Adjusting and closing journal entries

Adjusting and closing journal entries

Every business conducts several transactions in its day to day operations. A company records its transactions in journal entries where they can state the relevant account and their effects. Journal entries are recorded daily, depending on the insensitivity of business operations. The journal entries are adjusted at the end of the period to get an accurate figure. The purpose of closing entries is to eliminate temporary accounts. The aim is to get a precise reflection of the expenses and incomes generated throughout the accounting period.

Adjusting entries

The purpose of adjusting entries is to meet the accrual concept of accounting. Some business transactions affect revenues and expenses in more than one accounting period. For example, revenue might are earned this year, but the services related to the revenue are provided the next year. The accrual concept of accounting requires the business to recognize the expenses in the accounting period they are incurred and revenues in the accounting period they are earned.  A business operating in a service industry, for example, could receive service fees from clients on services they are yet to deliver. Similarly, a company can incur expenses for the next accounting period. Examples of entries to be adjusted are service revenue, rent expense, etc.

The second purpose of adjusting entries is to correct and fix errors in the books of accounts. The closed journal entries show responsible accounting, which allows easy referencing of the journal entries. The process of adjusting helps identify all the transactions that the accountant recorded incorrectly. The double entry, for example, could have figure-mismatch, which the closing entry operations will uncover.

Adjusting entries ensure that the next step of the accounting cycle is built from valid data. Accurate recording of transactions helps to reduce both over-taxation and over-charging by service providers. A business that has not accounted for the unearned revenues will record a lot of revenues for the services not yet delivered and hence massive taxes.

Closing entries

Closing entries are used to eliminate temporary accounts in the income statement and add them to permanent accounts in the balance sheet. The purpose of closing entries is to figure out the exact revenues and exact expenses and close them to the income summary accounts. GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards) requires that the business performs all the accounting cycles correctly. Temporary accounts include expenses and revenues incurred or earned respectively in an accounting period. All the expenses and revenues are closed to income summary accounts.

The Income summary accounts are then closed to the retained earnings account, which appears in the equity section of the balance sheet. An example is if the company incurred several expenses, which include rent expenses, insurance expenses, salaries, expenses, etc. Also, the company can earn revenue, such as sales revenue and service revenue. All the expenses are recorded on the credit side and income summary on the debit side. All revenues are recorded on the debit side and income summary on the credit side. After then, the Income summary is debited, and the retained earnings are credited.

References

Carroll, M., & Lopes, R. (2019). Journal Entries. In Antarctica: Earth’s Own Ice World (pp. 162-178). Springer, Cham.

Warren, C., Jonick, C., & Schneider, J. (2020). Accounting. Cengage Learning.