The following points highlight the four main types of accounting. The types are:- 1. Adjusting Entries 2. Transfer Entries 3. Closing Entries 4. Opening Entries.
Types # 1. Adjusting Entries:
It is a normal practice to make entries in the accounting records on cash basis (revenues and expenses actually received and paid). However, there is a need to formulate accounting transactions based on accrual convention. The accrual convention demands that the right to receive cash and the obligation to pay cash be accounted.
This necessitates the adjusting entries to be passed through general journal. In addition, there is a need to account for reserves and provisions, losses on assets, incomes on liabilities, interest on owner’s equity, interest on drawings, etc., and most importantly the closing stock (ascertained after closing the books of accounts for the year/period).
Adjusting entries have the following examples:
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1. Closing stock
2. Outstanding expenses
3. Accrued income
4. Prepaid expense
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5. Income received in advance
6. Depreciation
7. Provision for bad and doubtful debts
8. Recovery of bad debts
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9. Provision for discount on debtors
10. Provision for discount on creditors
11. Interest on capital
12. Interest on drawings
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1. Closing Stock:
Since stock taking is done after closing the books of accounts, closing stock appears as an adjusting item (recorded outside the trial balance). Closing stock should be shown as an asset in the balance sheet and charged to the credit side of trading account and profit and loss account as revenue.
2. Outstanding Expenses:
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They are expenses incurred but not paid during the accounting period. For example, wages, salaries, interest on loan, rent. Since such expenses are a charge on the income statement (trading and profit and loss A/c) during the current year, they should be debited and outstanding expense account should be credited which should appear as a liability in the balance sheet.
3. Accrued Income:
It is the income earned but not received during the accounting period. For example, interest on deposits, rent, commission, and discount. Since such incomes form the incomes of the current year, they should be credited to the income statement (trading and profit and loss A/c) and accrued income account should be debited, which should appear as an asset in the balance sheet.
4. Prepaid Expenses:
They are the expenses paid in advance, i.e., though the expense is paid during the accounting period, its benefit might accrue during the subsequent years. For example, insurance premium paid is Rs.1,000 where the premium actually to be paid is Rs.600 during the current accounting period. Here, Rs.400 (1,000 – 600) paid in advance does not form the expense of the current year.
Therefore, only Rs.600 should be charged to the current year’s income statement as expense. The advance Rs.400 should be carried forward to next year and shown as an asset in the balance sheet of the current year. (Similarly for advertisement, rent, etc.)
5. Income Received in Advance:
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This is an unearned income for the current accounting period. Hence, it is to be carried forward to the next year for adjustment. Since it is an income which is not earned, it should be shown as a liability in the current year’s balance sheet. The items of this kind may be commission, rent, interest, discount, fees, etc.
For example fees actually earned is Rs.800 but cash received towards fees is Rs.1,000 during the accounting period. The difference between Rs.1,000 received and Rs.800 earned, i.e., Rs.200 is the income received in advance which is a liability for this year.
6. Depreciation:
It is a non-cash expense incurred (which amounts to loss suffered) by the business due to the wear and tear, depletion, obsolescence, etc., of the long-term fixed asset. Based on the estimated life of the asset that portion of the non-cash expense chargeable during the current year should be debited to income statement (Trading and Profit and Loss A/c).
7. Provision for Bad and Doubtful Debts:
Debts can be classified as good debts, doubtful debts, and bad debts. Good debts are sure to be collected, doubtful debts are amounts of debts that may or may not be collected and bad debts are amounts that cannot be collected from debtors. As and when bad debts occur, they should be considered as loss and charged to income statement.
If the bad debts are identified before the preparation of the trial balance, the bad debts amount appears on the debit column of the trial balance. As the bad debts item does not appear outside the trial balance, no adjustment entry is necessary.
For doubtful debts, a provision is made during the accounting period.
If bad debts happen next year, they are adjusted towards the provision made in the previous year.
8. Recovery of Bad Debts:
Suppose the bad debts which were written off are recovered during the current year. Then debit cash account and credit bad debts recovered account and consider the recovered amount as profit by transferring the same to the income statement.
9. Provision for Discount on Debtors:
Estimated loss due to discount allowed to debtors is provided for in the same way as provision for bad and doubtful debts.
10. Provision for Discount on Creditors:
Estimated income from the discount allowed by the creditors should be credited to income statement.
11. Interest on Capital:
Business being an independent entity, capital invested by the proprietor may carry interest at a normal rate. Such interest being a loss to the business should be charged to income statement.
12. Interest on Drawings:
Business being an independent entity, if owner has drawn money from the business for personal use, it becomes drawings, and the owner should pay interest on such drawings to the business which should be treated as income.
There can be many more items requiring adjusting entries depending on the type of event happening. For example, goods lost in transit, drawings in kind by the owner etc.
Types # 2. Transfer Entries:
The entries that are passed for transferring the nominal accounts to income statement (Trading and Profit and Loss Account) are called as transfer entries. Some prefer to treat them as closing entries also, as these accounts are closed by transferring them to income statement.
But they cannot be considered as closing entries because this transfer is only a step to get the closing entry passed, i.e., the net result of the income statement (Profit and Loss A/c) when transferred to the balance sheet closes all the nominal accounts at once, which should be considered as closing entry. In fact, entries passed for the outstanding expenses or accrued incomes to the concerned expenses and income accounts also should be treated as transfer entries.
Examples of transfer entry are as follows:
i. For transferring revenue items appearing in the trial balance to trading, and profit and loss account.
ii. For transferring expense and loss items appearing in the trial balance to trading, and profit and loss account.
The list of revenues and expenses given is not exhaustive.
Types # 3. Closing Entries:
The entries that are passed for transferring assets and liabilities including the owner’s equity (plus profit or minus loss in the case of sale proprietorship and partnership firms) along with retained earnings or loss suffered in the case of corporates are called closing entries.
The closing entries represent the closing ledger balances of assets and liabilities, and owner’s equity along with the net result of the income statement (profit or loss). Closing entries are passed on the last day of the financial year.
Examples of closing entries are as follows:
Types # 4. Opening Entries:
Opening entries are passed on the first day of the current year to bring the assets and liabilities + owner’s equity into books. The closing entries that are passed on the last day of the previous year are reversed to form the opening entries of the current year.
Examples of opening entries are as follows:
