Principles of Financial Accounting: The Accounting Cycle - Adjusted Trial Balance

What It Is

An Adjusted Trial Balance (ATB) is a list of all general ledger accounts with their balances after adjusting entries have been made. It is essential in financial accounting as it ensures that the financial statements accurately reflect the company's financial position and performance. If a company buys $10,000 of inventory on December 31, but the invoice is not received until January 2, the company must make an adjusting entry to record the inventory purchase on December 31.

Key Concepts & Formulas

• Accruals: Accrued expenses or revenues that have not been recorded yet. Example: Accrued salaries of $5,000 on December 31.
• Prepaid Expenses: Expenses paid in advance of the period. Example: Prepaid rent of $2,000 on January 1.
• Depreciation: The decrease in value of a tangible asset over its useful life. Example: Depreciation of $1,000 on a machine with a useful life of 5 years.
• Amortization: The decrease in value of an intangible asset over its useful life. Example: Amortization of $500 on a patent with a useful life of 10 years.
• Matching Principle: Expenses are matched with revenues in the same period. Example: Rent expense of $2,000 in January is matched with the revenue earned in January.
• GAAP (Generally Accepted Accounting Principles): The set of rules and guidelines that accountants follow to prepare financial statements. Example: GAAP requires that depreciation be recorded on a straight-line basis.
• Adjusted Trial Balance Formula: ATB = TB + Adjusting Entries, where TB is the Trial Balance and Adjusting Entries are the journal entries made to adjust the accounts.

Journal Entry Examples

1. Accrued Salaries:
   • Dr. Salaries Expense $5,000
   • Cr. Salaries Payable $5,000 Explanation: Salaries expense is debited to record the expense, and salaries payable is credited to record the liability.
2. Prepaid Rent:
   • Dr. Rent Expense $2,000
   • Cr. Prepaid Rent $2,000 Explanation: Rent expense is debited to record the expense, and prepaid rent is credited to record the asset.
3. Depreciation:
   • Dr. Depreciation Expense $1,000
   • Cr. Accumulated Depreciation $1,000 Explanation: Depreciation expense is debited to record the expense, and accumulated depreciation is credited to record the decrease in asset value.

Common Mistakes

1. Mistake: Confusing debits and credits for expense accounts.
   • Correction: Expenses are debited, and revenues are credited. Use the mnemonic "DEBIT" (Decrease Expense, Balance Increases).
2. Mistake: Failing to match expenses with revenues in the same period.
   • Correction: Use the matching principle to match expenses with revenues in the same period.
3. Mistake: Not recording depreciation and amortization.
   • Correction: Record depreciation and amortization on a straight-line basis over the asset's useful life.

Exam Tips

1. Tip: A debit increases assets AND expenses – remember 'ADE' (Assets, Drawings, Expenses).
2. Tip: Reversing normal balances can be a trap – make sure to debit the account with the normal balance of a debit and credit the account with the normal balance of a credit.
3. Tip: Use the adjusting entries to ensure that the financial statements accurately reflect the company's financial position and performance.

Quick Practice

1. Problem: What is the adjusting entry for accrued salaries of $5,000?
   • Answer: Dr. Salaries Expense $5,000, Cr. Salaries Payable $5,000
   • Explanation: Salaries expense is debited to record the expense, and salaries payable is credited to record the liability.
2. Problem: What is the adjusting entry for prepaid rent of $2,000?
   • Answer: Dr. Rent Expense $2,000, Cr. Prepaid Rent $2,000
   • Explanation: Rent expense is debited to record the expense, and prepaid rent is credited to record the asset.
3. Problem: What is the adjusting entry for depreciation of $1,000?
   • Answer: Dr. Depreciation Expense $1,000, Cr. Accumulated Depreciation $1,000
   • Explanation: Depreciation expense is debited to record the expense, and accumulated depreciation is credited to record the decrease in asset value.

Last-Minute Cram Sheet

1. Dividends are NOT an expense – they go directly to retained earnings.
2. Normal Balances: Assets, Expenses, Dividends, and Losses have normal debit balances, while Revenues, Liabilities, and Equity have normal credit balances.
3. GAAP Principles: Matching principle, Materiality, Consistency, and Full Disclosure.
4. Accruals: Accrued expenses or revenues that have not been recorded yet.
5. Prepaid Expenses: Expenses paid in advance of the period.
6. Depreciation: The decrease in value of a tangible asset over its useful life.
7. Amortization: The decrease in value of an intangible asset over its useful life.
8. Adjusted Trial Balance Formula: ATB = TB + Adjusting Entries
9. Matching Principle: Expenses are matched with revenues in the same period.
10. Reversing normal balances can be a trap – make sure to debit the account with the normal balance of a debit and credit the account with the normal balance of a credit.