measured properly and its related assisted and

liabilities be brought to correct balance for

CORRECTING ENTRIES financial statements

When an erroneous journal entry has Adjusting entries ensure the application
been posted already in the ledger, a correcting of the accrual basis of accounting and the
entry must be prepared to correct the error. An matching principle.
error may occur in the selection of the account/s
to be used or in the recording of amount/s, or Adjusting entries are generally prepared for
both. the following items:
- Accrued Expenses
- Accrued Revenue
- Prepaid Expenses or Deferred
CASH BASIS AND ACCRUAL BASIS Expenses
- Unearned Revenues or Deferred
Under the cash basis of accounting, revenue Revenues
is recognized when cash is received and - Depreciation of Property, Plant and
expenses is recognized when cash is paid. Equipment
- Uncollectible accounts or Bad Debts
Under the accrual basis of accounting, - Other Adjustments
revenue is recognized when sales are made or
services are performed, regardless of when
cash is received and expense is recognized as ACCRUAL ITEMS
incurred, whether or not cash is paid out.
Accruals refers to the recognition of expenses
THE MATCHING PRINCIPLE
already incurred though not yet paid, and the
recognition of revenue already earned though
The Matching principle relates to the not yet received. Generally accepted accounting
expense recognition which requires that costs principles require that adjustments be made for
and expenses incurred in generating the accrued items such as accrued revenues and
revenue should be properly matched against the accrued expenses.
related revenue in determining the net income or
net loss for the period. Example is, the Accrued Expenses are expenses
recognition of warranty expense for the period already incurred but not yet paid as the end of
the merchandise is sold rather than when actual the accounting period. These are also called
warranty repair occurs. In other words, if the Accrued Liabilities or Accrued Payables (e.g.
revenue is recognized upon sale of the “” payables…) Failure to prepare the adjusting
merchandise the related warranty costs should entry for accrued expenses will result in
also be recognized on the date of sale. understated expenses.

Accrued Revenue are revenues

already earned by the business but not yet
ADJUSTING ENTRIES
collected as at the end of the accounting period.
These are also called Accrued Assets or
Adjusting entries are entries prepared at Accrued Receivable (e.g. ‘’ Receivable…)
the end of an accounting period to update or Failure to prepare the adjusting entry for
adjust the balance of accounts. It is very accrued revenues will result in understated
important that adjustments be recorded correctly revenues and understated assets for the period.
so that the company’s profit for the period me
 clients or customers can not pay their accounts
on time and worst these receivables from clients
DEFERRAL ITEMS can no longer be collected. To comply with the
matching principle, companies prepare adjusting
Deferrals refers to the postponement of entries to recognize the anticipated loss that the
the recognition of revenue which the company business might incur arising from these
has received or collected in advance and the uncollectible accounts.
postponement of the recognition of expense
which has been paid in advance. Thus, under Doubtful Accounts Expense is used
the concept of deferrals income received in instead of Uncollectible Accounts Expense or
advance should be taken up as liability and Bad Debts Expense. Further, the allowance
expense paid in advance be account should also depend on the expense
taken up as an asset. account used to record doubtful accounts. The
allowance accounts may be Allowance for
Prepaid Expenses are expenses paid Doubtful Accounts and Allowance for Bad Debts.
in advance. Since the economic benefits will be Consistency as to the use of accounts must be
received in the future, prepaid expenses are applied.
treated as assets. They are expected to become
expenses through the passage of time or
through its usage and consumption. Prepaid
WORKSHEET
Expense is the exact opposite of the Accrued
Expense. Failure to prepare the adjusting entry
for prepaid expenses will result in the Is a columnar sheet used to summarize
understatement of expenses and the information needed to make the adjusting,
overstatement of assets for the period. correcting and closing entries and to prepare the
financial statements. A worksheet is only a tool
Unearned Revenue is revenue used in accounting and does not form part of the
collected in advance. Since these revenues are formal accounting records. It is only used each
not yet earned by the business, these are time financial statements are prepared, either
treated as liabilities. They are expected to monthly, quarterly, semi-annually or annually.
become revenue through the passage of time or
through the delivery of goods or services.
Unearned Revenue is the exact opposite of the
REAL AND NOMINAL ACCOUNTS
Accrued Revenue. Failure to prepare the
adjusting entry for unearned revenue will result
in the understatement of revenue and the Real accounts are the assets, liabilities,
overstatement of liability for the period. and capital accounts which are indicators of the
company’s financial position. It has running
balances (means its ending balances are carried
forward as beginning balanced in the next
ACCOUNTING FOR UNCOLLECTIBLE accounting period).
ACCOUNTS
Nominal accounts are revenue
accounts which are indicators of the company’s
Uncollectible Accounts or Bad Debts financial performance. The balances of the
relates to the company's receivables which nominal accounts are reported only in the year
might not be collected. Extending credit or of recognition and need to be closed to the
rendering services on account is normal in capital account prior the start of the next
business operations. There are times when accounting period.
 2. Statement of Financial Performance
3. Statement of changes in Owner’s
Capital/Equity
CLOSING ENTRIES
4. Statements of Cash Flows
5. Notes to the Financial Statement
Are prepared at the end of the
accounting period to bring the balances of the
temporary or nominal accounts to restart at zero
so that these accounts will be ready to receive OTHER UNDERLYING ASSUMPTIONS
new data for the next accounting period. The
non-closing of these accounts will result in The Going Concern Assumption
difficulties in determining the respective financial This assumes that unless there is
performance of the company for every year. evidence to the contrary, the business entity will
continue to operate for an indefinite period.
The trial balance that is generated prior
to the posting of closing process is called the The Unit of Measurement
Pre-Closing Trial Balance while trial balance This is specific that accounting should
generated after the closing process is called the measure and report the results of a business’s
Post-Closing Trial Balance economic activities in terms of a monetary unit
such as the Philippine Peso. Thiis assumption
The closing entries, like the correcting recognizes that the use of a standard monetary
and adjusting entries, must be recorded in the unit throughout all the financial statements is an
General Journal and posted in the General effective means of aggregating and
ledger. communicating accounting information. It is a
standard practice to ignore changes in the
purchasing power of pesos.

FINANCIAL STATEMENTS

After completing the worksheet, all STATEMENT OF FINANCIAL POSITION

information needed to prepare the Financial
statements are readily available. Financial The statement of financial position, also
Statements is the end product of the accounting known as the Balance Sheet, is the financial
process. They are the means by which financial statement which shows the real accounts,
information about an economic entity is namely, the assets, liabilities and owner’s equity,
communicated to the various uses of financial which are indicators of the financial position or
information. condition of the company as of a given date
usually at the close of the last day of a month or
Financial statements may be prepared a year. This statement is based on the
on a monthly basis (the shortest accounting Post-Closing Trial Balance column of the
period), at the end of every three months Worksheet since the items appearing therein are
(quarterly basis), six months (semi-annual basis) only real accounts. In a classified Statement of
or one year (annual basis). Financial statements Financial Position, to provide more specific
that are prepared for a period of less than a year information for the users, the assets and
are called Interim Financial Statements. liabilities are classified into current and
noncurrent.
The five components of Financial Statements
are: ➔ Current Assets are cash and other
1. Statement of financial Position assets that are converted into cash or
 used up in a relatively short period of
STATEMENT OF CHANGES IN OWNER’S
time, usually one or less. It commonly EQUITY
includes cash, short-term receivables
(e.g. accounts receivable and notes
receivable), supplies, inventory, prepaid The Statement of Changes in Owner’s
expenses, etc. These are listed in the Capital/Equity, or simply the Capital Statement,
order of liquidity or their convertibility is the summary of changes in the owner’s equity
into cash. that have occurred during a specific period of
➔ Non-current Assets are long term time. This Statement is prepared by showing the
assets for use in the business rather beginning capital balance, adding net income (or
than sale. It includes long-term deducting net loss) and subtracting the owner’s
receivables, investments, fixed assets, withdrawals. The result is the ending capital that
intangible assets, etc. is forwarded to the Statement of Financial
➔ Current liabilities are debt usually due Position.
within one year, the payment of which
will normally require the use of the
current assets. Current liabilities are STATEMENT OF CASH FLOWS
usually listed in the order of their
maturity, the sooner the liability is to be
The Statement of Cash Flows is the financial
paid, the earlier it is listed. Examples are
statement that provides information about the
short-term payables (e.g. accounts
cash receipts and cash payments of an entity for
payable and notes payable), accrued
a given period of time. Reported in the cash flow
liability, unearned revenue, etc.
statement are the sources of cash and the uses
➔ Non-current liabilities are long term
or disbursements made by the company. Cash
debts that will be paid after a relatively
flow information is useful in providing users the
long period of time, usually more than
basis to assess the ability of the company to
one year. These are also listed
generate cash and the need of the company to
according to maturity. Examples are
utilize those cash flows.
long-term payables such as Mortgage
Payable and Bonds Payable.
This statement involves three types of business
activities such as operating, investing and
financing activities. It shows the proper
STATEMENT OF FINANCIAL presentation of the three types of business
PERFORMANCE activities during the period:

➔ Operating Activities involve the

The Statement of Financial Performance
production or purchase of merchandise
is the financial statement that shows the
and the sale of goods and services to
summary of the company's revenue and
customers. It also includes the
expenses for a given period. The result of a
expenditures related to administering
company's business operation is reported in this
the business. Operating activities
financial statement. This statement is based on
generally relate to the calculation of net
the nominal accounts, namely: the revenue and
income as it creates revenues and
expense accounts in the Pre-Closing Trial
expenses in the company’s main line of
Balance column of the Worksheet.
business.

➔ Investing Activities involve the

purchase or sale of assets that are
 classified on the balance sheet as Relevance - to be useful, information must be
property, plant and equipment, relevant to the decision-making needs of users.
intangible assets and long-term Information has the quality of relevance when it
investments. If a company loans money would influence a decision by helping users form
to other parties, the cash receipts from predictions about the outcome of past, present
collecting the loans are classified as and future events, or confirm and correct prior
investing activities. However, collections expectations.
of interest are not investing activities,
they are reported as operating activities. Reliability - to be useful, information must be
reliable. Information has the quality of reliability
➔ Financing Activities obtains funds from when it is free from errors and bias and can be
banks, investors and creditors needed depended upon by users to represent faithfully
to launch and sustain the business. what it purports to represent. In other words, the
Financing activities include issuing financial statements are reliable if they represent
stock, borrowing money by issuing faithfully the actual economic effects of
notes and bonds, selling treasury stocks transactions, are neutral, prudent and complete
and distributing dividends to in all material respects.
stockholders
Understandability - information provided in the
financial statements must be presented in a form
and expressed in terminology that a user
NOTES TO THE FINANCIAL STATEMENT
understands. Understandability is very essential
because even if the financial statement is
The Notes to the Financial relevant and reliable, it may prove to be useless
Statements is added as one of the basic if it is not understood by the users.
financial statement companies are required to
prepare to make the financial statements more Comparability - is the ability to bring together
useful and meaningful to those who might have for the purpose of noting points of likeness and
an interest in the business. This statement differences. Users must be able to financially
presents in narrative form the significant compare the statements of an entity through
accounting policies and other related time in order to identify trends in financial
explanatory notes that have affected the position and performance from one accounting
preparation of the financial statements. period to the next. Knowing the past trends,
Example of a note to the financial users can reasonably make more accurate
statement, is a disclosure regarding a lawsuit for predictions and decisions. Comparability also
which the company is the defendant. Other allows comparisons between two or more
relevant information which cannot be shown in enterprises engaged in the same industry.
the face of the financial statements is reported in
this statement.

CHARACTERISTICS OF FINANCIAL
STATEMENT

The qualitative characteristics of financial

statements consists of the attributes or qualities
that make information provided in the financial
statements useful to users. These are: