ADJUSTMENTS, FINANCIAL
STATEMENTS & CLOSING
PROCESS
ADJUSTING JOURNAL ENTRIES (AJE)
 Necessary due to timing differences between when:
 revenue is generated and cash is received
 expense is incurred and cash is paid
 “To Do” list triggered by transaction or event
 Typically performed monthly (effective last business day)
 Posted to the general ledger
 Financial statements derived from adjusted (versus unadjusted) trial balance
 Two types:
 Revenue
 Expense
REVENUE RECOGNITION
TIMING: CASH RECEIVED VERSUS DELIVERY OF GOOD OR SERVICE
BEFORE
DURING
AFTER
Recognition
Unearned Revenue
Revenue
Accounts Receivable
Explanation
Liability on
Balance Sheet
until service is
performed or
goods delivered
Recognize
Revenue on
Income
Statement at
time of service or
delivery
Revenue
recognized at time
of service or
delivery; Asset on
Balance Sheet
(IOU) until cash
received
REVENUE AJE: UNEARNED REVENUE
 Payment received before service is performed or goods are delivered
 Liability initially recognized on balance sheet
 Over a period of time, service is performed or goods are delivered
 Adjusting journal entry to recognize the revenue stream and reduce the IOU
(because the obligation has been satisfied):
Unearned Revenue
Revenue
 Impact:
 Liability
 Revenue
XXX
XXX
REVENUE AJE: ACCRUED REVENUE
 Payment received after service is performed or goods are delivered
 No bill or invoice delivered or cash exchanged prior to the close of the accounting
period
 Asset needs to be recognized on balance sheet
 Adjusting journal entry to recognize the revenue stream and add the future benefit
to be received from the customer:
Accounts Receivable
Revenue
 Impact:
 Asset
 Revenue
XXX
XXX
INTEREST
 Interest rates quoted on any financial instrument will always be annual

Interest = P x R x T where:
 P = principal
 R = interest rate
 T = time period (fraction of the year)
EXPENSE RECOGNITION
TIMING: CASH PAID VERSUS EXPENSE INCURRED TO GENERATE REVENUE
BEFORE
DURING
AFTER
Recognition
Prepaid Expense
Expense
Accounts Payable
Explanation
Asset on
Balance Sheet
until service is
performed or
goods delivered
Recognize
Expense on
Income
Statement at
time of service or
delivery
Expense
recognized at time
of service or
delivery; Liability
on Balance
Sheet until cash
paid
EXPENSE AJE: PREPAID EXPENSES
 Cash paid before benefit is received
 Asset initially recognized on the balance sheet
 Over a period of time, the benefit is used (expires)
 Adjusting journal entry to recognize the diminished value of the asset as a result of
the passage of time:
Expense
Prepaid Expenses
 Impact:
 Asset
 Expense
XXX
XXX
EXPENSE AJE: DEPRECIATION
 Expense specifically associated with long-lived assets (PPE)
 Recognizes that usefulness, or value, goes down over a period of time (i.e. due to
obsolescence, or wear and tear)
 Adjusting journal entry to allocate costs over a period of time as the company
uses the asset to generate revenues:
Depreciation Expense
Accumulated Depreciation
 Straight-Lined Depreciation Expense =
 Impact:
 Asset
 Expense
XXX
XXX
Historical Cost – Residual Value
Useful Life
ACCUMULATED DEPRECIATION
 Contra-asset
 Credit (versus debit) balance; subtracts from (versus adds to) asset base
 Net Book Value = Historical Cost – Accumulated Depreciation
 Indicates what remains as far as the usefulness or benefit of an asset
 Historical cost remains unchanged but accumulated depreciation grows
with the passage of time
EXPENSE AJE: ACCRUED EXPENSES
 Cash paid after benefit is received
 No bill or invoice received or cash exchanged prior to the close of the accounting
period
 Liability needs to be recognized on balance sheet
 Adjusting journal entry to recognize the expense (benefit used) and create the IOU
that will be satisfied at some future date upon the exchange of cash:
Expense
Accounts Payable
 Impact:
 Liability
 Expense
XXX
XXX
CLOSING PROCESS
 Occurs annually on the last day of the fiscal year to zero out temporary
accounts and hit the “reset button” for the start of the next fiscal period
 What temporary accounts? Revenues & Expenses
 Income statement accounts have balances that accumulate for a period not to
exceed 12 months
 Closing entries:
 Transfer balances in the temporary accounts to retained earnings
 Establish a zero balance (“fresh start” for next fiscal year)
 Posted to the general ledger
 Post-close trial balance prepared (final step of the accounting cycle)
CLOSING ENTRIES
 To close out revenue accounts, post closing entries in the following format:
Revenue
XXX
Retained Earnings
XXX
 To close expense accounts, post close entries in the following format:
Retained Earnings XXX
Expense
XXX