"The Adjusting Process", Part III

Adjusted Trial Balance

  • After preparing adjusting entries, the next step is to prepare the adjusted trial balance.
  • This follows the process of recording, journalizing, and posting the adjusting entries.
  • The adjusted trial balance reflects updated account balances after adjustments.
  • The first trial balance is unadjusted, while the second is adjusted.

Purpose

  • The key purpose is to prepare this trial balance after all adjusting entries have been made, including deferrals and accruals.
  • The adjusted trial balance is prepared using account balances from the general ledger or T-accounts.
  • T-accounts are manual versions of the general ledger maintained in the accounting system.

Account Changes

  • Cash balance typically remains unchanged from the unadjusted to the adjusted trial balance.
  • Cash is not used in adjusting entries; any change indicates an error.
  • Revenues and expenses are accounts that will change from the unadjusted to the adjusted trial balance.

Equality of Debits and Credits

  • Total debits must equal total credits in the adjusted trial balance.
  • This proves the equality of the left side (debits) and the right side (credits).

Financial Statement Preparation

  • Financial statements can be directly prepared from the adjusted trial balance.
  • Annual financial statements can be prepared based on a fiscal year (12 months).
  • Interim financial statements can be prepared monthly or quarterly.
  • Revenue and expense accounts from the adjusted trial balance are used to prepare the income statement.
  • Accrual accounting is followed, focusing on the income statement.
  • Revenues and expenses are updated and adjusted for amounts earned or used up.

Connecting Adjusted Trial Balance to Financial Statements

Income Statement

  • The income statement is prepared first for a specific time period.
  • Amounts from the adjusted trial balance are directly used on the income statement and are updated from the adjusting process.
  • Example: Net income of 143,650 is the net gain.
  • Net Income = Revenues - Expenses, which shows the business goal of profitability being met.
  • It is a single-step income statement where total revenues are subtracted from total expenses.

Statement of Owner's Equity

  • The updated amount of capital is used on the statement of owner's equity.
  • This statement explains changes to the owner's claim showing: Beginning Balance + Investments - Drawings = Ending Balance.
  • Drawings decrease the owner's claim as resources are taken out.

Balance Sheet

  • The balance sheet shows the financial health or position of the business at a point in time.
  • Assets are listed in order of liquidity, with cash listed first.
  • Resources must equal claims: Total Assets = Total Liabilities + Owner's Equity.
  • The numbers are based on updated amounts from adjusting entries.
  • Example: Total assets are 421,150.

Review Questions

What is an Adjusted Trial Balance?

  • An adjusted trial balance verifies that accounts are still in balance after preparing adjusting entries, including deferral and accrual adjustments.
  • It shows that everything remains in balance from the unadjusted to the adjusted trial balance.

Order of Financial Statements

  1. Income statement (profitability)
  2. Statement of owner's equity
  3. Balance sheet (specific date).
  4. Statement of cash flows (liquidity).
    • Statement of Cash Flows is broken into three categories of business activities: operating, investing, and financing.