22208 Chap.3 Adjusting Entries and the Closing Process
Adjusting Entries and the Closing Process
Week 3 explains why accrual accounting needs adjusting entries at period end. The cash basis records revenue and expenses when cash moves; the accrual basis records them when earned or incurred. Four situations need an adjustment: unearned revenue, accrued revenue, prepaid expenses and accrued expenses.
An adjusted trial balance then feeds the statements, and closing entries transfer revenue, expenses and dividends to retained earnings so the next period starts from zero.
The topic’s lecture example takes the same small app developer from Week 2 and makes four month-end adjustments: earning part of a deposit, recognising half-finished work, using a month of insurance and accruing a week of salaries.
The module practice set then broadens the drill with interest on term deposits and loans, part-week wages, supplies counts and long-term contracts, all calculated on a monthly basis, followed by full adjusted trial balances and closing entries.
What this chapter covers
- 01
Cash basis versus accrual basis of accounting
- 02
Unearned revenue and accrued revenue
- 03
Prepaid expenses and accrued expenses
- 04
Working adjustments on a monthly basis
- 05
The adjusted trial balance and the statements
- 06
Closing entries straight to retained earnings
- 07
Effect of omitted adjustments on profit
Worked example · free
Closing a month’s temporary accounts
- 1Close revenue: Dr Service revenue 21,000, Cr Retained earnings 21,000.
- 1Close expenses: Dr Retained earnings 13,600, Cr Wages expense 9,800, Cr Rent expense 3,800.
- 1Close dividends: Dr Retained earnings 2,000, Cr Dividends 2,000.
- 1Change in retained earnings: 21,000 − 13,600 − 2,000 = $5,400 increase.
Key terms
- Accrual basis
- Recording revenue when it is earned and expenses when they are incurred, whatever the timing of cash.
- Prepaid expense
- An asset created when cash is paid before the related expense is incurred, used up by later adjustments.
- Accrued expense
- An expense incurred but not yet paid at period end, recorded with a payable.
- Closing entries
- Entries that reduce revenue, expense and dividend accounts to zero by transferring them to retained earnings.
- Accrued revenue
- Revenue earned but not yet received or billed at period end, recorded with a receivable.
- Adjusted trial balance
- The trial balance prepared after adjusting entries are posted, used to draw up the financial statements.
Adjusting Entries and the Closing Process FAQ
Does an adjusting entry ever involve cash?
No. Every adjusting entry pairs one balance sheet account, such as a prepaid asset, a payable or unearned revenue, with one income statement account. If your entry debits or credits cash, you are recording a new transaction rather than adjusting for timing.
How do I work out the expired part of a prepayment?
Divide the total by the number of months it covers and multiply by the months that have passed. The subject’s practice questions use a monthly rather than daily basis, so a twelve-month policy uses one twelfth per month.
Why are revenue and expense accounts closed but assets are not?
Revenue, expense and dividend accounts measure a single period, so they must restart at zero. Assets, liabilities and share capital describe a position at a date and carry their balances forward.
What is the difference between accrued revenue and unearned revenue?
The timing of cash. Accrued revenue is earned before any cash arrives, so the adjustment creates a receivable. Unearned revenue is cash received before the work is done, so it starts as a liability and the adjustment moves the earned portion into revenue.
What happens to profit if an adjustment is forgotten?
It depends on the type. Forgetting to expense used insurance or to accrue unpaid interest or tax leaves expenses too low, so profit is overstated. Forgetting to record sales made at period end leaves revenue too low, so profit is understated. Work out which line is missed, then the direction follows.
Exam move
For each adjustment, first name its scenario in the two-by-two grid of revenue or expense and cash before or after, then write the entry. Practise wage accruals with day counts, and finish each set by closing the accounts and reconciling retained earnings to the statement of changes in equity.
Keep a list of the adjustment types you get wrong in practice; most students consistently confuse one pair, and naming it is the quickest fix before the final exam.
Finally, take one unadjusted trial balance from the module practice set and carry it all the way through adjustments, an adjusted trial balance, the statements and closing entries in one sitting, timing yourself so you know how long a full cycle question really takes.
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