Even though using bookkeeping software will help with the daily use of accounting functions for a small business, it’s still important to have an understanding of the basic functions of accounting. Before learning about adjusting and closing entries, it’s important to understand debits and credits and their relationship to the various journals. Understanding how debits and credits work is the first step into grasping the fundamentals of bookkeeping.
General Ledger Adjusting Entries
Certain general ledger (GL) accounts need to adjusted at the end of the accounting period. In most small businesses the accounting period is at the end of each month and at the end of the fiscal year. Normally adjustments are made after the initial trial balance is created. Once the trial balance is proven, the adjusting entries are posted and the trial balance is reformulated. The types of GL accounts that are adjusted at the end the account period include:
- Accrued revenues are any kind of revenue that has been earned in the current accounting period that haven’t been recorded.
- Accrued expenses, like accrued revenues are expenses for the current accounting period that hasn’t been recorded.
- Prepaid expenses are expenses that are paid in advance and need to be adjusted to the accounting period where the expenses were incurred.
- Inventory adjustments like value increase or decrease, shortage and overages and other inventory evaluations adjustments.
- Allowance for bad debts that are usually predetermined for each accounting period
- Depreciation of fixed assets is the devaluation of assets like equipment.
General Ledger Closing Entries
Certain GL accounts are closed out or zeroed out at the end of the fiscal year or at the end of an accounting period. Normally the GL accounts that are closed are generally accounts related to the income statement like revenue and expenses. The revenue and expense accounts are posted to an income summary account.
- Revenue – Debit (decrease)
- Income Summary – Credit (increase)
- Income Summary – Debit (decrease)
- Expense – Credit (decrease)
General Journal – Adjusting and Closing Entries
One of the main functions of the general journal is for adjusting and closing entries. The general journal is also known as a journal voucher or JV. The JV allows for detailed explanations of a posting transaction. The general journal is also used for correcting posting errors made to other journals and for posting transactions not covered by other journals.
Certain GL accounts like assets and liabilities are permanent accounts. The amounts in these GL accounts roll over to the next accounting period. Once the closing entries are completed, the amount posted to the income summary account is then posted to the retained earnings account. Transferring the total amount to retained earnings closes the income summary account.