Differences Between Adjustment And Closing Journal Entries In Business Accounting - Essay.

Describe Business Accounting ?

What is Difference between adjustment and closing journal entries ?

Adjustment Journal Entries

The following assignment will help us understand the basic concepts of accounting. We have been provided with the trial balance and few adjustments that are require to be entered in the books. We have passed these journals, made the revised trial balance in order to update the information. using the updated trial balance we have made the income statement and balance sheet with the said information.

Adjustment journal entries are those entries that translate an entity's accounting basis into accrual basis of accounting. It is basically an entry made before issuing it to the financial statements of an entity. Let us understand this through an example. Suppose the company takes up a loan on December 1 with an obligation of paying first interest on March 1. However, the books of account close on December 31. Now, for the preparation of income statement of December and for the balance sheet as on December 31, it is important for the company to show all the expenses incurring in the month of December whether paid or not. The interest obligation might arise on the company on March 1, but it is already owning a liability of an interest expense of December to be paid to bank. This is where an adjusting entry is made so that the interest expenses of December is included in the income statement and the due interest as on December 31 is included in the December balance sheet. The adjusting entry to be passed would require debiting of interest expense and crediting of interest payable with the amount of interest for the month of December. This interest expense would be recorded in the income statement while the interest payable would be reflected in the balance sheet (Piper, 2015).

We need adjusting entries for the following reasons :

• For recording of incomes that has been earned but not received, also called accrued income.
• For recording of expense that has been incurred but not paid by the company, also called expenses payable(Siciliano, 2015).
• Where a company has made advanced payments, such excessive payment that accounts for the next year, are required to be recorded as prepaid expenses.
• In case of vice versa, where a company has received advanced payments, such excessive receiving of money is recorded as a liability because until and unless the goods or services aren't delivered, revenues cannot be recorded. So, as soon as the delivery is made, the liability is cancelled and the same amount is reported as revenue.

Following are the adjustment journal entries:

A trial balance is a part of an accounting process that represents a list of all the balances in ledger accounts of an organization. It excludes accounts that contain zero balances. There are two columns with headings "debit balance" and "credit balance" where debit balances are listed in the first column while credit balances are listed in the second column respectively. The trial balance is considered as a check of double entry accounting system because the total of debit balances should match with the total credit balances. The trial balance is considered as a useful tool to be used by accountants and auditors to have a view of the ledger balances before proposed adjustments, their adjustments that are being proposed and ledger balances after such adjustments. These final balances are often referred as the adjusted trial balance and are even used in the financial statements by an organization. Trial balance is more like a reference or self check process as it is not distributed to the outsiders as it doesn't form a part of the financial statements (Girard, 2014). It is like an internally created or electronically generated document used by accounting and auditing staff for verification purposes.

Journal

There are various purposes of creating a trial balance:

• Accountants use trial balance for verification purposes as unmatched balances will indicate an error in the amount or incorrect posting in the ledger.
• Trial balance helps in checking of mathematical accuracy whether amounts recorded are genuine and correct.
• It helps in maintaining the double entry accounting system, that is, whether every debit balance has an equal credit balance. That is every debit entry has a counter credit entry(Taillard, 2013).
• It helps in checking of recording of ledger balances and gives a summary of closing balances or current balances in the prepared ledgers.
• It is used as a part of internal check up of books of accounts by the management as well as the auditor.

However, the disadvantage of trial balance is that it eliminates the zero balance account and therefore, the auditor might not be able to discover if any expense has been incurred and written off or paid during the month. For example, penalty paid for the breach of contract in the month of June will not be shown in the trial balance ending in March because the expense incurred is immediately paid during the same month (McLaney & Adril, 2016).

An adjusted trail balance is the second trial balance but not the original one because of the difference of adjusting entries. Adjusting entries are basically made to record accrued expenses or incomes or prepaid expenses or incomes. So, preparation of second trial balance is testing of equality between debits and credits after adjustment of such entries. Such adjusting trail balance doesn't form a part of financial statement but is generate internally for verification purposes.

The bookkeeping or accounting processes have two basis of preparation, either on a cash basis or on an accrual basis. However, it is preferable for the business organizations to follow accrual basis of accounting where the revenues are recognized as soon as it is earned and not received in actuality while expenses are recorded as soon as it is incurred and not actually paid. The reason behind this is to provide accountability of the recordings and proper measurement of elements of income statement as well as the balance sheet. As we know trial balance takes into consideration all the ledger amounts irrespective whether it's a balance sheet item or a income statement item. That is why, adjusting entries resulting in creation of both an asset or a liability and an income or an expense respectively are incorporated accurately into trial balance leading to a balanced adjusted trial balance (Robinson, 2014).

Income statement

The entries that are made at the end of an accounting period to record such incurred expenses or accrued incomes that would help in the best preparation and presentation of financial statements so as to comply with the norms of accrual system and relevant accounting standards are called adjusting entries. The further explanation with an example has already been explained above. Coming to closing entries, these entries are passed on the last day of an accounting period. Usually the expense and revenue account are supposed to be made nil at the year end so as to start a new year with zero balance in these accounts. At the year end, any balances in these accounts are ended up in retained earnings in case of a company or owner's equity in case of a sole proprietorship (Parrino, 2013).

Comparing both the entries, adjusting entries are required to be passed in the accounting software. However, for closing entries, there is no effort of passing such entries because the accounting software system does it automatically. Adjusting entries contains both balance sheet item and an income statement item while closing entries usually contain income statement items. Closing entries are passed for having a nil balance in the expense and revenue account while adjusting entries are passed for recognition of accrued incomes and incurred expenses. Adjusting entries are prior entries and are nullified as soon as the income is received or expense is paid or goods or services are delivered, etc. However, closing entries every year's entries (Simpson, 2012).

This is how adjusting entries and closing entries are differentiated. However, both of them are a part of bookkeeping process for the compliance with the relevant accounting standards.

Following are the closing journal entries:

Conclusion

Using the above data we can practically implement the accounting concepts in order to prepare the accounts. The journal entries and trial balance are the first steps towards the preparation of the financial statements. The above has helped us understand these concepts.

Girard, S. L. (2014). Business finance basics. Pompton Plains, NJ: Career Press.

McLaney, E., & Adril, D. P. (2016). Accounting and Finance: An Introduction. United Kingdom: Pearson.

Parrino, R. (2013). Fundamentals of Corporate Finance, 2nd Edition. Milton: John Wiley & Sons.

Piper, M. (2015). Accounting made simple. United States: CreateSpace Pub.

Robinson, T. (2014). Business accounting. New York, NY: Prentice Hall.

Siciliano, G. (2015). Finance for Nonfinancial Managers. New York: McGraw-Hill.

Simpson, M. (2012). Financial accounting. Basingstoke: Macmillan Press.

Taillard, M. (2013). Corporate finance for dummies. Hoboken, N.J.: Wiley.