Question

1. In Chapter 2 of your book, it describes the accounting cycle. Phase 4 of the accounting cycle is to prepare the adjusting entries. Describe two types of adjusting entries. If those entries were not made, what would the impact be on the financial statements.

2. How does double entry book-keeping and the system of debits and credits ensure accuracy in financial reporting? Can you relate the concept of double entry bookkeeping or the accounting equation to other aspects of life or learning?

Answer 1

1.
Two types of adjusting entries are described as follows

a. Prepayments - This represents the amount that has already been paid, that means cash has been paid but the benefit has not been obtained. In other words, it is a CASH EXPENSE and is not yet ACCRUED. The consumption is still pending which means that the EXPENSE does not relate to this period. This needs to be adjusted.

If this entry was not made then the expense side of the income statement would be overstated, which means Income would be understated.

b. Non cash expenses- Non cash expenses like depreciation require adjustment at year end (or at whatever frequency the financial statements are issued) Matching principle is required to be followed. These expenses pertain to the assets that are used in the current period. The benefit obtained in the current period is matched with the expenses of the current period.

If this entry was not made then expense side shall be understated and Income would be overstated. Also, assets side would be overstated in the balance sheet.

2.
Double entry book keeping and the system of debits and credits provide accuracy since it provides a system of checks and balances. Balance sheets must tally in a double entry system. If it doesn't then there is an error which can be found out during reviews. There are chances of human errors which is reduced by the double entry system. Also, double entry system works on matching principle, the expenses and benefits of the period must be recorded in the same period (Accrual concept as well). So this gives a better picture about the business than the single entry system.

A very simple relation is with KARMA or Newton's Third Law

"To every action there's and equivalent and opposite reaction"

Which is nothing but, to every debit there will be credit of the same amount.