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Effects on financial statements when no adjustments have been made

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The effects on the income statement and
balance sheet if adjustments are not
made.
The process of preparing the financial statements begins with the adjusted trial balance.
Preparing the adjusted trial balance requires "closing" the book and making the necessary
adjusting entries to align the financial records with the true financial activity of the
business.
An adjusting entry is a journal entry made at the end of an accounting period that
allocates income and expenditure to the appropriate years. Adjusting entries are generally
made in relation to prepaid expenses, prepayments, accruals, estimates and inventory.
Throughout the year, a business may spend funds or make assumptions that might not be
accurate regarding the use of a good or service during the accounting period. Adjusting
entries allow the company to go back and adjust those balances to reflect the actual
financial activity during the accounting period. Failure to record the adjusting entries can
result in understatement of expenses and overstatement of income, which
ultimately can affect the amount of taxes paid.
Look at these two common examples I have outlined for you.
EXAMPLES:
Q1. A company borrowed $100,000 on December 1 by signing a six-month note that
specifies interest at an annual percentage rate (APR) of 12%. No interest or principal
payment is due until the note matures on May 31. The company prepares financial
statements at the end of each calendar month. If the company fails to make the December
31 adjusting entry there will be four consequences:
1) Interest Expense will be understated (too little expense being reported)
2) Net Income will be overstated (too much net income being reported)
3) Owner's equity will be overstated
4) Interest Payable will be understated
The accounting equation and balance sheet will show liabilities (Interest Payable)
understated and owner's equity overstated.
The Interest expense account in the income statement should be debited while crediting
the Interest payable account in the balance sheet

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Q2. A bank lent $100,000 to a customer on December 1 that required the customer to
pay an annual percentage rate (APR) of 12% on the amount of the loan. The loan is due
in six months and no payment of interest or principal is to be made until the note is due
on May 31. The bank prepares monthly financial statements at the end of each calendar
month. If the company fails to make the December 31 adjusting entry there will be four
consequences:
1) Prepaid Insurance will be overstated.
2) Insurance Expense will be understated.
3) Net Income will be overstated.
4) Owner's equity will be overstated.
The accounting equation and balance sheet will show assets (Prepaid Insurance
overstated and owner's equity overstated)
Debit-Interest Receivable account ( in the balance sheet)
Credit-Interest income/Interest revenue account ( in the income statement)
Fr om the above you can see that the expenses are understated while the income is
overstated
There are two scenarios where adjusting journal entries are needed before the financial
statements are issued:
Nothing has been entered in the accounting records for certain expenses or
revenues, but those expenses and/or revenues did occur and must be included in
the current period's income statement and balance sheet.
Something has already been entered in the accounting records, but the amount
needs to be divided up between two or more accounting periods.
Adjusting entries almost always involve a
balance sheet account (Interest Payable, Prepaid Insurance, Accounts Receivable,
etc.) and an
income statement account (Interest Expense, Insurance Expense, Service
Revenues, etc.)
as informed in the first two introductory paragaraphs
BEST WISHES to you as you prepare for your
exams.

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The effects on the income statement and balance sheet if adjustments are not made.The process of preparing the financial statements begins with the adjusted trial balance. Preparing the adjusted trial balance requires "closing" the book and making the necessary adjusting entries to align the financial records with the true financial activity of the business.An adjusting entry is a journal entry made at the end of an accounting period that allocates income and expenditure to the appropriate years. Adjusting entries are generally made in relation to prepaid expenses, prepayments, accruals, est ...
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