ADJUSTING THE ACCOUNTS

THE ACCOUNTING PERIOD

The activities of an enterprise can be divided into specific periods such as a month, a quarter, a
semester, or a year. The accounting period is usually s span of 12 months. It may be a calendar
year or fiscal year. Calendar year is the normal year which ends December 31 of each year.
Fiscal year is an accounting year of 12 consecutive months that may or may not coincide with
the calendar year.

ACCRUAL VERSUS CASH ACCOUNTING

Accrual Accounting requires that all revenue earned whether payment is received or not should
be recognized in the period the goods or services are delivered re rendered and that all related
costs to deliver the goods or to render the whether paid or not should be recognized as expense to
match the revenue.

Cash-basis Accounting requires that all revenue is recognized only when cash is received while
expenses are recognized only when cash is paid.

IMPORTANCE OF ADJUSTING ENTRIES

Adjusting Entries are entries made at the end of the period to assign revenues to the period in
which they are earned and expenses to the period in which they are incurred.

Many accounts need adjustments to reflect the current conditions as of time of reporting in order
for the statements to be meaningful. There may be financial data not previously recognized that
need to be recorded to make the books of accounts up to date like the expenses already incurred
but no payment until sometime in the subsequent period, and revenues already earned but no
cash is collected yet.

ITEMS THAT NEED ADJUSTMENTS

PREPAID EXPENSES

Prepaid Expenses are expenditures paid for goods that are not yet consumed like supplies,
insurance and rent.

METHODS OF RECORDING PREPAYMENTS

Asset Method

1. Example for Supplies

a. Purchase of supplies worth P 5,000 is recorded as
(Upon Prepayments)

Supplies 5,000
Cash 5,000
 b. At the end of a period, physical count of unused supplies showed a total of P3,500.
This shows that if P 3,500 is unused, then P 1,500 worth of supplies is used or consumed.
(Adjusting entry) P3,500-P1,500.

Supplies Expense 1,500

Supplies 1,500

2. Example for Insurance

a. On October 1, 2020, a company paid P12,000 as insurance premium for one year. The
entry to record the payment under the asset method is:
(Upon Prepayments)

Prepaid Insurance 12,000

Cash 12,000

b. With the passage of time, the prepaid insurance gradually expires, that’s why on Dec.
31, an adjusting entry is required to recognize the expired portion of the insurance
premium as expense. (P12,000X3/4)
(Adjusting entry)

Insurance Expense 3,000

Prepaid Insurance 3,000

3. Example for Rent

a. On Dec. 1, the company paid P18,000 as rent for one year. The entry to record the
payment under the asset method is:
(Upon Prepayments)

Prepaid Rent 18,000

Cash 18,000

b. On Dec. 31, the entry will be (18,000/12 months.) x 1 month =1,500.00

(Adjusting entry)

Rent Expense 1,500

Prepaid Rent 1,500

EXPENSE METHOD

This method of recording prepayments requires an entry debiting an expense account upon
payment.
1. Example for supplies

a. In the previous example, if the supplies purchased were recorded, the entry would be:

Supplies Expense 5,000

Cash 5,000
 b. The adjusting entry required to reflect the unused portion would be

Supplies 3,500
Supplies Expense 3,500

2. Example for Insurance

a. If the Expense Method is used to record the prepayment, the entry made upon payment
is:
Insurance expense 12,000
Cash 12,000

b. The adjusting entry on Dec. 31, would be:

Prepaid Insurance 9,000

Insurance Expense 9,000

3. Example for Rent

a. If the Expense Method is used to record the prepayment, the entry made upon payment
is:
Rent expense 18,000
Cash 18,000

b. The adjusting entry on Dec. 31, would be:

Prepaid Rent 16,500

Rent Expense 16,500

ACCRUED EXPENSES

These are items already recorded as expenses but not yet paid, thus creating an obligation to
make payments in the future. The most common examples are salaries of employees and utilities
expenses like bills from Meralco and Manila Waters.

On June 15, when the company pays the salaries of employees, the payment will be recorded as:

Salaries Expense P xxx

Cash P xxx

No accrual for salary payment on June 15 because this date is a regular working day. The salary
for the 2nd half of the month which is due June 30 will not be paid on that day because it is a
non-working day. So the salary of the employees will be paid the following Monday, July 2. The
bookkeeper will recognize the expense on June 30 with the following entry:

Salaries Expense P xxx

Accrued Salaries or Salaries Payable P xxx
ACCRUED INTEREST ON NOTES RECEIVABLE

A company issued a 90-day 10% note on Dec. 1 for P100,000. The notes payable is due 90 days
from date of issue including interest earned for 90 days. If financial statements are prepared on
Dec. 31, which are normally the case, then the company must record the interest for 30 days as:

Interest Expense 833.33

Accrued Interest 833.33
Solution: = (100,000 * 10% * 30/ 360)

ACCRUED REVENUE
These are revenues already earned but no payment is received yet.

Interest Receivable P833.33

Accrued Interest Revenue P 833.33

DEFERRED REVENUE OR UNEARNED REVENUES

This is the exact opposite of accrued revenues. In this case, payment is received in advance prior
to delivery of services, or delivery of goods, thus, creating a liability for the amount collected in
advanced; however, as the company renders the service, the unearned revenue becomes earned
revenue.

Revenue method

For example, on Aug. 1, a tenant paid its rent for one year in advance in the amount of P 24,000.
At the time cash is received, the entry is:

Cash 24,000
Rent Revenue 24,000

When financial statement is prepared on Dec. 31, an adjustment is necessary to reflect the
unearned portion of the rent that corresponds to the period Jan. 1, 2020 – July 31, 2020. The
adjusting entry would be:

Rent Revenue (7/12 x 24,000) 14,000

Unearned Rent Revenue 14,000

Liability Method

If the liability method is used to record the receipt of P24,000, the entry upon receipt would be:

Cash 24,000
Unearned Rent Revenue 24,000

On Dec. 31, the amount earned must be recognized as revenue through an adjusting entry.

Unearned Rent Revenue 10,000

Rent Revenue (P24,000X5/12) 10,000
UNCOLLECTIBLE ACCOUNT EXPENSE OR DOUBTFUL ACCOUNTS

In any enterprise selling on account to its customers, experience show that some customers will
not be able to pay their accounts as they fall due. Uncollectible accounts or bad debts are
accounts of customers who do not pay what they have promised to pay. The enterprise should
provide allowance for uncollectible accounts and recognize an expense or loss from these
accounts. Other terms for uncollectible accounts are “Bad Debts” and “Doubtful accounts”.

a. Based on Percentage of Sales on Account or service revenue on account

For example, the company estimates that 2% of sales on account are proven to be uncollectible.
The entry would be:

Uncollectible account expense xxx

Allowance for uncollectible accounts xxx

The allowance for doubtful accounts is a contra account which is deducted from the accounts
receivable in the balance sheet to arrive at its net realizable value.

b. Based on Accounts Receivable Balance

Example 1: The following balances are available from the records of Manila Premier Hotel at
December 31, 2020:

Accounts Receivable, 12/31 P 800,000

Allowance for uncollectible accounts,1/1 12,000 Cr.
Service Revenue on account 2,500,000

The company’s estimate for uncollectible accounts is 2% of accounts receivable.

Solution: Required allowance P800,000 X 2% = P16,000

Less: Allowance 1/1 12,000
Increased Uncollectible Accounts P4,000

The adjusting entry required to reflect the expense for the year is:

Uncollectible account expense 4,000

Allowance for uncollectible accounts 4,000

Accounts receivable end P800,000

Less: Required allowance 16,000
Net Realizable value P784,000

Example 2: Assume the following balances:

Accounts Receivable, 12/31 800,000

Allowance for uncollectible accounts 22,000 Cr.
Service revenue on account 2,500,000
Since the required allowance is only P16,000, and the balance of the allowance account is
P22,000, the allowance for uncollectible accounts should be reduced by P 6,000. The adjusting
entry would be:
Allowance for uncollectible accounts 6,000
Uncollectible accounts expense 6,000

Accounts receivable end P800,000

Less: Required allowance 16,000
Net Realizable value P784,000

WORTHLESS ACCOUNT 

When an account of a certain customer is already “hopeless” for collection, it is considered as

“worthless account” and the same must be writtten-off from the record. 

Assume: 

Of the P20,000 outstanding Account Receivable, the followingwere its composition as gleaned
from the Subsidiary ledgers: 

SCHEDULE OF ACCOUNTS RECEIVABLE 

Caasi, Isagani P 6,500 

Desierto, Ronald     800 
Oliva, Eric 12,700 
      Total P20,000 
 
Assuming that the account of Mr. Ronald Desierto is hopeless for collection, the balance of his
account is written-off as follows: 
 
Estimated Uncollectible Account P800 
                Accounts Receivable- Ronald Desierto P800 
                     To Write-off th account of Mr. Desierto 

After posting this entry in the General Lefger, the result would be: 
 
Accounts Receivable before the write-off  P20,000  
Less: Accounts Receivable written-off          800  
Accounts Receivable balance  P19,200    
 
RECOVERY OF UNCOLLECTIBLE ACCOUNTS  

If by circumstance or a matter of luck, the customer whose account is already written-off will
pay later his account balance, the recording of said collection depends upon the period when it
took place. However, to give you a little idea on how should this collection be recorded, let's take
this common method of recording bad debts recovery wherein collection is being charged to
miscellaneous income. 

Assume:  

After the write-off, Mr. Ronald Desierto paid his account. The journal entry to record collection
would be:  
Cash  P800  
     Miscellaneous Income  P800  
          To record recovery of uncollectible written-off.  
 
AGING OF ACCOUNTS RECEIVABLE  

This is the most reasonable basis of calculating Uncollectible Account Expenses based on

classified past due accounts., The actual receivable being aged by category is multiplied by the
uncollectible percentage to arrive at the required estimate.  

To illustrate:  

Davao Ports and Stevedoring Services has an outstanding Accounts Receivable of P150,000 with
recorded Estimated Uncollectible Account of P2,000. 

Probability of Collection  98%  97%  95% 

Name of Customers  Collectible Balance  1-30 days  31-60 days  61 days and over 
Misamis Trading  P4,300  2,000  2,300  - 
Dumaguete Superstore  58,700  20,000  25,000  13,700 
Dipolog Enterprise  74,000  35,000  30,000  9,000 
Saragani Commercial  13,000  13,000  3,000  - 
Total  P150,000  67,000  60,300  22,700 
Aging of Past Due
Collectible BalanceUncollectible PercentageRequired Estimates
Account
1-30 days  67,000  2%  1.340 
31-60 days  60,300  3%  1,809 
61 days and over  22,700  5%  1,135 
  P150,000    P4,284 
 
 
The required Estimated Uncollectible Account P4,284 
Less: Estimated Uncollectible Accounts already provided                     2,000 
Needed increase in Estimated Uncollectible Accounts                        P2,284 
 
Uncollectible account expense 2,284
Allowance for uncollectible accounts 2,284

Accounts Receivable P150,000

Less: Estimated Uncollectible Accounts 4,284
Net Realizable value P145,716

DEPRECIATION

Depreciation is the systematic means of allocating the cost of long-lived asset over its estimated
economic life. Depreciation does not necessarily measure the decline in the value of an asset but
it shows only the portion of the cost of the asset that has expired due to using up the asset. The
assets that are subject to depreciation are called depreciable assets. The formula:

Depreciation Expense = Cost of Asset – Scrap value/residual value/salvage value

Estimated economic life

Cost of asset is the amount of company paid to purchase the asset. It includes the invoice price
plus transportation charges and installation fees.
Scrap value is the amount expected to be recovered at the end of an asset’s useful life. It is also
called residual value or salvage value. Estimated economic life is the same as the estimated
useful life of an asset.
Depreciation cost or value is the difference between the cost of an asset and its scrap value.

Example: A delivery equipment was purchased on Jan. 3, 2020 for P600,000. It is estimated that
the vehicle’s salvage value at the end of 10 years is P50,000.

Dep. Expense = 600,000 – 50,000 = 55,000/yr.

10 yrs.

The adjusting entry on Dec. 31, 2020 will be:

Depreciation Expense 55,000

Accumulated Depreciation-D/E 55,000

Accumulated Depreciation is a contra account, which is reported as a deduction from the related
asset account.

The presentation of the asset and its related accumulated depreciation in the balance follows:

Delivery Equipment P 600,000

Less: Accumulated Depreciation 55,000
Book value P 545,000

Book value is the part of the cost of the asset that is not yet allocated to an expense account.

DISPOSAL OF PROPERTY AN EQUIPMENT

The acquisition of a property and equipment is not intended for sale by the business. However, it
might be deemed wise for the business to sell its fixed asset in order to acquire a new one which
can be more productive in its operations. When this event happened, the cost of the fixed assets
together with its valuation account is being removed from the records by way of a journal entry.
The sale may result to having either gain or loss transaction.

Assume:

The business ha a computer which it acquired a year ago. Per records, the acquisition cost was P
35,000 and its accumulated depreciation was P 7,000 as of the date of sale. The net book value
therefore is P28,000.

Case 1: The computer was sold for P30,000

Journal entry to record the disposal at a gain:

Cash P 30,000
Accumulated Depreciation-Office Equipment 7,000
Office Equipment P35,000
Gain on Disposal of Office Equipment 2,000
 To record the disposal of computer
(The sale resulted to having gain because the cash proceeds is bigger than its net book value.
While the cash proceeds is P30,000, the net book value is P28,000)

Case 2: The computer was sold for P25,000

Journal Entry to record the disposal at a loss

Cash P 25,000
Accumulated Depreciation-Office Equipment 7,000
Loss on Disposal of Office Equipment 3,000
Office Equipment P35,000
To record the sale of computer.

(The sale resulted to having a loss because the cash proceeds is smaller than its net book value.
While the cash proceeds is P25,000, the net book value is P28,000)

ADJUSTING THE ACCOUNTS

THE WORKSHEET

The worksheet simplifies the adjusting and closing process. It can also reveal errors. The
worksheet is not part of the ledger or the journal, nor is it a financial statement. It is a summary
device used by the accountant for his convenience.

The working paper or the worksheet is a device used as a convenient and orderly way of
organizing the accounting data to facilitate the checking of accounting records and preparation of
adjusting entries, financial statements, and closing entries.

It is not a part of the formal accounting records, but by means of the working paper, the
accountant is able to assemble in one paper all data necessary in adjusting and closing the books
of accounts, including the preliminary preparation of the financial statements.

PREPARING THE WORKSHEET (Step 5)

The steps in the preparation of a worksheet will be illustrated using the Weddings “R” Us case:

1. Enter the account balances in the unadjusted trial balance columns and total the
amounts.

2. Enter the adjusting entries in the adjustments columns and total the amounts.

When a worksheet is used, all adjustments are first entered in the worksheet. The
required adjustments for Weddings “R” Us were explained in the previous chapter.
As each adjustment is entered, a letter is used to identify the debit entry and the
corresponding credit entry. Note that the adjustments are not journalized until the
worksheet is completed and the financial statements prepared.
 3. Compute each account’s adjusted balance by combining the unadjusted trial balance
and the adjustment figures. Enter the adjusted amounts in the adjusted trial balance
columns.

A simple convention to observe when extending amounts from the trial balance to the
adjusted trial balance follows:

 Add when the type of adjustment (debit or credit) is the same as the unadjusted
balance.
 Subtract when the type of adjustment (debit or credit) is different from the
unadjusted balance.

4. Extend the asset, liability and owner’s equity amounts from the adjusted trial balance
columns to the balance sheet columns. Extend the income and expense amount to the
income statement columns. Total the statement columns.

Every account is either a balance sheet account or an income statement account. Asset,
liability, capital and withdrawal accounts are extended to the balance sheet columns.
Income and expense accounts are moved to the income statement columns. Debits in the
adjusted trial balance remain as debits in the statement columns while credits as credits.
At this stage, the initial totals of the income statement and balance sheet columns are not
equal.

5. Compute profit and loss as the difference between total revenues and total expenses
in the income statement. Enter profit or loss as a balancing amount in the income
statements and in the balance sheet, and compute the final column totals.

Profit or loss is equal to the difference between the debit and credit columns of the
income statement.

Example:

Revenues (Income Statement credit column total) 71,700

Expenses (Income Statement debit column total) 36,700
Profit 35,000

ESSENCE OF FINANCIAL STATEMENTS

The financial statements are the means by which the information accumulated and processed in
financial accounting is periodically communicated to the users. Without accounting
information embodied in the financial statements, users may not be able to arrive at a sound
economic decision.

Per revised Philippine Accounting Standards (PAS) No. 1, the objective of financial statements
is to provide information about the financial position, financial performance, and cash flows of
an entity that is useful to a wide range of users in making economic decisions. An entity shall
present with equal prominence all of the financial statements in a complete set of financial
statements.

COMPLETE SET OF FINANCIAL STATEMENTS 1. A statement of

comprehensive
Per revised PAS No. 1, a complete set of financial statements comprises: income for the
period;
1. A statement of financial position as at the end of the period;
2. A statement of
changes in
equity for the period
 3. A statement of cash flows for the period;

4. Notes, comprising summary of significant accounting policies and other explanatory

information; and

5. A statement of financial position as at the beginning of the earliest comparative period

when an entity applies an accounting policy retrospectively or makes a retrospective
restatement of items in its financial statements or when it reclassifies items in its financial
statements.

 Statement of Financial Position (or balance sheet) – lists all the assets, liabilities
and equity of an entity as at a specific date.
 Income statement – presents a summary of the revenues and expenses of an entity
for a specific period.
 Statement of Changes in Equity – presents a summary of the changes in capital such
as investments, profit or loss, and withdrawals during a specific period.
 Statement of Cash Flows – reports the amount of cash received and disbursed
during the period.
 Accounting policies – are specific principles, bases, conventions, rules and practices
adopted by the enterprise in preparing and presenting financial statements.
 Notes to Financial Statements – provide narrative descriptions or disaggregation of
items presented in the statements and information about items that do not qualify
for recognition in the statements.

Statement of Comprehensive Income

An entity shall present all items of income and expense recognized in a period;

a. In a single statement of comprehensive income, or

b. In two statements; a statement displaying components of profit or loss (separate income

statement) and a second statement beginning with profit or loss and displaying
components of other comprehensive income (statement of comprehensive income).

The income statement is a statement showing the performance of the enterprise for a given
period of time. It summarizes the revenues earned and expenses incurred for that period of time.

Gevera Wedding Consultancy

Income Statement
For the Month Ended May 31, 2020
Revenues
Consulting Revenues P 67,770
Referral Revenues 4,000
Total 71,700
Expenses
Salaries Expense P 15,600
Utilities Expense 4,400
Rent Expense 4,000
Depreciation Expense – Service Vehicle 4,000
Interest Expense 3,500
Supplies Expense 3,000
Insurance Expense 1,200
Depreciation Expense – Office Equipment 1,000
Total 36,700
Profit P 35,000

*All figures are assumed.

Information about the performance of an enterprise, in particular its profitability, is required in

order to assess potential changes in the economic resources that it is likely to control in the
future. It is also useful in predicting the capacity of the enterprise to generate cash flow from
its existing resource base.

Statement of Changes in Equity

The statement of changes in equity summarizes the changes that occurred in owner’s equity. This
statement is now a required statement (per revised Philippine Accounting Standards (PAS) No.
1). Changes in an enterprise’s equity between two balance sheet dates reflect the increase or
decrease in its net assets during the period.

Gevera Wedding Consultancy

Statement of Changes in Equity
For the Month Ended May 31, 2020

Gevera, Owner’s Equity, 5/1/2020 P 250,000

Add: Additional Investments by Gevera 0
Profit 35,000 35,000
Total 285,000
Less: Withdrawals 14,000
Gevera, Owner’s Equity, 5/31/2020 P 271,000

Statement of Financial Position

The statement of financial position is a statement that shows the financial position or condition
of an entity by listing the asset, liabilities and owner’s equity as at a specific date. The
information needed from this statement are the net balances at the end of the period, rather than
the total from the period as in the income statement. The statement is also called the balance
sheet.

Users of the financial statements analyze the balance sheet to evaluate an entity’s liquidity, its
financial flexibility, and its ability to generate profits, and its solvency.

 Liquidity – refers to the availability of cash in the near future after taking account of the
financial commitments over this period.

 Financial flexibility – is the ability to take effective action to alter the amounts and
timings of cash flows so that it can respond to unexpected needs and opportunities.

 Solvency – refers to the availability of cash over the longer term to meet financial
commitments as they fall due.

Format

The balance sheet can be presented in either the report format or the account format. The report
format simply lists the assets, followed by the liabilities then by the owner’s equity in vertical
sequence. The account format lists the assets on the left and the liabilities and owner’s equity
on the right. Either balance sheet format is acceptable.
Classification

The revised PAS No. 1 does not prescribe the order or format in which an entity presents items
in the statement of financial position; what is required is the current and non-current distinction
of assets and liabilities. Assets can be presented current then non-current, or vice versa.
When presentation based on liquidity provides accounting information that is reliable and more
relevant to decision-makers then an entity shall present all assets and liabilities I order of
liquidity. For example,

 Assets are classified and presented in decreasing order of liquidity. Cash is the most
liquid. Assets that are least likely to be converted to cash are listed last.

 Liabilities are generally classified and presented based on time of maturity such that
obligations which are currently due are listed first.

Gevera Wedding Consultancy

Statement of Financial Position
May 31, 2020

Assets
Current Assets
Cash P 22,200
Accounts Receivable 17,300
Supplies 15,000
Prepaid Rent 4,000
Prepaid Insurance 13,200
Total Current Assets 71,700
Non-current Assets
Service Vehicles 420,000
Less: Accumulated Depreciation 4,000 416,000
Office Equipment 60,000
Less: Accumulated Depreciation 1,000 59,000 475,000
Total Assets 546,700

Liabilities
Current Liabilities
Notes Payable P 210,000
Accounts Payable 53,000
Salaries Payable 1,800
Utilities Payable 1,400
Interest Payable 3,500
Unearned Referral Revenues 6,000
Total Current Liabilities 275,700

Owner’s Equity
Gevera, Capital, 5/31/20 271,000
Total Liabilities and Owner’s Equity P 546,700

Statement of Cash Flows

The statement of cash flows provides information about the cash receipts and cash payments of
an entity during a period. It is a formal statement that classifies cash receipts (inflows) and cash
payments (outflows) into operating, investing and financing activities. This statement shows the
net increase or decrease in cash during the period and the cash balance at the end of the period; it
also helps project the future net cash flows of the entity.

Cash Flows from Operating Activities

Operating activities generally involve providing services, and producing and delivering goods.
Cash flows from operating activities are generally the cash effects of transactions and other
events that enter into the determination of profit or loss. This cash flow can be presented using
either the direct or the indirect method.

Using the direct method, the entity’s net cash provided by (used in) operating activities is
obtained by adding the individual operating cash inflows and then subtracting the individual
operating cash outflows.

The indirect method derives the net cash provided by (used in) operating activities by adjusting
profit for income and expense items not resulting from cash transactions. The adjustments begin
with profit followed by the addition of expense and charges that did not entail cash payments.
Then, increases in current assets and decreases in current liabilities involved in the determination
of profit but which did not actually increase or decrease cash, are subtracted from profit. Finally,
decreases in current assets and increases in current liabilities are added to profit to obtain net
cash provided by (used in) operating activities.

Profit P Xxx
Adjustments for:
Non-Cash Expenses (e.g. Depreciation) xx
Increases in Current Asset Accounts (xx)
Decreases in Current Liability Accounts (xx)
Decreases in Current Asset Accounts xx
Increases in Current Liability Accounts xx
Cash Flows from Operating Activities P xxx

Per Philippine Accounting Standards (PAS) No. 7, enterprises are encouraged to report cash
flows from operating activities using the direct method but the indirect method is acceptable.
Only the direct method is illustrated here. The following are the major classes of operating cash
flows using the direct method:

Cash Inflows
 Receipts from sale of goods and performance of services
 Receipts from royalties, fees, commissions and other revenues

Cash Outflows
 Payments to suppliers of goods and services
 Payments to employees
 Payments for taxes
 Payments for interest expense
 Payment for other operating expenses

Cash Flows from Investing Activities

Investing activities include making and collecting loans; acquiring and disposing of investments
in debt or equity securities; and obtaining and selling of property and equipment and other
productive assets.

Cash Inflows
 Receipts from sale of property and equipment
  Receipts from sale of investments in debt or equity securities
 Receipts from collections on notes receivable

Cash Outflows
 Payments to acquire property and equipment
 Payments to acquire debt or equity securities
 Payments to make loans to others generally in the form of notes receivable

Cash Flows from Financing Activities

Financing activities include obtaining resources from owners and creditors.

Cash Inflows
 Receipts from investments by owners
 Receipts from issuance of notes payable

Cash Outflows
 Payments to owners in the form of withdrawals
 Payment to settle notes payable

RELATIONSHIPS AMONG THE FINANCIAL STATEMENTS

The financial statements are based on the same underlying data and are fundamentally related.

1. The income statement reports all income and expenses during the period. The profit or
loss is the final figure in this statement.

2. The statement of changes in equity considers the profit or loss figure from the income
statement as one of the determining factors that explains the change in owner’s equity.

3. The statement of financial position reports the ending owner’s equity, taken directly from
the statement of changes in equity.

4. The statement of cash flows reports the net increase or decrease in cash during the period
and ends with the cash balance reported in the balance sheet. This statement is prepared
based on information from the income statement and the balance sheet

CLOSING ENTRIES POST-CLOSING TRIAL BALANCE

Income, expense and withdrawal accounts are temporary accounts that accumulate information
related to a specific accounting period. These temporary accounts facilitate income statement
preparation. At the end of each year, the balances of these temporary accounts are transferred to
the capital account. Thus, the balance of the owner’s capital account represents the cumulative
net result of income, expense, and withdrawal transactions. This phase of the cycle is called the
closing procedure.

A temporary account is said to be closed when an entry is made such that its balance becomes
zero. Closing simply transfers the balance of one account to another account. In this case, the
balances of the temporary accounts are transferred to the capital account. A summary account –
Income Summary is used to close the income and expense accounts. The steps in closing the
accounts of an entity will be illustrated using the Gevera Wedding Consultancy case.

*ALL FIGURES IN THE PROBLEM ARE ASSUMED*

1. Close the income accounts

 Income accounts have credit balances before the closing entries are posted. For this
reason, an entry debiting each revenue account in the amount of its balance is needed to
close the account. The credit is made to the income summary account. The entry to close
the income accounts for the Gevera Wedding Consultancy is as follows.

2020
May 31 Consulting Revenues 410 67,700
Referral Revenues 420 4,000
Income and Expense Summary 330 71,700

The dual effect of the entry is to make the balances of the income accounts equal to zero,
and to transfer the balances in total to the credit side of the income summary account.

2. Close the expense accounts

Expense accounts have debit balances before the closing entries are posted. For this
reason, a compound entry is needed crediting each expense account for its balance and
debiting the income summary for the total. These data can be found in the debit side of
the income statement columns of the worksheet.

2020
May 31 Income and Expense Summary 330 36,700
Salaries Expense 510 15,600
Supplies Expense 520 3,000
Rent Expense 530 4,000
Insurance Expense 540 1,200
Utilities Expense 550 4,400
Depreciation Expense – Service Vehicle 560 4,000
Depreciation Expense – Office Equipment 570 1,000
Interest Expense 590 3,500

The effect of posting the closing entry is to reduce the expense account balances to zero
and to transfer the total of the account balances to the debit side of the income summary
account.

3. Close the income summary account

After posting the closing entries involving the income and expense accounts, the balance
of the income summary account will be equal to the profit or loss for the period. A profit
is indicated by a credit balance and a loss by a debit balance. The income summary
account, regardless of the nature of its balance, must be closed to the capital account. For
the Gevera Wedding Consultancy, the entry is as follows:

2020
May 31 Income and Expense Summary 330 35,000
Gevera, Capital 310 35,000

The effect of posting this closing entry is to close the income summary account balance
and to transfer the balance to Gevera’s capital account for the profit.

4. Close the withdrawal account

The withdrawal account shows the amount by which capital is reduced during the period
by withdrawals of cash or other assets of the business by the owner for personal use. For
this reason, the debit balance of the withdrawal account must be closed to the capital
account as follows:
 2020
May 31 Gevera, Capital 310 14,000
Gevera, Withdrawal 320 14,000

The effect of posting this closing entry is to close the withdrawal account and the transfer
of the balance to the capital account.

PREPARATION OF A POST-CLOSING TRIAL BALANCE (Step 9)

It is possible to commit an error in posting the adjustments and closing entries to the ledger
accounts; thus, it is necessary to test the equality of the accounts by preparing a new trial
balance. This final trial balance is called a post-closing trial balance.

 The post-closing trial balance verifies that all the debits equal the credits in the trial
balance.

 The trial balance contains only balance sheet items such as assets, liabilities, and ending
capital because all income and expense accounts, as well as the withdrawal account, have
zero balances.

 Notice that only the balance sheet accounts have balances because at this point, all the
income statement accounts have been closed. (See next page)

Gevera Wedding Consultancy

Post-Closing Trial Balance
May 31, 2020

Debit Credit

Cash P 22,200
Accounts Receivable 17,300
Supplies 15,000
Prepaid Rent 4,000
Prepaid Insurance 13,200
Service Vehicle 420,000
Accumulated Depreciation – Service 4,000
Vehicle
Office Equipment 60,000
Accumulated Depreciation – Office 1,000
Equipment
Notes Payable 210,000
Accounts Payable 53,000
Salaries Payable 1,800
Utilities Payable 1,400
Interest Payable 3,500
Unearned Referral Revenues 6,000
Gevera, Capital 271,000
Total P 551,700 551,700
OPENING ENTRY

Cash 22,200
Account Receivable 17,300
Supplies 15,000
Prepaid Rent 4,000
Prepaid Insurance 13,200
Service Vehicle 420,000
Office Equipment 60,000
Accumulated Depreciation- Service Vehicle 4,000
Accumulated Depreciation-Office Equipment 1,000
Accounts Payable 53,000
Notes Payable 210,000
Salaries Payable 1,800
Utilities Payable 1,400
Interest Payable 3,500
Unearned Referral Revenue 6,000
Gevera, Capital 271,000

REVERSING ENTRIES (Step 10)

Preparing the post-closing trial balance may not be the last step in the accounting cycle. Some
entities elect to reverse certain end-of-period adjustments on the first day of the new period. A
reversing entry is a journal entry which is the exact opposite of a related adjusting entry made at
the end of the period. It is basically a bookkeeping technique made to simplify the recording of
regular transactions in the next accounting period.

It should be emphasized that reversing entries are optional. Also, the act of reversing a
previously should be reversed. Generally, a reversing entry should be made for any adjusting
entry that increased an asset or a liability account. Therefore, all accruals are reversed but only
deferrals initially recorded in income statement – income or expense – accounts are reversed.

Illustration. To show how reversing entries can be helpful, consider the adjusting entry made in
the records of Gevera Wedding Consultancy to accrue salaries expense:

2020
May 31 Salaries Expense 1,800
Salaries Payable 1,800

When the employees are paid on the next regular payday, the entry would be:

2020
May 31 Salaries Payable 410 67,700
Salaries Expense 420 4,000
Cash 330 71,700

Note that when the payments are made, without a prior reversing entry, the accountant must look
into the records to find out how much of the P 7,200 applies to the current accounting period and
how much was accrued at the beginning of the period.
This step may appear easy in this simple case, but think of the problems that may arise if the
company has many employees, especially if some of them are paid on the different time
schedules such as weekly or monthly. A reversing entry is an accounting procedure that helps to
solve this difficult problem. As noted above, a reversing entry is exactly what its name implies. It
is a reversal of the adjusting entry made. For example, observe the following sequence of
transactions and their effects on the ledger account – salaries expense:

1. Adjusting Entry

2020
May 31 Salaries Expense 1,800
Salaries Payable 1,800

2. Closing Entry

2020
May 31 Income Summary 15,600
Salaries Expense 15,600

3. Reversing Entry

2020
June 1 Salaries Payable 1,800
Salaries Expense 1,800

4. Payment Entry

2020
June 10 Salaries Expense 7,200
Cash 7,200

These transactions had the following effects on salaries expense:

a. Adjusted salaries expense to accrue P1, 800 in the proper accounting period.
b. Closed the P15, 600 in total salaries expense for May to income summary.
c. Established a credit balance of P1, 800 on June 1 in salaries expense equal to the expense
recognized through the adjusting entry on May 31. The liability account salaries payable
was reduced to a zero balance.
d. Recorded the P7, 200 payment of two weeks’ salaries in the usual manner. The reversing
entry has the effect of leaving a balance of P5, 400 (P7, 200-P1, 800) in the salaries
expense account. This P5, 400 balance represented the salaries expense for the nine
workdays in June.

Making the payment entry was simplified by the reversing entry. Reversing entries apply to all
accrued expenses or revenues
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