Notes by Muhammad Jahangeer Miana: 2017

Wednesday 26 April 2017

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
	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 some error in the journal entries or in the ledger or in the calculations.

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:

Date	Account	Debit	Credit
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 Depreciation		1,100
	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
	Service Revenue		3,000

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

	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
Utilities Payable		3,964
Unearned Revenue		4,000
Common Stock		100,000
Service Revenue		82,600
Wages Expense	38,200
Miscellaneous Expense	3,470
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 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

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
28,500	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
$17,600			$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

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:

Date	Transaction
Jan 2	An amount of $36,000 was paid as advance rent for three months.
Jan 3	Paid $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 4	Purchased office supplies costing $17,600 on account.
Jan 13	Provided services to its customers and received $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 first two weeks of January, aggregating $19,100.
Jan 18	Provided $54,100 worth of services to its customers. They paid $32,900 and promised to pay the remaining amount.
Jan 23	Received $15,300 from customers for the services provided on January 18.
Jan 25	Received $4,000 as an advance payment from customers.
Jan 26	Purchased office supplies costing $5,200 on account.
Jan 28	Paid wages to its employees for the third and fourth week of January: $19,100.
Jan 31	Paid $5,000 as dividends.
Jan 31	Received electricity bill of $2,470.
Jan 31	Received telephone bill of $1,494.
Jan 31	Miscellaneous expenses paid during the month totaled $3,470

The following table shows the journal entries for the above events.

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 Receivable	21,200
	Service Revenue		54,100
Jan 23	Cash	15,300
	Accounts Receivable		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
	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
	Utilities Payable		1,494
Jan 31	Miscellaneous Expense	3,470
	Cash		3,470

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:

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.