Accrual Basis of Accounting, Adjusting Entries, Adjusted Trial Balance & Closing Entries
The Complete Beginner-to-Advanced Guide to the Accounting Cycle (Simple, Clear & Exam-Ready)
Introduction:
To truly understand accounting, you must understand this flow:
👉 Accrual Accounting → Adjusting Entries → Adjusted Trial Balance → Closing Entries
These steps form the backbone of accurate financial statements.
Core Idea
Accounting is not just about cash. It is about recording income and expenses at the right time so that profit is shown correctly.
1. Accrual Basis of Accounting
What is Accrual Accounting?
The Accrual Basis of Accounting means:
Income is recorded when it is earned
Expenses are recorded when they are incurred
It does not depend on cash movement.
Simple Definition
Accrual accounting records transactions when they occur, not when cash is received or paid.
Accrual vs Cash Basis
Why Accrual Accounting is Important
* Shows true profit
* Matches income with related expenses
* Required for companies
* Supports better financial decisions
2. Adjusting Entries
What are Adjusting Entries?
Adjusting entries are made at the end of the accounting period to:
Ensure all incomes and expenses are correctly recorded.
Adjusting entries are made at the end of the accounting period to:
Ensure all incomes and expenses are correctly recorded.
Types of Adjusting Entries
1. Outstanding Expenses
* Expenses incurred but not yet paid
* Expenses incurred but not yet paid
2. Prepaid Expenses
* Expenses paid in advance but not yet used
* Expenses paid in advance but not yet used
3. Accrued Income
* Income earned but not yet received
* Income earned but not yet received
4. Income Received in Advance
* Income received but not yet earned
* Income received but not yet earned
Journal Entries for Adjustments
Outstanding Expense
Expense A/C DrTo Outstanding Expense A/C
Prepaid Expense
Prepaid Expense A/C DrTo Expense A/C
Accrued Income
Accrued Income A/C DrTo Income A/C
Income Received in Advance
Income A/C DrTo Unearned Income A/C
Why Adjusting Entries Matter
Without adjusting entries:
❌ Profit will be incorrect
❌ Expenses will be incomplete
❌ Financial statements will be misleading
👉 Adjusting entries ensures accuracy, completeness, and fairness.
3. Adjusted Trial Balance
What is an Adjusted Trial Balance?An Adjusted Trial Balance is prepared after all adjusting entries are recorded.
It shows updated balances of all accounts.
Purpose of Adjusted Trial Balance
* Verify accuracy of accounts* Ensure total debits = total credits
* Prepare financial statements
Format of Adjusted Trial Balance
Simple Example
After adjustments:Rent Expense = 5,000
Outstanding Rent = 5,000
👉 Both will appear in the adjusted trial balance.
4. Closing Entries (Ending the Accounting Period)
What are Closing Entries?Closing entries are made to:
👉 Transfer all temporary accounts to the capital account.
📌 Temporary Accounts Include
* Income accounts
* Expense accounts
* Drawings account
Steps of Closing Entries
Income A/c Dr
To Profit & Loss A/c
Step 2: Close Expense Accounts
Profit & Loss A/c Dr
To Expense A/c
Step 3: Transfer Profit to Capital
Profit & Loss A/c Dr
To Capital A/c
Step 4: Close Drawings
Capital A/c Dr
To Drawings A/c
Why Closing Entries are Important
* Reset accounts for the next period
* Determine final profit or loss
* Keep accounting records organized
Full Accounting Cycle
1. Record transactions
2. Apply accrual concept
3. Pass adjusting entries
4. Prepare adjusted trial balance
5. Record closing entries
👉 This completes the accounting cycle.
Real-Life Example
Rahul runs a small business:
* Earned Rs. 10,000 (not yet received)
* Paid Rs. 3,000 in advance
* Incurred Rs. 2,000 expense (not yet paid)
Adjustments:
* Accrued income = 10,000
* Prepaid expense = 3,000
* Outstanding expense = 2,000
👉 Now the profit shown will be accurate.
* Accrued income = 10,000
* Prepaid expense = 3,000
* Outstanding expense = 2,000
👉 Now the profit shown will be accurate.
Advantages of This System
* Accurate profit calculation
* Better decision-making
* Widely accepted accounting method
⚠️ Disadvantages
* Slightly complex for beginners
* Requires adjustments
* Does not show real-time cash flow
Pro Tips
* Remember: Earned = Income | Incurred = Expense
* Focus on adjustment-based questions
* Practice journal entries regularly
Conclusion
If you understand these four topics, you understand the core foundation of accounting.
👉 Accrual accounting ensures correctness
👉 Adjusting entries ensures completeness
👉 Adjusted trial balance ensures accuracy
👉 Closing entries ensure proper finalization
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