $10,100 credit balance in the adjusted trial balance column requires adding
together both credits in the trial balance and adjustment columns (9,500 + 600). You will do the same process for
all accounts. Once all accounts have balances in the adjusted trial balance columns, add the debits and
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credits to make sure they are equal. In the case of Printing Plus, the balances equal $35,715. If you check the
adjusted trial balance for Printing Plus, you will see the same equal balance is present.

Next you will take all of the figures in the adjusted trial balance columns and carry them over to either the
income statement columns or the balance sheet columns.
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YOUR TURN

Income Statement and Balance Sheet

Take a couple of minutes and fill in the income statement and balance sheet columns. Total them when you
are done. Do not panic when they do not balance. They will not balance at this time.
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Solution

Every other account title has been highlighted to help your eyes focus better while checking your work.

Looking at the income statement columns, we see that all revenue and expense accounts are listed in either the
debit or credit column. This is a reminder that the income statement itself does not organize information into debits
and credits, but we do use this presentation on a 10-column worksheet.
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You will notice that when debit and credit income statement columns are totaled, the balances are not the same.
The debit balance equals $5,575, and the credit balance equals $10,240. Why do they not balance?
If the debit and credit columns equal each other, it means the expenses equal the revenues. This would happen if
a company broke even, meaning the company did not make or lose any money. If there is a difference between
the two numbers, that difference is the amount of net income, or net loss, the company has earned.

In the Printing Plus case, the credit side is the higher figure at $10,240. The credit side represents revenues. This
means revenues exceed expenses, thus giving the company a net income. If the debit column were larger, this would
mean the expenses were larger than revenues, leading to a net loss. You want to calculate the net income and enter
it onto the worksheet. The $4,665 net income is found by taking the credit of $10,240 and subtracting the debit of
$5,575. When entering net income, it should be written in the column with the lower total. In this instance, that would
be the debit side. You then add together the $5,575 and $4,665 to get a total
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of $10,240. This balances the two columns for the income statement. If you review the income statement, you see
that net income is in fact $4,665.
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258 Chapter 4 The Adjustment Process

We now consider the last two columns for the balance sheet. In these columns we record all asset, liability, and
equity accounts.
When adding the total debits and credits, you notice they do not balance. The debit column equals $30,140, and
the credit column equals $25,475. How do we get the columns to balance?
Treat the income statement and balance sheet columns like a double-entry accounting system, where if you have
a debit on the income statement side, you must have a credit equaling the same amount on the credit side. In this
case we added a debit of $4,665 to the income statement column. This means we must add a credit of $4,665 to
the balance sheet column. Once we add the $4,665 to the credit side of the balance sheet column, the two
columns equal $30,140.
You may notice that dividends are included in our 10-column worksheet balance sheet columns even though this
account is not included on a balance sheet. So why is it included here? There is actually a very good reason
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we put dividends in the balance sheet columns.

When you prepare a balance sheet, you must first have the most updated retained earnings balance. To get that
balance, you take the beginning retained earnings balance + net income – dividends. If you look at the worksheet
for Printing Plus, you will notice there is no retained earnings account. That is because they just started business
this month and have no beginning retained earnings balance.
If you look in the balance sheet columns, we do have the new, up-to-date retained earnings, but it is spread out
through two numbers. You have the dividends balance of $100 and net income of $4,665. If you combine these two
individual numbers ($4,665 – $100), you will have your updated retained earnings balance of $4,565, as seen on the
statement of retained earnings.

You will not see a similarity between the 10-column worksheet and the balance sheet, because the 10-column
worksheet is categorizing all accounts by the type of balance they have, debit or credit. This leads to a final balance
of $30,140.
The balance sheet is classifying the accounts by type of accounts, assets and contra assets, liabilities, and equity.
This leads to a final balance of $29,965. Even though they are the same numbers in the accounts, the totals on
the worksheet and the totals on the balance sheet will be different because of the different presentation methods.

LINK TO LEARNING

Publicly traded companies release their financial statements quarterly for open viewing by the general public,
which can usually be viewed on their websites. One such company is Alphabet, Inc. (trade name Google).
Take a look at Alphabet’s quarter ended March 31, 2018, financial statements
(https://openstax.org/l/50AlphaMar2018) from the SEC Form 10-Q.

YOUR TURN

Frank’s Net Income and Loss

What amount of net income/loss does Frank have?

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260 Chapter 4 The Adjustment Process

Solution
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In Completing the Accounting Cycle, we continue our discussion of the accounting cycle, completing the last steps
of journalizing and posting closing entries and preparing a post-closing trial balance.
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Key Terms
10-column worksheet all-in-one spreadsheet showing the transition of account information from the trial balance
through the financial statements
accounting period breaks down company financial information into specific time spans and can cover a
month, quarter, half-year, or full year
accrual type of adjusting entry that accumulates during a period, where an amount was previously
unrecorded
accrued expense expense incurred in a period but not yet recorded, and no money has been paid accrued
revenue revenue earned in a period but not yet recorded, and no money has been collected adjusted trial
balance list of all accounts in the general ledger, including adjusting entries, which have
nonzero balances
adjusting entries update accounting records at the end of a period for any transactions that have not yet been
recorded
book value difference between the asset’s value (cost) and accumulated depreciation; also, value at which
assets or liabilities are recorded in a company’s financial statements
calendar year reports financial data from January 1 to December 31 of a specific year
contra account account paired with another account type that has an opposite normal balance to the paired
account; reduces or increases the balance in the paired account at the end of a period
deferral prepaid expense and revenue accounts that have delayed recognition until they have been used or
earned
fiscal year twelve-month reporting cycle that can begin in any month, and records financial data for that twelve-
month consecutive period
interim period any reporting period shorter than a full year (fiscal or calendar)
modified accrual accounting commonly used in governmental accounting and combines accrual basis and cash
basis accounting
tax basis accounting establishes the tax effects of transactions in determining the tax liability of an
organization
useful life time period over which an asset cost is allocated