Question

You just started an internship working in a small business that is in its second year of operation. The business owner wants to apply for a bank loan as soon as possible, and is very anxious to receive the second year financial statements. The business owner has observed you performing the steps in the recording process of journalizing, posting and preparing a trial balance, and he doesn't understand why you can't prepare the financial statements without first preparing adjusting entries and an adjusted trial balance.  Explain to the business owner the need and purpose of adjusting entries, and why the adjusted trial balance should be the source for the financial statements.

Answer 1

Adjusting entries are made in the accounts to conform the accrual concept.It is a fundamental concept which requires revenues is  recorded when they are earned not when they received in cash and expenses are recorded when they are incurred not when they paid.

A transaction will affect revenues and expenses in more than one accounting period

And also all transations have not been documented during the period

So adjusting entries are made to update ledger accounts

Eg:Depreciation,Accrual and prepayments

An adjusted trial balance is prepared   after adjusting entries have been made

The reason for preparing the adjusted trial balance is to ensure the adjusting entries were done correctly.

This is the final step before preparing financial statements which will be read by users

And also It is to bring the entity's financial statements into compliance with an accounting framework, (GAAP or IFRS)