ACC1100 · Introduction To Financial Accounting
Accrual Accounting and Adjusting Entries
This chapter covers Topics 3–5: the move from cash to accrual accounting and the adjusting entries it requires, then how the adjusted trial balance rolls into the four statements and the accounting cycle. Under accrual accounting you recognise income when earned and expenses when incurred, regardless of when cash changes hands — so at period end you post adjusting entries for accruals, prepayments, depreciation, doubtful debts and unearned income, each touching one income/expense account and one asset/liability account but never cash. From the adjusted trial balance you build the statements in a fixed order (Income Statement → Statement of Changes in Equity → Balance Sheet) because each feeds the next, then close the temporary accounts. Monash teaches the closing-entry mechanics as concept-only, so the focus is knowing why and where, not the income-summary journals.
What this chapter covers
- 01Cash vs accrual — earned/incurred, not received/paid
- 02Accruals: income earned not received, expenses incurred not paid
- 03Prepayments & unearned income (the how-first-recorded trap)
- 04Depreciation & doubtful debts adjustments
- 05The adjusted trial balance → the four statements (fixed order)
- 06The accounting cycle & closing entries (concept only at Monash)
Worked example: from adjusted trial balance to closing capital
- +1(a) Total income = 92,000 + 1,500 = 93,500 (only income accounts).
- +1Total expenses = 41,000 + 18,000 + 2,400 + 600 + 13,500 = 75,500.
- +1Profit = 93,500 − 75,500 = 18,000 (Income Statement, a period).
- +2(b) Closing capital = opening 60,000 + profit 18,000 − drawings 14,000 = 64,000 (Statement of Changes in Equity).
- +1(c) Profit (18,000) leaves the Income Statement and enters the Statement of Changes in Equity; closing capital (64,000) leaves the SOCE and lands in the Balance Sheet equity, where A = L + E ties out.
Key terms
- Accrual basis
- Recognise income when earned and expenses when incurred, regardless of cash timing. It is underpinned by the accounting-period assumption: profit must reflect a period’s real activity, not its cash flows.
- Adjusting entry
- A period-end entry that updates accounts for amounts earned or incurred but not yet recorded — accruals, prepayments, depreciation, doubtful debts, unearned income. Each touches one income/expense account and one asset/liability account, and never cash.
- Prepayment
- An expense paid in advance (e.g. insurance) recorded first as an asset, then expensed as it is used — or income received in advance (unearned income) recorded as a liability until earned. The trap is how it was first recorded.
- Adjusted trial balance
- The trial balance after all adjusting entries are posted — the single tidy column from which the four statements are prepared in their fixed order.
- Temporary vs permanent accounts
- Income, expenses and drawings are temporary (they measure one period) and are closed to zero; assets, liabilities and capital are permanent (a standing balance) and carry forward. Closing empties the temporaries into Capital.
Accrual Accounting and Adjusting Entries FAQ
Why can a profitable business still run out of cash?
Because accrual accounting records income when earned and expenses when incurred, not when cash moves. A business can be profitable but cash-poor (credit sales not yet collected) or cash-rich but unprofitable (a big loan inflow). That gap is exactly why the Statement of Cash Flows exists alongside the Income Statement, and why the exam loves “earned but not yet received” and “paid but not yet incurred” timing.
Do adjusting entries ever touch cash?
No — that is the defining feature. Every adjusting entry pairs one income or expense account with one asset or liability account, and never cash. If your adjusting entry credits or debits Cash, it is not an adjusting entry; the cash already moved (or will move) and is recorded separately.
Why must the statements be built in a fixed order?
Because they articulate. The Income Statement computes profit; the Statement of Changes in Equity adds profit to opening capital and subtracts drawings to get closing capital; the Balance Sheet then carries closing capital as equity, where A = L + E ties out. Build them out of order and you have no profit to feed the SOCE and no closing capital to feed the Balance Sheet.
Do I need to write closing journal entries for ACC1100?
No. Monash states the closing-entry mechanics “will not be covered”. You must know the temporary/permanent split, the role of the Profit & Loss Summary, and that a post-closing trial balance (permanent accounts only) readies the books for next period — but not how to write income-summary journals.
Exam move
Treat adjusting entries as a fixed checklist: for each of accruals, prepayments, depreciation, doubtful debts and unearned income, name the income/expense account and the asset/liability account it pairs with, and remember cash is never one of them. Watch the prepayment “how was it first recorded?” trap and the doubtful-debts top-up to a target allowance. Then drill the IS → SOCE → BS chain until the hand-offs (profit, closing capital) are automatic, and learn the temporary/permanent split for the closing concept. The exam almost always walks this same cycle on a fresh set of numbers.
