Module No – Title : Correcting Entries and Financial Statements, Closing of Books

and Reversing Entries (8)

1. Overview
This learning material provides the learner the purpose of
correcting entries and how to prepare them. The learners also will be
able to prepare some financial statements from using the woksheet.

2. Desired Learning Outcomes

At the end of the learning session, you should be able to:
a) Prepare correcting entries
b) Prepare some financial statements
c) Understand the need to close the book.
d) Prepare Reversing Entries

Lesson 1- Correcting Entries

In the previous module we already identified the six basic adjusting entries,
its purpose and eventually to prepare the adjusted trial balance. But what if an
error occurred or was discovered in the accounting records? Do we have to let it
be? No. it should be immediately corrected to prevent the processing of wrong
data that will result to unreliable financial statements.

A correcting entry is a journal entry whose purpose is to rectify the effect of

an incorrect entry previously made.
To illustrate how to prepare correcting entries, here are some examples.
The correct entry is:
Dec 5 Taxes and Licenses 3,750.00
Cash 3,750.00
Suppose the bookkeeper, for whatever reason, debited Transportation
Expense instead of Taxes and Licenses.
The entry made was:
Dec 5 Transportation Expense 3,750.00
Cash 3750.00

On December 5, 2019, Gray Electronic Repair Services paid P3,750

registration and licensing fees for the business.
 Upon analysis, the Transportation Expense is overstated (higher than in
should be) because the bookkeeper recorded transportation expense but it was not
really a transportation expense.

Also, Taxes and Licenses is understated (lower than it should be). The amount
should have been recorded but was not recorded under this account.

Now, to increase Taxes and Licenses, we debit it. To decrease Transportation

Expense, we credit it. Remember that to increase/record an expense, we debit it; to
decrease an expense, we credit it. The correcting entry would then be:
De
31 Taxes and Licenses 3,750.00
c
Transportation Expense 3,750.00
Note: The correcting entry is dated when the error is discovered. In this case,
we assumed that it was discovered and corrected on December 31.

Another Example
Using the example above, but let us assume the bookkeeper used the correct
account name but recorded it as P375 and not P3,750.
This was the entry made:
De
5 Taxes and Licenses 375.00
c
Cash 375.00
The entry should have been:
De
5 Taxes and Licenses 3,750.00
c
Cash 3,750.00
How will we correct this? Cash is overstated because the accountant
recorded a credit to cash of P375 instead of P3,750. Taxes and Licenses is also
understated because it recorded at P375 when it should have been P3,750. We
should then decrease Cash and increase Taxes and Licenses by P3,375 (P3,750-
P375)
From the examples above the preparation of correcting entries may be
summed up as follows:
1. Determine the entry made. – What was the erroneous/wrong entry made?
2. Determine the correct entry. – What entry should have been made?
3. Analyze #1 and #2 to come up with the correcting entry.
Lesson 2- Financial Statements

The preparation of the financial statements is the eight step in the 10-step
accounting cycle. These are the end-product reports of accounting.
The preparation of the financial statements is the summarizing phase of
accounting that have been discussed in our Module 1. A complete set of financial
statements is made up of five components: Income Statement, Statement of Changes
in Equity, Balance Sheet, Statement of Cash Flows, and Notes to Financial
Statements. But for this module, we will just focus on the first three financial
statements.

Let us take a look on those financial statements

 Income Statement - The Income Statement, also referred to as Profit and
Loss (P&L) Statement, shows an entity's results of operations for a particular
period. It presents an entity's revenues and expenses, and the resulting net
income or net loss (deduct expenses from revenues)
Let us take a look in this example of a service industry.
 Statement of Changes In Equity - The Statement of Owner's Equity shows
the changes in the capital account due to contributions, withdrawals, and net
income or net loss. Capital is increased by owner contributions and income,
and decreased by withdrawals and expenses.

 Statement of Financial Position - The Statement Financial position pertains

to the resources owned and controlled by the company (assets), and the
claims against them (liabilities and capital).
Hence, if you have a report that presents a company's assets, liabilities and
capital, then you are probably looking at a company's financial position.
Below is an example of Statement of Financial Position presented the Report
Form. Another presentation is called Account Form, where Assets are
presented on the Left while liabilities and capital are presented on the right.
Lesson 3- Closing Entries

Closing journal entries are made at the end of an accounting period to

prepare temporary accounts for the next period. Temporary accounts consist of
all revenue and expense accounts because these are measured periodically. We
do also close the withdrawal accounts of owner/s in the case of sole
proprietorships and partnerships to the capital account Take note that closing
entries are prepared only for temporary accounts. Permanent accounts
are never closed.

Let us take a look at the Trial Balance of Kobi Electronic and Repair
Services for illustration with just easy four steps.
Four Steps:
1. Close all income accounts to Income Summary
Date
Account Debit Credit
2019
12 31 Service Income 95,500
Income Summary 95,500

2. Close all expense accounts to Income Summary

Date
Account Debit Credit
2019
12 31 Income Summary 37,250
Taxes and Licenses 3,750
Rent Expense 15,000
Salary Expense 18,500

3. Close Income Summary to the appropriate capital account

 Date
Account Debit Credit
2019
12 31 Income Summary 58,250
Kobi, Capital 58,250

4. Close withdrawals to the capital account.

Date
Account Debit Credit
2019
12 31 Kobi, Capital 70,000
Kobi, Drawing 70,000

The purpose of closing entries is to prepare the temporary accounts for the
next accounting period. In other words, the income and expense accounts will have
zero balance when the next accounting period starts. The post-closing trial balance
will reflect only the permanent accounts also known as Financial Position Accounts.

Lesson 4. Reversing Entries.

Reversing entries are made at the beginning of the new accounting period to
enable a smoother accounting process. In this step, adjusting entries made at the
end of the previous accounting period are simply reversed, hence the term
"reversing entries".
However, not all adjusting entries qualify for this step.
 The only types of adjusting entries (see module 7) that may be reversed are
those that are prepared for the following:
 Accrued income
 Accrued expense
 Unearned Revenue (using income method)
 Prepaid expense (using expense method)
The purposes of reversing entries are:
1. To close out accounts created when the adjusting entries were
prepared as listed above.
2. For consistency in the accounting procedure for recording income
and expenses.
3. To simplify the bookkeeping entries in the following accounting
period.
Let us take a look at the adjusting entries made in module 7 and prepare the
reversing entries.
 Accrued income
Adjusting entry made
3 13,000.0
Dec Accounts Receivable
1 0
Service Revenue 13,000.00
Reversing entry to be made
Jan 1 Service Revenue 13,000.00
Accounts Receivable 13,000.00
 Accrued expense
Adjusting entry made
3
Dec Utilities Expense 9,000.00
1
Utilities Payable 9,000.00
Reversing entry to be made
Jan 1 Utilities Payable 9,000.00
Utilities Expense 9,000.00
 Unearned Revenue (using income method)
Adjusting entry made
 Dec 31 Rent Income 40,000.00
Unearned Rent Income 40,000.00
Reversing entry to be made
Jan 1 Unearned Rent Income 40,000.00
Rent Income 40,000.00
 Prepaid expense (using expense method)
Adjusting entry made
Dec 31 Service Supplies 9,000.00
Service Supplies Expense 9,000.00
Reversing entry to be made
Jan 1 Service Supplies Expense 9,000.00
Service Supplies 9,000.00

EVALUATION:

I.True or False

1. Financial position may be assessed by referring to a balance sheet.

2. The account Commissions Earned would appear on the balance sheet.

3. Financial Statements cannot be prepared correctly until all the accounts have been adjusted.

4. Closing entries clear income and expense accounts at the end of the period.

5. A reversing entry is a journal entry which is the exact opposite of a related adjusting entry
made at the end of the period.

II. Preparing the Financial Statements

The accounts for the balance sheet, statement of changes in equity and income statement of
Zet Sibug, CPA, are as follows:

Accounts Payable 63,500 L

Accounts Receivable 198,000 A
Accumulated Depreciation – Building 110,000 Contra A
Accumulated Depreciation – Office Equipment 120,000 Contra A
Auditing Revenues 1,361,500 Income
Building 750,000 A
Cash 118,500 A
Depreciation Expense – Building 55,000 Expense
Depreciation Expense – Office Equipment 60,000 Expense
Sibug, Capital, 1/1/2020 1,193,500 Equity - beg
Sibug, Withdrawals 165,000 Equity - Drawing
Land 75,000 A
Notes Receivable 60,000 A
Office Equipment 362,500 A
Office Supplies Expense 96,000 E
Office Supplies 28,000 A
Professional Development Expense 86,500 E
Rent Expense 52,500 E
Salaries Expense 735,000 E
Salaries Payable 30,500 L
Travel Expense 41,000 E
Utilities Expense 18,000 E

During the year, Sibug invested additional P22,000 in the business. Addt’l Investment

Required:
1. Prepare the income statement, statement of changes in equity and balance sheet.
2. Prepare the closing entries.