Main Points Summary

The five main topics we covered in chapters 4 and 5 are:
1)    Adjustments
2)    Accounts Involved in Adjustments
3)    The Closing Process
4)    The Worksheet
5)    Classification Groups

Adjustments

Adjustments are done at the end of an accounting period to recognize internal transactions and bring asset and liability accounts to their proper balances after all transactions for an accounting period. It is based on the revenue recognition principle and the matching principle.

There are five different types of adjusting entries:
-Adjustments for Prepaid Expenses
-Adjustments for Amortization
-Adjustments for Unearned Revenues
-Adjustments for Accrued Expenses
-Adjustments for Accrued Revenues

Accounts Involved in Adjustments

Prepaid Expenses refers to the use of assets paid for in advance such as insurance or rent (debit expense, credit asset). Amortization adjustments are done to record the usage of a capital (long-term) assets life (debit expense, credit asset). Unearned Revenue is adjusted to recognize revenues earned (debit unearned revenue, credit revenue). Accrued Expenses are adjusted to recognize unrecorded and unpaid expenses (debit expense, credit liability). Lastly, Accrued Revenues are adjusted to recognize unrecorded and not yet received revenues (debit asset, credit revenue).

The Closing Process

After financial statements are completed, the closing process begins. The main function of the closing process is to ensure that the account is ready for the next fiscal period. The owner’s equity should reflect the revenue, expense and withdrawals accounts. In order to measure results from the period that has just ended, those accounts should begin with balances set at zero. Additionally, the increases that come from the net income should reflect the capital account of the owner. The decreases due to the net losses and withdrawals should also be shown in the owner’s capital account. Most accounts involved in the closing process are known as Temporary or Nominal Accounts, these accounts are the Revenue, Expense, Withdrawals and Income Summary accounts. These accounts are closed, with the balances brought to zero at the end of every fiscal period.

Process of closing:
-Close Revenue accounts into Income Summary (Debit = Revenue, Credit = Income Summary)
-Close Expense accounts into Income Summary (Debit = Income Summary, Credit = Income Summary)
-Close Income Summary account into Owner’s Capital account (Credits and Debits depend on Net Income / Net Loss)
-Close Withdrawals account into Owner’s Capital account (Debit = Capital, Credit = Drawings)

The Worksheet

The worksheet is used to to prepare for the creation of financial statements, such as the Income Statement, the Statement of Owner’s Equity, and the Balance Sheet. The worksheet contains five different sections for the Unadjusted Trial Balance, the Adjustments, the Adjusted Trial Balance, the Income Statement, and the Balance Sheet / Statement of Owners Equity. Every account can be listed onto the worksheet. Figures are all recorded into the Trial Balance sections before being moved over to their appropriate sections. Revenues and Expenses to the Income Statement section and Assets, Liabilities, and Owner’s Capital and Withdrawal into the Balance Sheet section. The Net Income / Loss also appears on the worksheet under the Income Statement and Balance Sheet sections.

Classification Groups

There are three major categories within a classified balance sheet; they are assets, liabilities, and owner’s equity. Within those three, there are multiple sub categories

Assets:
-Current assets (cash, accounts receivable), used within the fiscal period
-Long term investments (stocks, bonds, unused land), last more than one fiscal period
-Plants, property, and equipment (land, buildings, equipment), last more than one fiscal period
-Intangible assets (patents, grants, copyrights, trademarks, goodwill)

Liabilities:
-Current liabilities (accounts payable, notes payable, unearned revenue), paid within a fiscal period
-Long term liabilities (mortgage payable, bank loan), paid over multiple fiscal periods

Owners Equity:
-Capital

How does the unit relate to GAAPs?

In this unit we learn how to do adjustments. When adjusting we recognize the revenue recognition principle and the matching principle. We also learn that accrual basis accounting is founded on the revenue recognition principle, the matching principle and the time period principle.

How does the unit relate to identifying, recording, measuring, and communication information?

We identify what accounts are needed to do the adjustments for the accounting period and the accounts needed for the closing process. Then we record and measure the by using the general journal. Finally we communicate the information by posting post-closing trial balance, and classified balance sheets.

How do the topics covered ensure that accounting information is relevant, reliable, consistent, and comparable?

The GAAPS, which in this case are: matching principle, time period principle and revenue recognition principle ensure that the accounting information is relevant, reliable, consistent and comparable.