4 5 Prepare Financial Statements Using the Adjusted Trial Balance Principles of Accounting, Volume 1: Financial Accounting

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).

The third step in the process is posting journal information to a ledger. Posting takes all transactions from the journal during a period and moves the information to a general ledger, or ledger. As you’ve learned, account balances can be represented visually in the form of T-accounts. Following the steps of analyzing transactions, recording entries, posting to ledgers and creating the trial balance the accounting cycle continues with steps 5-7 of the accounting cycle.

It is not worth it to recordevery time someone uses a pencil or piece of paper during theperiod, so at the end of the period, this account needs to beupdated for the value of what has been used. Both US-based companies and those headquartered in other countries produce the same primary financial statements—Income Statement, Balance Sheet, and Statement of Cash Flows. The T-account summary for Printing Plus after closing entries are journalized is presented in Figure 5.7. Notice that the Income Summary account is now zero and is ready for use in the next period.

You then add together the $5,575 and $4,665 to get a total of $10,240. If you review the income statement, you see that net income is in fact $4,665. 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. 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 Printing Plus adjusted trial balance for January 31, 2019, is presented in Figure 5.4. The business has been operating for several years but does not have the resources for accounting software. This means you are preparing all steps in the accounting cycle by hand.

1. Besides deferrals, other types of adjusting entries include accruals.
2. Interest can be earned from bank account holdings, notes receivable, and some accounts receivables (depending on the contract).
3. Sincethere was no bill to trigger a transaction, an adjustment isrequired to recognize revenue earned at the end of the period.
4. The company does not use all six months of insurance immediately but over the course of the six months.
5. 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.

The Retained Earnings account balance is currently a credit of $4,665. Printing Plus has a $4,665 credit balance in its Income Summary account before closing, so it will debit Income Summary drop shipping sales tax and credit Retained Earnings. Let’s explore each entry in more detail using Printing Plus’s information from Analyzing and Recording Transactions and The Adjustment Process as our example.

Why Some Accounts Have Incorrect Balances on the Trial Balance

This net income figure is used to prepare the statement of retained earnings. 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 https://www.wave-accounting.net/ expenses in the presentation. For Printing Plus, the following is its January 2019 Income Statement. The next day, January 1, 2019, you get ready for work, but before you go to the office, you decide to review your financials for 2019.

The Adjustment Process

Keep in mind that the trial balance introduced in the previous chapter was prepared before considering adjusting entries. Subsequent to the adjustment process, another trial balance can be prepared. This adjusted trial balance demonstrates the equality of debits and credits after recording adjusting entries. Therefore, correct financial statements can be prepared directly from the adjusted trial balance. The next chapter provides a detailed look at the adjusted trial balance.

However, it is also reduced each year by the ever-growing accumulated depreciation. The asset cost minus accumulated depreciation is known as the book value (or “net book value”) of the asset. For example, at December 31, 20X2, the net book value of the truck is $50,000, consisting of $150,000 cost less $100,000 of accumulated depreciation. By the end of the asset’s life, its cost has been fully depreciated and its net book value has been reduced to zero. Customarily the asset could then be removed from the accounts, presuming it is then fully used up and retired.

The Accounting Period

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.

At the end of the month, the company took an inventory ofsupplies used and determined the value of those supplies usedduring the period to be $150. Adjusting entries requires updates to specific account types atthe end of the period. Not all accounts require updates, only thosenot naturally triggered by an original source document.

Chapter 3: Recording adjusting entries

Since the expense was incurred in December, it must be recorded in December regardless of whether it was paid or not. In this sense, the expense is accrued or shown as a liability in December until it is paid. Unearned revenues are also recorded because these consist of income received from customers, but no goods or services have been provided to them. In this sense, the company owes the customers a good or service and must record the liability in the current period until the goods or services are provided. A tool that can be helpful to businesses looking for an easier way to view their accounting processes is to have drillable financial statements. This feature can be found in several software systems, allowing companies to go through the accounting cycle from transaction entry to financial statement construction.

Notice that the balances in the expense accounts are now zero and are ready to accumulate expenses in the next period. The Income Summary account has a new credit balance of $4,665, which is the difference between revenues and expenses (Figure 5.5). The balance in Income Summary is the same figure as what is reported on Printing Plus’s Income Statement. What is the current book value of your electronics, car, and furniture? Are the value of your assets and liabilities now zero because of the start of a new year?

Accrued Rent

The closing entry will debit both interest revenue and service revenue, and credit Income Summary. One of the main duties of a bookkeeper is to keep track of the full accounting cycle from start to finish. The cycle repeats itself every fiscal year as long as a company remains in business. We begin by introducing the steps and their related documentation. The accounting cycle is a step-by-step process to record business activities and events to keep financial records up to date.

Income Tax Expense increases (debit) and Income Tax Payableincreases (credit) for $9,000. The following are the updated ledgerbalances after posting the adjusting entry. Interest Expense increases (debit) and Interest Payableincreases (credit) for $300. Previously unrecorded service revenue can arise when a companyprovides a service but did not yet bill the client for the work.This means the customer has also not yet paid for services.