Question

why adjusting entries and closing entries are needed. What is their purpose? How are they different? (no handwriting)

Answer 1

Adjusting Journal Entries:-

The adjusting journal entries are prepared at the end of accounting period to adjust the account balances with correct balances. The correct balances are based on accrual concept of accounting and matching principle. Under matching principle, expenses to be recognized in the period when the revenue related to those expense recognized.

The accrual concept include recognizing expenses and incomes when they are earned and accrued irrespective of cash paid or received. For example, if interest is paid on Sept 30 of each year and accounting year ends on Dec 31 every year, then the interest expense from Oct 1 to Dec 31 will be debited on Dec 31 (which is an adjusting entry).

The main purpose of the adjusting entries to update the accounts in accordance with accrual concept and matching principle.

Closing Journal Entries:-

The closing journal entries are used to close the temporary accounts at the end of each year and transfer their balances to permanent accounts (i.e. balance sheet). Temporary accounts include revenues, expenses and dividends and permanent accounts include assets, liabilities and equity accounts.

The net difference between revenue and expenses is transferred to retained earnings (i.e. net income credited to retained earnings account). Dividends paid is deducted from retained earnings.

Difference:-

The purpose of adjusting entries and closing entries are completely different where the former is used for calculating correct closing ledger balances in accordance with accrual concept and matching principle, the latter is used for closing all the temporary accounts (revenues, expenses and dividends account).