Lecture Notes: Chapter 4 – Adjustments, Financial Statements, and the Closing Process
Based on Financial Accounting, 11th Edition by Libby, Libby, and Hodge
Introduction
Chapter 4 explores the final steps in preparing accurate financial statements for a specific
accounting period. These include adjusting entries, which align recorded revenues and expenses
with the accrual basis of accounting, and the closing process, which resets temporary accounts in
preparation for the next period. Students will also learn how to prepare all primary financial
statements—income statement (with earnings per share), statement of stockholders' equity,
and balance sheet—and how to compute and interpret the total asset turnover ratio, an
important measure of operating efficiency.
1. The Purpose of Adjustments
Financial statements are most useful when they reflect the true financial position and
performance of a business. Because not all business activities are captured by regular journal
entries, adjusting entries are needed at the end of each period.
1.1 Why Adjustments Are Necessary
To apply the revenue recognition and matching principles
To ensure assets and liabilities are reported accurately
To include revenues earned and expenses incurred during the period—even if cash hasn't
changed hands
Adjustments help convert cash basis records to accrual basis financial statements.
1.2 Categories of Adjustments
There are four common types of adjusting entries:
Type Description Example
Deferred Unearned revenue becoming
Cash received before revenue is earned
Revenues earned
Deferred
Cash paid before expense is incurred Prepaid rent or supplies used
Expenses
Accrued Revenue earned but not yet received or Interest earned but not yet
Revenues recorded collected
, Type Description Example
Expenses incurred but not yet paid or
Accrued Expenses Salaries owed but not yet paid
recorded
1.3 Examples of Adjusting Entries
1. Deferred Revenue Example
A client pays $1,200 in advance for 12 months of services. One month of service has been
performed by period-end.
Adjustment:
Decrease Unearned Revenue (Liability) by $100
Increase Service Revenue by $100
Unearned Revenue 100
Service Revenue 100
2. Deferred Expense Example
Company paid $3,000 for six months of rent. One month has passed.
Adjustment:
Increase Rent Expense $500
Decrease Prepaid Rent $500
Rent Expense 500
Prepaid Rent 500
3. Accrued Revenue Example
$200 in interest earned but not yet received.
Adjustment:
Increase Interest Receivable (Asset) $200
Increase Interest Revenue $200
Interest Receivable 200
Interest Revenue 200
Based on Financial Accounting, 11th Edition by Libby, Libby, and Hodge
Introduction
Chapter 4 explores the final steps in preparing accurate financial statements for a specific
accounting period. These include adjusting entries, which align recorded revenues and expenses
with the accrual basis of accounting, and the closing process, which resets temporary accounts in
preparation for the next period. Students will also learn how to prepare all primary financial
statements—income statement (with earnings per share), statement of stockholders' equity,
and balance sheet—and how to compute and interpret the total asset turnover ratio, an
important measure of operating efficiency.
1. The Purpose of Adjustments
Financial statements are most useful when they reflect the true financial position and
performance of a business. Because not all business activities are captured by regular journal
entries, adjusting entries are needed at the end of each period.
1.1 Why Adjustments Are Necessary
To apply the revenue recognition and matching principles
To ensure assets and liabilities are reported accurately
To include revenues earned and expenses incurred during the period—even if cash hasn't
changed hands
Adjustments help convert cash basis records to accrual basis financial statements.
1.2 Categories of Adjustments
There are four common types of adjusting entries:
Type Description Example
Deferred Unearned revenue becoming
Cash received before revenue is earned
Revenues earned
Deferred
Cash paid before expense is incurred Prepaid rent or supplies used
Expenses
Accrued Revenue earned but not yet received or Interest earned but not yet
Revenues recorded collected
, Type Description Example
Expenses incurred but not yet paid or
Accrued Expenses Salaries owed but not yet paid
recorded
1.3 Examples of Adjusting Entries
1. Deferred Revenue Example
A client pays $1,200 in advance for 12 months of services. One month of service has been
performed by period-end.
Adjustment:
Decrease Unearned Revenue (Liability) by $100
Increase Service Revenue by $100
Unearned Revenue 100
Service Revenue 100
2. Deferred Expense Example
Company paid $3,000 for six months of rent. One month has passed.
Adjustment:
Increase Rent Expense $500
Decrease Prepaid Rent $500
Rent Expense 500
Prepaid Rent 500
3. Accrued Revenue Example
$200 in interest earned but not yet received.
Adjustment:
Increase Interest Receivable (Asset) $200
Increase Interest Revenue $200
Interest Receivable 200
Interest Revenue 200
