Wednesday, 26 April 2017

Adjusted Trial Balance

Adjusted Trial Balance

An Adjusted Trial Balance is a list of the balances of ledger accounts which is created 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
Adjusted Trial Balance
January 31, 2010
DebitCredit
Cash$20,430
Accounts Receivable5,900
Office Supplies4,320
Prepaid Rent24,000
Equipment80,000
Accumulated Depreciation$1,100
Accounts Payable5,200
Utilities Payable3,964
Unearned Revenue1,000
Interest Payable150
Notes Payable20,000
Common Stock100,000
Service Revenue85,600
Wages Expense38,200
Supplies Expense18,480
Rent Expense12,000
Miscellaneous Expense3,470
Electricity Expense2,470
Telephone Expense1,494
Depreciation Expense1,100
Interest Expense150
Dividend5,000
Total$217,014$217,014
The totals of an adjusted trial balance must be equal. Any difference indicates that there is some error in the journal entries or in the ledger or in the calculations.

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:
DateAccountDebitCredit
Jan 31Supplies Expense18,480
Office Supplies18,480
Supplies Expense = $22,800 − $4,320 = $18,480
Jan 31Rent Expense12,000
Prepaid Rent12,000
Rent Expense = $36,000 ÷ 3 = $12,000
Jan 31Depreciation Expense1,100
Accumulated Depreciation1,100
Depreciation Expense = ($80,000 − $14,000) ÷ (5 × 12) = $1,100
Jan 31Interest Expense150
Interest Payable150
Interest Expense = $20,000 × (9% ÷ 12) = $150
Jan 31Unearned Revenue3,000
Service Revenue3,000

Unadjusted Trial Balance

Unadjusted Trial Balance

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.
An unadjusted trial balance is the one which is created before any adjustments are made in the ledger accounts.
The preparation of a trial balance is very simple. All we have to do is to list the balances of the ledger accounts of a business.

Example

Following is the unadjusted trial balance prepared from the ledger accounts of Company A.
Company A
Unadjusted Trial Balance
January 31, 2010
 
 DebitCredit
Cash$20,430 
Accounts Receivable5,900 
Office Supplies22,800 
Prepaid Rent36,000 
Equipment80,000 
Accounts Payable $5,200
Notes Payable 20,000
Utilities Payable 3,964
Unearned Revenue 4,000
Common Stock 100,000
Service Revenue 82,600
Wages Expense38,200 
Miscellaneous Expense3,470 
Electricity Expense2,470 
Telephone Expense1,494 
Dividend5,000 
Total$215,764$215,764
Since, in double entry accounting we record each transaction with two aspects, 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, but this does not mean that all errors cause the trial balance to unbalance. There are few types of mistakes which will not unbalance the trial balance and they may escape un-noticed if we do not review our work carefully. For example, to omit an entry, to record a transaction twice, etc.

Posting Journal Entries to Ledger Accounts

Posting Journal Entries to 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
$100,000$36,000 $21,200$15,300
28,50060,000   
32,90017,600   
15,30019,100   
4,00019,100   
 5,000   
 3,470   
$20,430  $5,900 
Office Supplies Prepaid Rent
$17,600  $36,000 
5,200    
$22,800  $36,000 
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
$19,100  $3,470 
19,100    
$38,200  $3,470 
Electricity Expense Telephone Expense
$2,470  $1,494 
$2,470  $1,494 

Journal Entries

Journal Entries

Analyzing 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 during the whole period. Transaction analysis is a process which 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 analyzing transactions, accountants classify and record the events having 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, 2010 with an initial capital of 5,000 shares of common stock having $20 par value. During the first month of its operations, the company engaged in following transactions:
DateTransaction
Jan 2An amount of $36,000 was paid as advance rent for three months.
Jan 3Paid $60,000 cash on the purchase of equipment costing $80,000. The remaining amount was recognized as a one year note payable with interest rate of 9%.
Jan 4Purchased office supplies costing $17,600 on account.
Jan 13Provided services to its customers and received $28,500 in cash.
Jan 13Paid the accounts payable on the office supplies purchased on January 4.
Jan 14Paid wages to its employees for first two weeks of January, aggregating $19,100.
Jan 18Provided $54,100 worth of services to its customers. They paid $32,900 and promised to pay the remaining amount.
Jan 23Received $15,300 from customers for the services provided on January 18.
Jan 25Received $4,000 as an advance payment from customers.
Jan 26Purchased office supplies costing $5,200 on account.
Jan 28Paid wages to its employees for the third and fourth week of January: $19,100.
Jan 31Paid $5,000 as dividends.
Jan 31Received electricity bill of $2,470.
Jan 31Received telephone bill of $1,494.
Jan 31Miscellaneous expenses paid during the month totaled $3,470
The following table shows the journal entries for the above events.
DateAccountDebitCredit
Jan 1Cash100,000 
 Common Stock 100,000
Jan 2Prepaid Rent36,000 
 Cash 36,000
Jan 3Equipment80,000 
 Cash 60,000
 Notes Payable 20,000
Jan 4Office Supplies17,600 
 Accounts Payable 17,600
Jan 13Cash28,500 
 Service Revenue 28,500
Jan 13Accounts Payable17,600 
 Cash 17,600
Jan 14Wages Expense19,100 
 Cash 19,100
Jan 18Cash32,900 
 Accounts Receivable21,200 
 Service Revenue 54,100
Jan 23Cash15,300 
 Accounts Receivable 15,300
Jan 25Cash4,000 
 Unearned Revenue 4,000
Jan 26Office Supplies5,200 
 Accounts Payable 5,200
Jan 28Wages Expense19,100 
 Cash 19,100
Jan 31Dividends5,000 
 Cash 5,000
Jan 31Electricity Expense2,470 
 Utilities Payable 2,470
Jan 31Telephone Expense1,494 
 Utilities Payable 1,494
Jan 31Miscellaneous Expense3,470 
 Cash 3,470

Accounting Principles

Accounting Principles

Accounting follows a certain framework of core principles which makes the information generated through an accounting system valuable. Without these core principles accounting would be irrelevant and unreliable.
These principals include:
  1. Accrual Concept
  2. Going Concern Concept
  3. Business Entity Concept
  4. Monetary Unit Assumption
  5. Time Period Principle
  6. Revenue Recognition Principle
  7. Full Disclosure Principle
  8. Historical Cost Concept
  9. Matching Principle
  10. Relevance and Reliability
  11. Materiality Concept
  12. Substance Over Form
  13. Prudence Concept
  14. Understandability Concept
  15. Comparability Principle
  16. Consistency Concept
These principles are the building blocks that form the basis of more complex and specialized principles called GAAP or generally accepted accounting principles such as the International Financial Reporting Standards, US GAAP, etc. They deal with matters like accounting for revenue, accounting for income taxes, accounting for business combinations, etc.