The Purposes of adjusting and closing journal entries

The Purposes of adjusting and closing journal entries

Every business conducts several transactions in its day to day operations. A business records its transactions in journal entries here hey can state the relevant account, its effects on the credit and debit accounts (double entry) plus additional comments to explain why the company recorded them. Journal entries, however, are recorded daily depending on how intensive the business operations are. To get an accurate reflection of the expenses and incomes generated throughout the accounting period; therefore, the business adjusts the journal entries entered throughout that period. After adjusting the journal entries, the company gets an accurate figure on closing entry. Adjusting entries and closing entries serve the following purposes to the business.

The first purpose of adjusting and closing journal entries is to meet the accrual concept of accounting. Most transactions that the business conducts throughout its existence can affect (for more than accounting period) the revenues (income) and expenses generated or incurred. The accrual concept of accounting, on the other hand, 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 accounting periods to come (paying in advance). Prepaid expenses include a 5year rent paid and prepaid insurances that cover a period of more than the current accounting period. Even though the business made the prepayments in the current accounting period, it becomes misleading to record them in the current period. Income statements only record the income earned and expense incurred in the current financial period. From this scenario, therefore, adjusting entries and closing entries serve to associate specific income/ expenses to the financial period that the company used them.

The second purpose of closing entries and adjusting journal 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 when need be. An adjusted, closed journal entry clarifies all the accounts that every single transaction affected in a given accounting period. If the company needs corrections in a specific account, it becomes easy to fix errors and rectify them. Besides, the process of adjusting and closing the journal entries, in itself, 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 hence easy correction.

The third purpose of adjusting entries and closing entries is to figure out the exact revenues and exact expenses. GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards) requires that the business performs all the accounting cycles correctly. The accounts involving income, assets, liability and expenses are very significant to the success of the company hence should be as accurate as possible. Apart for ensuring that a ledger becomes up to date, adjusting entries ensure that the next step pf the accounting cycle is build from valid data. Besides, accurate recording of transactions helps to reduce both over-taxation by the taxation authorities and over-charging by service providers. A business that has not accounted for the unearned revenues (deferred revenues) will record a lot of revenues for both the services not yet delivered and inventories not sold. Enormous revenues recorded attract massive taxes as well, which cost the business a fortune.

Every company should conform to the matching principle stated by GAAP. A company will draw a better revenue recognition plan with correct and updated figures. Compared to analytics tools, adjusting entries and closing them helps the business to uncover all aspects of the transaction that other accounting activities/ operations fail to signify. Processes such as cash receipts and cash disbursements, on their own, cannot solely give a track of the business transaction. Besides, there exist business transactions that do not directly involve cash receipts and disbursements but affect the earnings and business wealth. In conclusion, therefore, it is essential that every company keeps adjusting entries and closing entries to serve the purposes explained above.

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.