Professional Documents
Culture Documents
An extended trial balance is a standard trial balance to which are added columns extending to
the right, and in which are listed the following categories:
1. Initial balances per general ledger. These are the account totals as of the end of the
accounting period, as compiled from the general ledger. The total of all initial
balance debits should equal the total of all initial balance credits.
2. Adjusting journal entries. These are journal entries to more closely align the reported
results and financial position of a business to meet the requirements of an accounting
framework, such as GAAP or IFRS. This generally involves the matching
of revenues to expenses under the matching principle, and so impacts reported revenue
and expense levels. See adjusting entries.
3. Income statement balances. These are the revenue, expense, gain, and loss accounts
used to create the income statement.
4. Balance sheet balances. These are the asset, liability, and equity accounts used to create
the balance sheet.
In all of the above columns, debit and credit amounts are listed in separate columns. Thus,
there are eight columns in total, with two columns assigned to each of the preceding categories.
A variation on the format of the extended trial balance is to begin with initial balances, add or
subtract adjusting journal entries, and finish with ending balances. This approach does not
separate the ending balances into income statement and balance sheet accounts, and so
provides somewhat less information to the reader; this is acceptable if the reader is not
attempting to create an income statement or balance sheet from the trial balance.
The extended trial balance is extremely useful for creating a visual representation of where
each of the accounts in the standard trial balance goes in the financial statements, which yields
revenues, expenses, and profits for the reporting period, as well as asset, liability, and equity
totals as of the end of the reporting period. Any computerized accounting system automatically
generates financial statements from the trial balance, so the extended trial balance is not a
commonly
generated
report
in
computerized
systems.
Adjusting Entries
Adjusting entries are journal entries recorded at the end of an accounting period to alter the
ending balances in various general ledger accounts. These adjustments are made to more
closely align the reported results and financial position of a business with the requirements of
an accounting framework, such as GAAP or IFRS. This generally involves the matching of
revenues to expenses under the matching principle, and so impacts reported revenue and
expense levels.
The use of adjusting journal entries is a key part of the period closing processing, as noted in
the accounting cycle, where you convert a preliminary trial balance into a final trial balance. It
is usually not possible to create financial statements that are fully in compliance with
accounting standards without the use of adjusting entries.
An adjusting entry can used for any type of accounting transaction; here are some of the more
common ones:
As shown in the preceding list, adjusting entries are most commonly of three types, which are:
Accruals. To record a revenue or expense that has not yet been recorded through a
standard accounting transaction.
Deferrals. To defer a revenue or expense that has been recorded, but which has not yet
been earned or used.
Estimates. To estimate the amount of a reserve, such as the allowance for doubtful
accounts or the inventory obsolescence reserve.
When you record an accrual, deferral, or estimate journal entry, it usually impacts an asset or
liability account. For example, if you accrue an expense, this also increases a liability account.
Or, if you defer revenue recognition to a later period, this also increases a liability account.
Thus, adjusting entries impact the balance sheet, not just the income statement.
Since adjusting entries so frequently involve accruals and deferrals, it is customary to set up
these entries as reversing entries. This means that the computer system automatically creates an
exactly opposite journal entry at the beginning of the next accounting period. By doing so, the
effect of an adjusting entry is eliminated when viewed over two accounting periods.
A company usually has a standard set of potential adjusting entries, for which it should
evaluate the need at the end of every accounting period. You should have a list of these entries
in the standard closing checklist. Also, consider constructing a journal entry template for each
adjusting entry in the accounting software, so there is no need to reconstruct them every month.
Adjusting Entry Examples
Depreciation: Arnold Corporation records the $12,000 of depreciation associated with its fixed
assets during the month. The entry is:
Debit
Depreciation expense
Credit
12,000
Accumulated depreciation
12,000
Allowance for bad debts: Arnold Corporation adds $5,000 to its allowance for doubtful
accounts. The entry is:
Debit
Bad debts expense
Credit
5,000
5,000
Accrued revenue: Arnold Corporation accrues $50,000 of earned but unbilled revenue. The
entry is:
Debit
Credit
50,000
Billed but unearned revenue: Arnold Corporation bills a customer for $10,000, but has not yet
earned the revenue, so it creates an adjusting entry to record the billed amount as a liability.
The entry is:
Debit
Sales
Credit
10,000
10,000
Credit
22,000
expenses
22,000
Prepaid assets: Arnold Corporation pays $30,000 toward the next month's rent. The company
records this as a prepaid expense. The entry is:
Debit
Prepaid expenses (asset)
Credit
30,000
Rent expense
30,000
Credit
18,000
Accrued expenses
18,000
You now create the following reversing entry at the beginning of the February accounting
period. This leaves the original $18,000 expense in the income statement in January, but now
creates a negative $18,000 expense in the income statement in February.
Debit
Accrued expenses
Credit
18,000
Expense
18,000
But we are not done yet. The supplier's invoice arrives later in February, and we record it with
the following entry, which offsets the negative $18,000 that would otherwise have appeared in
the company's income statement in February:
Debit
Expense
Credit
18,000
Accounts payable
18,000
The result is that the $18,000 expense appears in the company's income statement in January,
which is presumably when it was supposed to appear under the accrual basis of accounting,
while there is no net recognition of any expense at all in February. Thus, a reversing entry has
allowed us to properly record an expense during the period when the expense was incurred,
rather than in a later period, when the company obtains the supplier's invoice.
Two further examples of how to use a reversing entry are:
Accrued revenue. You accrue $10,000 of revenue in January, because the company has
earned the revenue but has not yet billed it to the customer. You expect to invoice the
customer in February, so you create a reversing entry in the beginning of February to
reverse the original $10,000 revenue accrual. The final billing, for a total of $12,000, is
completed later in the month. The net result is the recognition of $10,000 in revenue in
January, followed by the recognition of an additional $2,000 of revenue in February.
Accrued expenses. You accrue a $20,000 expense in January for a supplier invoice that
did not arrive in time for the month-end close. You expect the invoice to arrive a few
days after you close the month, so you create a reversing entry in early February for
$20,000. The invoice arrives, and you record it in February. The net result is the
recognition of a $20,000 expense in January, with no net additional expense recognition
in February.
What if you were to forget to make a reversing entry? In the first example, this means that the
accounting records would already show $10,000 of revenue that was recorded in January, and
will then show an additional $12,000 of revenue in February, so that revenue is overstated by
$10,000 through the two-month period. The key indicator of this problem will be an accrued
account receivable of $10,000 that the accounting staff should eventually spot if it is regularly
examining the contents of its asset accounts.
If you were to forget to reverse the expense in the second example, the accounting records
would show a $20,000 expense in January and another $20,000 expense in February, where the
February amount is erroneous. The key indicator of this problem will be an accrued liability of
$20,000 that the accounting staff should locate if it is periodically examining the contents of
the company's liability accounts.
If you expect to keep an accrual for a long period of time before reversing it, then make note of
the accrual in the journal entry records, and review it as part of every month-end closing
process until you can reverse it. This is also a good reason to conduct account reconciliations
for all balance sheet accounts at regular intervals, which will detect unreversed entries.
Accrual Basis
Definition: Accrual basis is a method of recording accounting transactions for revenue when
earned and expenses when incurred. The accrual basis requires the use of allowances for sales
returns, bad debts, and inventory obsolescence, which are in advance of such items actually
occurring. An example of accrual basis accounting is to record revenue as soon as the related
invoice is issued to the customer.
The alternative method for recording accounting transactions is the cash basis.
Accruals Concept
Accrual Definition
An accrual is a journal entry that is used to recognize revenues and expenses that have been
earned or consumed, respectively, and for which the related cash amounts have not yet been
received or paid out. Accruals are needed to ensure that all revenues and expenses are
recognized within the correct reporting period, irrespective of the timing of the related cash
flows. Without accruals, the amount of revenue, expense, and profit or loss in a period will not
necessarily reflect the actual level of economic activity within a business.
Accruals are a key part of the closing process used to create financial statements under the
accrual basis of accounting; without accruals, financial statements are considerably less
accurate.
Under the double-entry bookkeeping system, an accrued expense is offset by a liability, which
appears in a line item in the balance sheet. If accrued revenue is recorded, it is offset by an
asset, such as unbilled service fees, which also appears as a line item in the balance sheet.
It is most efficient to initially record most accruals as reversing entries. By doing so, the
accounting software in which they are entered will automatically cancel them in the following
reporting period. This is a useful feature when you are expecting to issue an invoice to a
customer or receive an invoice from a supplier in the following period. For example, a business
may know that a supplier invoice for $20,000 will arrive a few days after the end of a month,
but the controller wants to close the books as soon as possible. Accordingly, he records a
$20,000 reversing entry to recognize the expense in the current month. In the next month, the
entry reverses, creating a negative $20,000 expense that is offset by the arrival and recordation
of the supplier invoice.
Accrual Examples
Examples of accruals that a business might record are:
Expense accrual for interest. A local lender issues a loan to a business, and sends the
borrower an invoice each month, detailing the amount of interest owed. The borrower
can record the interest expense in advance of invoice receipt by recording accrued
interest.
Expense accrual for wages. An employer pays its employees once a month for the
hours they have worked through the 26th day of the month. The employer can accrue
all additional wages earned from the 27th through the last day of the month, to ensure
that the full amount of the wage expense is recognized.
Expense accrual for supplier goods and services. A supplier delivers goods at the end
of the month, but is remiss in sending the related invoice. The company accrues the
estimated amount of the expense in the current month, in advance of invoice receipt.
Sales accrual. A services business has a number of employees working on a major
project for the federal government, which it will bill when the project has been
completed. In the meantime, the company can accrue revenue for the amount of work
completed to date, even though it has not yet been billed.
Interest on loans, for which no lender invoice has yet been received
Goods received and consumed or sold, for which no supplier invoice has yet been
received
Services received, for which no supplier invoice has yet been received
Taxes incurred, for which no invoice from a government entity has yet been received
Wages incurred, for which payment to employees has not yet been made
by the time the company closes its books for the month. To properly record this expense in the
month of receipt, the accounting staff records an expense in the supplies expense account with
a debit in the amount that it expects to be billed by the supplier, and records a credit to an
accrued expenses liability account. Thus, if the amount of the office supplies were $500, the
journal entry would be a debit of $500 to the office supplies expense account and a credit of
$500 to the accrued expenses liability account.
The journal entry is normally created as an automatically reversing entry, so that the
accounting software automatically creates an offsetting entry as of the beginning of the
following month. Then, when the supplier eventually submits an invoice to the entity, it cancels
out the reversed entry.
To continue with the preceding example, the $500 entry would reverse in the following month,
with a credit to the office supplies expense account and a debit to the accrued expenses liability
account. The company then receives the supplier invoice for $500, and records it normally
through the accounts payable module of the accounting software, resulting in a debit to the
office supplies expense account and a credit to the accounts payable account. The net result in
the following month is therefore no new expense recognition at all, with the liability for
payment shifting to the accounts payable account.
Realistically, the amount of an expense accrual is only an estimate, and so is likely to be
somewhat different from the amount of the supplier invoice that arrives at a later date.
Consequently, there is usually a small additional amount of expense or negative expense
recognition in the following month, once the journal entry reversal and the amount of the
supplier invoice are netted against each other.
From a practicality perspective, immaterial expenses are not accrued, since it requires too
much work to create and document the related journal entry.
Examples of Accrued Expense Journal Entries
The first three entries should reverse in the following month. Income taxes are typically
retained as accrued expenses until paid.
an over accrual of an expense will result in a reduced profit in the period in which the journal
entry is recorded.
An accrual is usually set up as a reversing entry, which means that the exact opposite of the
original entry is recorded in the accounting system at the beginning of the next accounting
period. When an over accrual is recorded in one period, this means that the reversing entry
causing the reverse effect applies in the next accounting period. Thus:
If there is an over accrual of $500 of revenue in January, then revenue will be too low
by $500 in February.
If there is an over accrual of $1,000 of an expense in January, then the expense will be
too low by $1,000 in February.
An over accrual is not good from the perspective of the auditor, since it implies that a
company's accounting staff is not able to properly estimate the amounts of revenues and
expenses for which it is creating accruals.
The presence of over accruals can be combatted by only making an accrual entry when the
amount to be recorded is easily calculated. If the amount is subject to fluctuation, the most
conservative figure should be recorded.
Example of an Over Accrual
ABC International's accounting staff estimates that the amount of its phone bill for the month
of April will be $5,500, which is based on a recent history of approximately that amount per
month over the past few months. The accounting staff accordingly creates the following entry,
which it sets up as an automatically reversing entry:
Debit
Telephone expense
Credit
5,500
5,500
At the beginning of the next month (May), the accounting system generates a reversing entry,
which is:
Debit
Accrued expenses (liability)
Telephone expense
Credit
5,500
5,500
Finally, later in May, the phone company sends ABC the April phone bill in the amount of
$4,250. The invoice is reduced because of a combination of a rate decrease and ABC having
fewer land lines in use. The entry is:
Debit
Telephone expense
Credit
4,250
Accounts payable
4,250
Thus, ABC initially creates an accrual of $5,500 that exceeds the actual amount of the expense
by $1,250. The over accrual creates $1,250 too much expense in April, and $1,250 too little
expense in May.
If there is an under accrual of $2,000 of revenue in April, then revenue will be too high
by $2,000 in May.
If there is an under accrual of $4,000 of an expense in April, then the expense will be
too high by $4,000 in May.
Auditors are always watching for potential under accruals of expenses, on the grounds that this
creates too great a profit in the period being compiled, reviewed, or audited.
Example of an Under Accrual
ABC International's accounting staff estimates that the billing from a key materials supplier
will be $50,000 based on the amount of goods shipped to the company during the past month
(April). The accounting staff uses this estimate to create a cost of goods sold accrual for
$50,000, and sets it up as an automatically reversing entry, as follows:
Debit
Cost of goods sold expense
Accrued expenses (liability)
Credit
50,000
50,000
10
At the beginning of the next month (May), the accounting system generates a reversing entry,
which is:
Debit
Accrued expenses (liability)
Credit
50,000
50,000
Later in May, the supplier sends ABC its April invoice for $60,000. The invoice is higher than
expected, because ABC's accounting staff did not account for a large delivery from the
supplier. The entry is:
Debit
Cost of goods sold expense
Credit
60,000
Accounts payable
60,000
Thus, ABC initially creates an accrual of $50,000 that is lower than the actual amount of the
cost of goods sold by $10,000. The under accrual creates $10,000 too much profit in April, and
$10,000 too much expense in May.
If you have several small accruals, it may be acceptable to record them all within an "other
liabilities" account. You should not record any accruals in the accounts payable account, since
that is reserved for trade payables that are usually posted to the account through the accounts
payable module in your accounting software.
A less common accrual is for revenue. You record accrued revenue when you have earned
revenues from a customer, but have not yet billed the customer (once you bill the customer, the
sale is recorded through the billing module in your accounting software). Accrued revenue
11
situations may last for several accounting periods, until the appropriate time to invoice the
customer. Nonetheless, accrued revenue is characterized as short-term, and so would be
recorded within the current assets section of the balance sheet. The entry for accrued revenue is
typically a credit to the sales account and a debit to an accrued revenue account. Do not record
any revenue accruals in the accounts receivable account, since that is reserved for trade
receivables that are usually posted to the account through the billings module in your
accounting software.
You should always create accrual journal entries so that they automatically reverse themselves
in the next accounting period. Otherwise, there is a strong likelihood that they will remain on
the balance sheet long after they should have been removed.
Auditors will review any accruals on the balance sheet above a certain minimum size, so be
sure to maintain detailed supporting documentation containing the reasons why you have
recorded
them.
12
The trial balance is strictly a report that is compiled from the accounting records. However,
since adjusting entries may be made as a result of reviewing the report, it could be said that
trial balance accounting encompasses the adjustment process that converts an unadjusted trial
balance into an adjusted trial balance.
If there are subsidiaries in an organization that report their results to a parent company, the
parent may request an ending trial balance from each subsidiary, which it uses to prepare
consolidated results for the entire company.
The general ledger is the report preferred by internal accountants, since it also shows the
detailed transactions that comprise the ending balance. This additional level of detail reveals
the activity in an account during an accounting period, which makes it easier to conduct
research and spot possible errors.
Trial Balance Format
The initial trial balance report contains the following columns:
1.
2.
3.
4.
Account number
Account name
Ending debit balance (if any)
Ending credit balance (if any)
Each line item only contains the ending balance in an account. All accounts having an ending
balance are listed in the trial balance; usually, the accounting software automatically blocks all
accounts having a zero balance from appearing in the report.
The adjusted version of a trial balance may combine the debit and credit columns into a single
combined column, and add columns to show adjusting entries and a revised ending balance (as
is the case in the following example).
Example of a Trial Balance
The following trial balance example combines the debit and credit totals into the second
column, so that the summary balance for the total is (and should be) zero. Adjusting entries are
added in the next column, yielding an adjusted trial balance in the far right column.
ABC International Trial Balance August 31, 20XX
Unadjusted
Trial Balance
Adjusting
Entries
Adjusted
Trial Balance
Cash
$60,000
$60,000
Accounts receivable
180,000
Inventory
300,000
300,000
210,000
210,000
Accounts payable
(90,000)
(90,000)
50,000
230,000
13
Accrued liabilities
(50,000)
$(25,000)
(75,000)
Notes payable
(420,000)
(420,000)
Equity
(350,000)
(350,000)
Revenue
(400,000)
290,000
Salaries
200,000
(50,000)
(450,000)
290,000
25,000
225,000
Payroll taxes
20,000
20,000
Rent
35,000
35,000<
Other expenses
15,000
15,000
Total
$0
$0
$0
14
In an alternative format, the unadjusted trial balance may have a separate column for all debit
balances and a separate column for all credit balances. This is useful for ensuring that the total
of all debits equals the total of all credits.
ABC Company Trial Balance June 30, 20XX
Unadjusted
Trial Balance
Adjusting
Entries
Adjusted
Trial Balance
Cash
$60,000
$60,000
Accounts receivable
180,000
180,000
Inventory
300,000
300,000
210,000
210,000
Accounts payable
(90,000)
(90,000)
Accrued liabilities
(50,000)
$(25,000)
(75,000)
Notes payable
(420,000)
(420,000)
Equity
(350,000)
(350,000)
Revenue
(400,000)
(400,000)
290,000
290,000
Salaries
200,000
25,000
225,000
Payroll taxes
20,000
20,000
Rent
35,000
35,000<
Other expenses
15,000
15,000
Total
$0
$0
$0
The adjusting entry in the example is for the accrual of salaries that were unpaid as of the end
of June.
15
in a separate column, but in aggregate for each account; thus, it may be difficult to discern
which specific journal entries impact each account.
The adjusted trial balance is not part of the financial statements - rather, it is an internal report
that has two purposes:
To verify that the total of the debit balances in all accounts equals the total of all credit
balances in all accounts; and
To be used to construct financial statements (specifically, the income statement and
balance sheet; construction of the statement of cash flows requires additional
information).
The second application of the adjusted trial balance has fallen into disuse, since computerized
accounting systems automatically construct financial statements. However, it is the source
document if you are manually compiling financial statements. In the latter case, the adjusted
trial balance is critically important - financial statements cannot be constructed without it.
Example of an Adjusted Trial Balance
The following report shows an adjusted trial balance, where the initial, unadjusted balance for
all accounts is located in the second column from the left, various adjusting entries are noted in
the third column from the left, and the combined, net balance in each account is stated in the
far right column.
ABC International
Trial Balance
July 31, 20XX
Unadjusted
Trial Balance
Adjusting
Entries
Adjusted
Trial Balance
Cash
$60,000
$60,000
Accounts receivable
180,000
Inventory
300,000
300,000
210,000
210,000
Accounts payable
(90,000)
(90,000)
Accrued liabilities
(50,000)
50,000
$(25,000)
230,000
(75,000)
Notes payable
(420,000)
(420,000)
Equity
(350,000)
(350,000)
Revenue
(400,000)
290,000
Salaries
200,000
(50,000)
(450,000)
290,000
25,000
225,000
16
Payroll taxes
20,000
20,000
Rent
35,000
35,000<
Other expenses
15,000
15,000
Total
$0
$0
$0
The adjusting entries in the example are for the accrual of $25,000 in salaries that were unpaid
as of the end of July, as well as for $50,000 of earned but unbilled sales.
To ensure that the total of all debits equals the total of all credits, thereby ensuring that
all of the underlying transactions are in balance.
To use as the starting point for adjusting entries that will bring the information in the
trial balance into compliance with an accounting framework, such as Generally
Accepted Accounting Principles or International Financial Reporting Standards.
This unadjusted trial balance may contain a number of errors, only a few of which are easy to
spot in the trial balance report format. Here are the more common errors, with suggestions on
how to find them:
Entries made twice. If an entry is made twice, the trial balance will still be in balance,
so that is not a good document for finding it. Instead, for an ongoing transaction, you
may have to wait for the issue to resolve itself. For example, a duplicate invoice to a
customer will be rejected by the customer, while a duplicate invoice from a supplier
will (hopefully) be spotted during the invoice approval process.
Entries not made at all. Impossible to find on the trial balance, since it is not there (!).
Your best bet is to maintain a checklist of standard entries, and verify that all of them
have been made.
Entries to the wrong account. This may be apparent with a quick glance at the trial
balance, since an account that previously had no balance at all now has one. Otherwise,
the best form of correction is preventive - use standard journal entry templates for all
recurring entries.
Reversed entries. An entry for a debit may be mistakenly recorded as a credit, and vice
versa. This issue may be visible on the trial balance, especially if the entry is large
enough to change the sign of an ending balance to the reverse of its usual sign.
Transposed numbers. The digits in a number may have been switched. This is easy to
find, since the underlying entry is unbalanced, and so should not have been accepted by
17
the accounting software. If a manual system is being used, journal entry totals must
compared to the totals in the trial balance. This issue relates to the following one.
Unbalanced entries. This is listed last, since it is impossible in a computerized
environment, where entries must be balanced or the system will not accept them. If you
are using a manual system, then the issue will be apparent in the column totals of the
trial balance. However, locating the exact entry is vastly more difficult, and will call for
a detailed review of every entry, or at least of the totals in every subsidiary journal that
rolls into the general ledger.
Whenever you correct an error, be sure to use a clearly labeled journal entry with supporting
documentation, so that someone else can trace through your work at a later date.
Account
18
Number
Description
Debit
Credit
1000
Cash
1500
Accounts receivable
320,000
2000
Inventory
500,000
3000
Fixed assets
2,000,000
3100
Accumulated depreciation
(480,000)
4000
Accounts payable
$195,000
4500
Accrued expenses
108,000
5000
Retained earnings
642,000
5500
Common stock
$105,000
1,500,000
Totals
$2,445,000
$2,445,000
19