DATA FOR ADJUSTMENT

Ideally, all transactions must be recorded on the day of occurrence.  However, there are
accountable events that are not immediately journalized.  For instance, use of supplies and
earning of wages by employees are not journalized daily because it is inexpedient to do so. 
Some costs are not journalized during the accounting period because these costs expire with the
passage of time rather than as a result of recurring daily transactions.  Also, due to numerous
transactions in a day, the record keeper may have unintentionally failed to record certain
business transactions.  To include these transactions in the books of accounts before financial
statements are finally prepared, adjusting entries are necessary.  This is to ensure that all
revenues are recorded in the period when they are earned and all expenses are recognized in the
period when they are incurred.  This is in accordance with the accrual and periodicity
assumptions.

Adjusting Entries
These are general journal entries done at the end of the accounting period to split mixed accounts
and to bring the accounts up to date for the purpose of measuring the results of operations and
financial position as fair and accurate as possible. 

These entries are required when a business uses accrual accounting because of the timing
differences between the flow of cash and the recognition of revenues or expenses.

What are mixed accounts? Balance sheet account? Income statement account?

In previous moudules, we have noted that there are two kinds of accounts - Balance Sheet
Accounts and Income Statement Accounts.  However, another way of classifying these accounts
is as follows:

1. Real Accounts – these include all balance sheet accounts except Owner’s Drawing. These are
also known as Permanent Accounts because their ending balances are not brought down to zero
at the end of

2. Nominal Accounts – these include all income statement accounts and the owner’s drawing
account. These are also known as Temporary Accounts  because they relate only to the current
accounting period and their balances are eventually transferred to the capital account, thus,
bringing their balances to zero at the end of the accounting period.

3. Mixed Accounts – the nature of these accounts is partly real and partly nominal. It may
either be composed of :

a. Asset and expense elements

b. Liability and income elements

When are adjusting entries needed?

The easiest way to know when an adjusting entry is needed is by familiarizing oneself with the
six instances that normally require adjustments:

1. Prepayment of Expenses
2. Pre-collection of Income
3. Accrual of Expenses
4. Accrual of Income
5. Provision for Depreciation Expense
6. Provision for Doubtful Accounts Expense

Prepayments: Expenses and Income

PREPAYMENT OF EXPENSES

This is a situation when expenses though not yet incurred, used or consumed are paid in
advance.  Insurance, Rent, Advertising and Supplies are examples of expenses that may be paid
in advance.  An asset, particularly Prepaid Expense, must be recognized (e.g. Prepaid
Insurance, Prepaid Rent, Prepaid Advertising and Supplies) to record the unused or unexhausted
or unconsumed portion of the amount paid for these expenses.

There are two generally accepted treatments for prepayments: the ASSET Method and the
EXPENSE Method.

1. Asset Method – under this method, an asset account is debited upon advance payment of the
expense. At the end of the period, the asset account may become a mixed account because a
part of the entire amount debited to that account may have already been used.  Thus, such
portion must be treated already as an expense.

To illustrate, let us analyze the October 2 transaction on the purchase of supplies worth
P50,000.  (Assume that there’s no beginning inventory.) The entry to record the transaction
using the Asset Method is as follows:

Account Debit Credit

Supplies   P 50,000  
     Cash   P 50,000

If it was determined that P35,000 worth of supplies were used during the month, SUPPLIES
becomes a mixed account, that is: Expense (P35,000) and Asset (P15,000).
If the owner wishes to prepare fairly presented financial statements on October 31, 2020, the
appropriate adjusting journal entry that should be made is:

Account Debit Credit

Supplies Expense  P 35,000  
     Supplies   P 350600

2. Expense Method – under this method, an expense account is debited upon advance payment of
the expense. At the end of the period, the expense account may become a mixed account
because a part of the entire amount debited to that account may not have been incurred or
used yet.  This unused portion should be reclassified as an asset.

To illustrate, let us assume the October 2 transaction on the purchase of supplies made use of
the Expense Method.  The journal entry is as follows:

Account Debit Credit

Supplies Expense  P 50,000  
     Cash   P 50,000

If it was determined that P15,000 worth of supplies remains unused during the month,
SUPPLIES EXPENSE becomes a mixed account, that is: Expense (P35,000) and Asset
(P15,000).

Account Debit Credit

Supplies   P 15,000  
     Supplies Expense   P 15,000

Key Point: The ending balances of the asset and expense accounts under both methods will
still be the same.  In this case, Supplies would have a balance P15,000 and Supplies Expense
would have  P35,000.

PRE-COLLECTION OF INCOME

There are instances when it is the customer who pays in advance for services that the company is
engaged to render in the future.  In this case, the recognition of a liability such as Unearned
Revenue is necessary.

Like prepayments, there are two generally accepted methods that can be used: the LIABILITY
Method and the INCOME Method.
 1. Liability Method – under this method, a liability account is credited upon advance collection of
income.  At the end of the period, the liability account can become a mixed account because the
obligation to render services may have already been rendered.  Hence, it would be
inappropriate to recognize the entire amount credited as a liability.  The portion of the amount
credited that is equivalent to the rendered services should already be treated as an income.
(Take the letter of your block section 1C  as the second digit for the access code.)

To illustrate, let us assume  a transaction on October 27 where a client paid P10,500 for
laundry services to be rendered for seven days starting October 28- November 3, 2020.  The
journal entry will be as follows:

Account Debit Credit

Cash  P 10,500  
     Unearned Service Revenue   P 10,500

As of October 31, the client would have already used 4 days amounting to P6,000 of laundry
services.  Thus, the Unearned Service Revenue credited becomes a mixed account, that is:
Income (P 6,000) and Liability (P 4,500).

If the owner wishes to prepare fairly presented financial statements on October 31, 2020, the
appropriate adjusting journal entry that should be made is:

Account Debit Credit

Unearned Service Revenue  P 6,000  
     Service Revenue   P 6,000

2. Liability Method – under this method, an income account is credited upon advance collection
of income. At the end of the period, the income account can become a mixed account because
the services may not have been rendered yet.  Hence, it would be inappropriate to recognize the
entire amount credited as an income.  The portion of the amount credited that is equivalent to the
untendered services should be treated as a liability.

To illustrate, let us assume  a transaction on October 27 where a client paid P10,500 for
laundry services to be rendered for seven days starting October 28- November 3, 2020.  The
journal entry will be as follows:

Account Debit Credit

Cash  P 10,500  
     Service Revenue   P 10,500
As of October 31, the client would have already used 4 days amounting to P6,000 of laundry
services.  Thus, the Service Revenue credited becomes a mixed account, that is: Income (P
6,000) and Liability (P 4,500).

If the owner wishes to prepare fairly presented financial statements on October 31, 2020, the
appropriate adjusting journal entry that should be made is:

Account Debit Credit

Service Revenue  P 4,500  
     Unearned Service Revenue   P 4,500

Key Point: The ending balances of the liability and income accounts under both methods
will still be the same.  In this case, Unearned service revenue would have a balance P4,500 and
Service revenue would have  P6,000

Accruals: Expenses and Income

ACCRUAL OF EXPENSES

At the end of the accounting period, there are usually expenses that have been incurred or used or
consumed but not yet recorded in the accounts because they are not yet paid and the creditor has
not demanded for payment.  These expenses require adjusting entries where an expense account
is debited and a liability account (Accrued Expense or Accrued Payable) is credited.

To illustrate, assume that a company pays its employees P2,500 every Fridays for a five day
work; and October 31, the end of the month falls on a Wednesday, there is P1,500 of salaries
(P2,500/week divided by 5 days equals P500/day, times 3 days (Oct.29-Oct 31) employees
should have earned but have not yet received.  Thus, an adjusting entry should be made prior to
the preparation of the financial statements covering the month of October.

Account Debit Credit

Salaries Expense  P 1,500  
     Accrued Salaries Payable    P 1,500

Key Point: The adjusting entry to record the accrual of an expense is:

            Expense account                                                        XXX

                        Accrued expense/payable                                        XXX

 
ACCRUAL OF INCOME

Accrued Revenues or Accrued Income or Accrued Receivables are revenues for which a service
has been performed or goods delivered (in the case of a merchandising business) but for which
no entry has been recorded perhaps because the company has not demanded payment yet Any
revenues earned but not recorded during the current accounting period call for an adjusting entry
that debits an asset account and credits a revenue account. (Your year level (1) is the third
component of the password)

To illustrate, assume that on October 30, A company accepted a load of bed sheets, pillow cases
and comforters weighing 500 kilos for laundry from a client in the hotel industry. Cost per kilo is
P50. Let us assume further that Soap & Suds could wash only 100 kilos for a day; then, there is
P10,000 of revenue (P50/kilo times 100 kilos/day times 2 days (Oct.30-Oct 31) that should have
been earned but not yet received.  Thus, an adjusting entry should be made prior to the
preparation of the financial statements covering the month of October.

Account Debit Credit

Accrued Service Revenue  P 10,000  

     Service Revenue    P 10,000

Key Point: The adjusting entry to record accrual of an income is:

            Accrued revenue/income/receivable                      XXX

                        Income account                                                         XXX

Depreciation and Bad Debts

PROVISION FOR DEPRECIATION EXPENSE

When an enterprise purchases a fixed asset, it is in effect paying for the usefulness of that non-
current asset in advance for as long as it benefits the business organization.  Thus, the amount
paid to acquire this kind of asset must be deferred and allocated over the period benefited or its
estimated useful life.  The cost of a fixed asset allocated to a certain period is known as
Depreciation Expense.  Like any other expense, depreciation expense is incurred during an
accounting period to generate revenue.
Here’s another way of viewing depreciation:  Generally, Nothing lasts forever even for fixed
assets.  Due to certain physical factors like wear and tear and exposure to wind, rain, sun and
other elements and also functional or economic factors including obsolescence and inadequacy,
the value and usefulness of fixed assets decrease as time passes.  It will reach a point when it
becomes no longer useful, thus, its life is said to have ended.  Because of the limited life of these
tangible assets, their costs should be distributed as expenses over the years they benefit. 

It should be noted that all fixed assets depreciate except for land and art collections whose value
and usefulness generally does not decrease.

Key Point: The adjusting entry to record depreciation expense is:

            Depreciation expense                                               XXX

                        Accumulated depreciation                                        XXX

Accumulated Depreciation is a contra-fixed asset account that refers to the total amount of
depreciation recorded against an asset or group of assets during the entire   time the asset or
assets have been owned.  Being a contra-asset account, it is presented in the balance sheet as
deduction from the related asset account.

There are many methods of computing for the depreciation expense to be provided in a period. 
But the simplest and most common method is the Straight-line Method because it gives a
uniform amount of depreciation expense every year of the fixed asset’s useful life.  The formula
under this method is;     

     Cost – Salvage Value

Depreciation expense =
     Estimated Useful Life

Where:

 COST =  Purchase price + Incidental Costs necessary in acquiring and preparing the asset for
intended use
 SALVAGE VALUE = Estimated value to be received at the time the asset is sold or removed from
service when it is already fully depreciated. It is also known as Scrap Value and Residual Value.
 ESTIMATED USEFUL LIFE = Approximate length of time within which the fixed asset is to be used

To illustrate, assume that store equipment purchased on October 2,2020 costing P450,000 has a
scrap value of P7,500 and the estimated useful life is five years, the depreciation expense for
October is recorded as follows:

Account Debit Credit

Depreciation Expense [(P450,000-7,500)/5 years]  P 7,375  
     Accumulated Depreciation   P 7,375

(September is the 9th month of the year but the 4th digit in the access code)

PROVISION FOR DOUBTFUL ACCOUNTS EXPENSE

Doubtful Accounts Expense (also known as Bad Debts Expense and Uncollectible Accounts
Expense) are expenses incurred for the failure to collect accounts receivable.  The estimation of
the amount to be recorded as doubtful accounts expense is normally based on the experience of
the company or of the industry to which the company belongs.  Indicators like declaration of
bankruptcy of a customer; closure of business; the customer’s failure to reply of repeated
attempts to collect be also taken into consideration.

Key Point: The adjusting entry to record depreciation expense is:

            Doubtful accounts expense                                     XXX

                        Allowance for doubtful accounts                             XXX

Allowance for Doubtful Accounts (also known for Allowance for Bad Debts and Allowance for
Uncollectible Accounts) is a contra-receivable account that shows the claims on customers that
are expected to become uncollectible in the future.  This is credited instead of accounts
receivable because most often than not, it is difficult to determine which customers will not pay. 
Being a contra-asset account, it is deducted from the related asset account particularly accounts
receivable to get the net realizable value or the amount expected to be received in cash from
these receivables.

To illustrate, assume a company decided to provide an Allowance for Doubtful Accounts equal
to 1% of the outstanding accounts receivable of P20,000. The entry to record this adjustment is:

Account Debit Credit

Doubtful Accounts Expense (P20,000*1%=200)  P 200  
     Allowance for Doubtful Accounts   P 200

Finally, the last letter of the alphabet (Z) completes your pass combination.
Illustrative Example: Adjusting Entries
On December 31, 2020, the records of Zeke Company indicated the following:

1. On October 1, 2020, the company had purchased a two-year insurance policy for P4,800 and
recorded the purchase as an asset.
2. The company had borrowed P200,000 on a three-year, 9% loan from First Bank on July 1, 2020.
3. A total of P10,000 has been collected from customers for services to be rendered in the future,
and the company satisfied 30% of the obligations for these customers.
4. Employees’ salary of P3,500 for the last week has not yet been paid.
5. Machinery had been purchased last year for P100,000; its estimated useful life was estimated to
be 8 years.
6. The company decided to provide an Allowance for Doubtful Accounts equal to one-half of 1% of
the outstanding accounts receivable of P100,000.

Prepare the necessary adjusting entries at the end of the year.

The Worksheet
The WORKSHEET is a working paper that can be used to organize the work done at the end of
the accounting period particularly in summarizing adjusting entries and the account balances for
the eventual preparation of the financial statements.  It is a useful device for understanding the
flow of accounting data from the trial balance to the financial statements.

Worksheet Sections and Sources of Data

Statement of Statement of
Trial Adjusted
Adjustments comprehensive financial
Balance Trial Balance
income position
Account Titles (2)
(1) (3)
(4) (4)
Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr
                     
           

The contents of each column are explained below:

1. Copied from the general ledger

2. Adjusting entries data

3. Extension of trial balance and the adjustments

4. Amounts transferred from the adjusted trial balance section and separated into statement of
comprehensive income  and statement of financial position  accounts

Steps in the preparation of a 10-column worksheet are as follows:

1. Write the heading which is composed of three lines in the following order:

A. Name of the Company

B. Name of the report (worksheet), and

C. Period covered by the report (For the period ended ____ )

2. Write the following column headings:

A. Account Titles     C. Adjustments                            E. Statement of comprehensive income

B. Trial Balance         D. Adjusted Trial Balance       F. Statement of financial position

                        All column headings except for the Account Title should occupy two money
columns, one for debit and another for credit.  The words ‘Debit” and “Credit” must also be
written as part of the said column headings as shown in the illustration included in this
chapter.    

3. Prepare the trial balance on the worksheet.

                        From the ledger transfer all account titles and balances prior to adjustments
(except those having zero balances) or from the trial balance that may have been prepared
already to the worksheet under the first two column headings as mentioned in number 2.

                        Place a single rule under the two money columns in line with the last account title
entered. Take the totals of the amounts under the debit and the credit columns.  If they are equal,
place a double rule under each total to indicate that they are in balance and are assumed to be
correct.  Otherwise, check for errors before proceeding to the next step.

4. Enter the adjustments in the Adjustments columns.

                        Each amount entered must be labeled by a letter or number to facilitate the
preparation of the adjusting entries in the journal. 

                        If additional accounts are needed, they are inserted on the lines immediately after
the trial balance totals.
5. Combine the amounts under the Trial Balance and Adjustments columns and extend them to
the Adjusted Trial Balance columns.

                        If the amounts combined are both debits, their sum is written under the Debit
column of the Adjusted Trial Balance.  In the same manner, if both are credits, their sum is
written under the Credit column of the Adjusted Trial Balance.

The following schedule will prove useful as a guide in computing the adjusted balance of an
account:

Trial Balance   DR   CR   DR   CR

Adjustments + DR + CR - CR - DR

Adjusted Trial Balance = DR = CR = DR = CR

If a debit amount is combined with a credit amount or vice versa, take the difference of the two
amounts.  If the debit is greater than the credit, the difference is extended to the Debit column of
the Adjusted Trial Balance.  Otherwise, the difference should be written under the Credit column
of the Adjusted Trial Balance.

6. Place a single rule under the Debit and Credit columns of the Adjusted Trial Balance portion
in line with the last account title. Take the sum of the amounts under each column then double
rule the totals.

7. Extend the adjusted balance of each asset account to the Statement of Financial Position Debit
column

8. Extend the adjusted balance of each liability account, if any to the Statement of Financial
Position Credit column.

9. Extend the adjusted balance of the capital account to the Statement of Financial Position
Credit column.

10. Extend the adjusted balance of the drawing account, if any, to the Statement of Financial
Position Debit column.

11. Extend the adjusted balance of each income account to the Statement of Comprehensive
Income Credit column.
12. Extend the adjusted balance of each expense account to the Statement of Comprehensive
Income Debit column.

13. Extend the adjusted balance of all contra-accounts in the appropriate financial statement
column. For example, the adjusted balances of Allowance for Doubtful Accounts and
Accumulated Depreciation should be extended to the Statement of financial position  Credit
Column.

14. Place a single rule under the last eight money columns in line with the last account title.
Then, take the sum of the amounts under each column.

15. Compute for the difference of the total debits and total credits under the Statement of
comprehensive income   If the total credits exceed the total debits, the difference is the firm’s
net income and it is written immediately below the debit total in order to balance the two
columns.  However, if the total debits exceed the total credits, the difference is the firm’s net
loss for the period and it is written immediately below the credit total, again, in order to balance
the two columns.  Write “Net Income” or “Net Loss” whichever is appropriate under the
Account Title column in line with the computed difference.

16. Do step number 15 for the Statement of financial position   The difference of the total debits
and total credits of the Statement of financial position  portion should be equal to the difference
of the total debits and total credits of the Statement of comprehensive income  portion. 
Otherwise, check the amounts for errors.  Expect that in case there is net income, the debit total
is greater than the credit total.  Writing the difference immediately below the credit total signifies
that owner’s equity is increased as a result of the net profit.  It would be the exact opposite in a
net loss situation.

17. Place a single rule under the financial statement columns in line with: “Net Income” or “Net
Loss” and bring down the totals. After that, double rule these totals.

Errors in the Worksheet

After entering the balancing figure (net income or net loss of the period) in the proper side of the
statement of financial position  column, the worksheet should balance.  Remember, however,
that a balanced worksheet is never a guarantee that the worksheet was prepared correctly.  In
other words, a worksheet could balance even though several errors have been committed upon its
preparation.  For example, adjustments with wrong amounts will not affect the equality of the
worksheet.  If the adjusted balance of an account is extended to the correct side but a wrong
column, the worksheet will still balance.  It is up to the accountant to exercise utmost care at all
times in order to avoid errors.

If the worksheet is out-of-balance, this is a positive indication that an error or several errors were
committed.  Some examples of these errors are:

 The trial balance is not copied correctly

 An adjustment incorporated in the worksheet does not have equal debit and credit values
  There is an error in the computation of the adjusted balances
 An adjusted balance is extended to the wrong side of a column
 A column is not footed correctly
 Wrong net income or net loss (balancing figure) is computed
 The balance figure is entered on the wrong side of the statement of financial position

The Financial Statements

FINANCIAL STATEMENTS     

The steps in the accounting cycle culminate in the preparation of the financial statements.  The
statements are a structured presentation by management of the financial position and the results
of operations of the business enterprise.  They summarize and report the effects of the thousands
of transactions and activities during a certain period of time.  The primary purposes of preparing
the basic financial statements are:

 To be able to assess the financial condition of the enterprise, as reported in the Statement of
Financial Position
 To know whether the profit goals of the business are attained, as reported in the Statement of
Comprehensive Income

Aside from the statement of financial position  and Statement of Comprehensive Income , a
complete set of financial statements, presented at least annually, includes:

 Statement of Changes in Owner’s Equity

 Statement of Cash Flows
 Notes, comprising of a summary of significant account policies used and other explanatory
notes.

Based on the worksheet, financial statements can be easily prepared by using the data found
under the Statement of Comprehensive Income and Statement of Financial Position columns. 
That is, the Statement of Comprehensive Income can be prepared based on the Statement of
Comprehensive Income columns and the Statement in Owner’s Equity and Statement of
Financial Position can be prepared based on the Statement of Financial Position  columns.

The Four Financial Statements

 Balance Sheet - statement of financial position at a given point in time.

 Income Statement - revenues minus expenses for a given time period ending at a specified date.
 Statement of Owner's Equity - also known as Statement of Retained Earnings or Equity
Statement.
 Statement of Cash Flows - summarizes sources and uses of cash; indicates whether enough cash
is available to carry on routine operations.

Balance Sheet
  The balance sheet is based on the following fundamental accounting model:

Assets  =  Liabilities  +  Equity

 Assets - can be classed as either current assets or fixed assets.

 Current assets are assets that quickly and easily can be converted into cash - include cash,
accounts receivable, marketable securities, notes receivable, inventory, and prepaid assets such
as prepaid insurance.
 Fixed assets include land, buildings, and equipment.
 Liabilities - represent the portion of a firm's assets that are owed to creditors. Liabilities can be
classed as short-term liabilities (current) and long-term (non-current) liabilities.
 Current liabilities include accounts payable, notes payable, interest payable, wages payable, and
taxes payable.
 Long-term liabilities include mortgages payable and bonds payable.
 Equity - is referred to as owner's equity in a sole proprietorship or a partnership, and
stockholders' equity or shareholders' equity in a corporation. For a sole proprietorship or a
partnership, the equity would be listed as the owner or owners' names followed by the word
"capital". In the case of a corporation, equity would be listed as common stock, preferred stock,
and retained earnings.

 The balance sheet reports the resources of the entity. It is useful when evaluating the ability of
the company to meet its long-term obligations.

Income Statement

The income statement presents the results of the entity's operations during a period of time, such
as one year. The simplest equation to describe income is:

Net Income  =  Revenue  -  Expenses

Revenue refers to inflows from the delivery or manufacture of a product or from the rendering of
a service. Expenses are outflows incurred to produce revenue.

Income from operations can be separated from other forms of income. In this case, the income
can be described by:

Net Income  =  Revenue  -  Expenses  +  Gains  -  Losses

where gains refer to items such as capital gains, and losses refer to capital losses, losses from
natural disasters, etc.

Statement of Owners' Equity (Statement of Retained Earnings)

The equity statement explains the changes in retained earnings. Retained earnings appear on the
balance sheet and most commonly are influenced by income and dividends. The Statement of
Retained Earnings therefore uses information from the Income Statement and provides
information to the Balance Sheet.

The following equation describes the equity statement for a sole proprietorship:

Ending Equity  =  Beginning Equity  +  Investments  -  Withdrawals  +  Income

For a corporation, substitute "Dividends Paid" for "Withdrawals". The stockholders' equity in a
corporation is calculated as follows:

    Common Stock (recorded at par value)

+  Premium on Common Stock (issue price minus par value)
+  Preferred Stock (recorded at par value)
+  Premium on Preferred Stock (issue price minus par value)
+  Retained Earnings
----------------------------------------------------------------
=  Stockholders' Equity

Note that the premium on the issuance of stock is based on the price at which the corporation
actually sold the stock on the market. Afterwards, market trading does not affect this part of the
equity calculation. Stockholders' equity does not change when the stock price changes!

Cash Flow Statement

The nature of accrual accounting is such that a company may be profitable but nonetheless
experience a shortfall in cash. The statement of cash flows is useful in evaluating a company's
ability to pay its bills. For a given period, the cash flow statement provides the following
information:

 Sources of cash
 Uses of cash
 Change in cash balance

The cash flow statement represents an analysis of all of the transactions of the business, reporting
where the firm obtained its cash and what it did with it. It breaks the sources and uses of cash
into the following categories:

 Operating activities
 Investing activities
 Financing activities
The information used to construct the cash flow statement comes from the beginning and ending
balance sheets for the period and from the income statement for the period.

JOURNALIZING AND POSTING ADJUSTING ENTRIES

As mentioned earlier in this chapter, each of the adjustments shown on the worksheet results in
an adjusting entry that affects both the statement of financial position  and the statement of
comprehensive income .  An adjusting entry is a general journal entry to record an end-of-period
adjustment to an account.  Adjustments are increases or decreases to accounts which are
indicated on the worksheet at the end of the accounting period.

Journalizing the Adjusting Entries After the worksheet has been completed, the adjusting
entries are entered in the general journal under the heading ”Adjusting Entries”.  They are
journalized in the same order as they appear on the worksheet.  The account numbers are not
entered in the Posting Reference column until the posting is completed.  Adjusting entries
appear in the general journal immediately following the month’s journal entries for transactions.
Explanations and date are no longer necessary if the journal entries are captioned under the
heading “Adjusting Entries”.  It is presumed that such entries are dated as of the end of the
accounting period.

Posting the Adjusting Entries.  Like any other journal entries, the adjusting entries are posted
individually to the proper ledger accounts immediately after they are recorded.  To distinguish
the adjustments from the other entries when posted,  “AJE” with the letter or number label may
be placed under the Particulars column of the ledger; e.g. “AJE (a)” or “AJE (1)” or the
bookkeeper may simply write the word “Adjustment”.  This is not covered by any PAS but is
just a matter of practice to guide preparers and users of these books of accounts.

Journalizing and Posting Closing Entries

Immediately after journalizing and posting adjusting entries, another set of entries is prepared. 
The Statement of Changes in Owner’s Equity explicitly shows the effect of net income or loss
and owner’s withdrawals on capital.  Such effect is reflected in the books of accounts through the
preparation of CLOSING ENTRIES.

Closing entries are journal entries prepared at the end of the accounting period to transfer
temporary account balances to the capital account.  After posting these entries, all nominal
accounts would have ZERO balances; thus, they are said to be closed and are ready to
accumulate data in the next accounting period. 

Journalizing the Closing Entries.  Though each statement of comprehensive income  account
can be closed individually to the capital account, it would be more efficient if these revenue and
expense accounts are first closed to another temporary account, the INCOME SUMMARY
account.  Other account titles used are Income and Expense Summary and Revenue and Expense
Summary.  After that, the Income Summary account is closed to the Capital account.
The Income Summary account is distinct from the other accounts because it has no normal
balance.  If the business operations resulted in a net income, i.e. the revenues are greater than the
expenses; this account will have a credit balance.  If there is a net loss, i.e. expenses exceeded the
revenues; it will have a debit balance.

The Drawing account, on the other hand, is closed directly to the Capital account.

The account titles and adjusted balances to be debited and credited in the closing entries may
come directly from any of the following:

 General ledger – after all adjusting entries have already been posted
 Worksheet – to be taken from the statement of comprehensive income   Here the preparation
of the closing entries is simplified since all the information needed is already grouped under this
column.  Even the amount of the net income or loss for the period is readily available on the
face of the worksheet.
 Statement of comprehensive income

As a summary, we can say that there are basically four closing entries:

 An entry to close all statement of comprehensive income accounts with credit balances
(revenues) to the Income Summary

 Revenues (itemized)                         xxx

      Income Summary                                   xxx

 An entry to close all statement of comprehensive income accounts with debit balances
(expenses) to the Income Summary account

Income Summary                              xxx

      Expenses (itemized)                              xxx

 An entry to close the Income Summary account to the Capital account;

   Income Summary (net income)        xxx

     Capital                                                    xxx

                             OR
Capital                                                xxx

     Income Summary (net loss)                 xxx                                               

 An entry to close the Drawing account to the Capital account.

Capital                                               xxx

     Drawing                                                xxx

RULING AND BALANCING THE LEDGER ACCOUNTS

The postings of the journal entries of a period should be separated from the postings of the next
period.  To have this clear and distinct separation of postings, it is an accepted practice to rule
and balance the general ledger accounts before posting the journal entries of the following
period.

Ruling the ledger accounts is comparable to constructing a wall that will separate the postings of
one period from the postings of the next period.  Ruling and balancing the real ledger accounts is
comparable to constructing a wall that has a gate – the ending balance of the earlier period is
transferred to the other side of the wall and it becomes the beginning balance of the next period.

I. NOMINAL ACCOUNTS

1.
1. If there is only one debit and one credit amount, double rule across all the columns
except the Particulars column
2. If there is more than one debit and/or more than one credit amount, the following steps
are done:
1. A single rule is drawn across the money columns immediately below the last
figure of the longer of the two columns and on the same line of the shorter
column.
2. The total of each column is written below the single rulings.
3. Double rulings are drawn below the totals and across all columns except the
Particulars column.

II. REAL ACCOUNTS

1.
1. If there is only one debit or one credit amount, the real account is not ruled any longer,
and is left as is.
2. If there is more than one amount entered in the ledger regardless of whether debited or
credited, these steps may be followed:
 1. The balance of the account is written on the first available line of the amount
column having the smaller total. “Balance” is written in the Particulars column, a
check is placed in the Post Reference column to differentiate it from posted
entries, and the last day of the period is written in the Date column. This is done
to make both sides of the ledger equal.
2. A single ruling is drawn across the money columns immediately below the last
figure in the longer of the two columns and on the same line of the shorter
column.
3. The total of each column is written below the single rulings.
4. Double rulings are drawn below the total and across all columns except the
Particulars column.
5. The balance is written in the amount column of the side that was originally the
larger, “Balance” is written in the Particulars column, a check mark is placed in
the Post Reference column, and the first day of the next accounting period is
written in the Date column.

The steps explained in the previous paragraphs are different from the steps performed at the time
of preparing the unadjusted trial balance.  For the purpose of determining the unadjusted balance
of each ledger account, the debit and credit money columns of each ledger account are also
footed but the totals (footings) are written in very small pencil figures.  The pencil footings are
temporary totals needed to arrive at the unadjusted balance of the account.  It is not necessary to
draw single horizontal lines or double lines if the accountant is still in the stage of preparing the
trial balance.

The Post-closing Trial Balance

After the accounts are ruled, another trial balance may be prepared to prove the equality of the
debits and credits of the accounts remaining with open balances in the ledger.  However, it
includes only the real accounts with remaining balances after posting the closing entries for the
nominal accounts.

This is called the Post-closing Trial Balance.  It is also known as After-closing Trial balance.  It
is prepared to test the equality of the ledger balances that are carried forward from the previous
period to the first day of the next accounting period.  The accounts appearing in this trial balance
are those accounts contained in the statement of financial position .  Thus, a post-closing trial
balance may be defined as a statement of financial position  in a trial balance form.

This is another error-detecting tool used in accounting.  Remember that a post-closing trial
balance may balance even though there are errors committed in performing the steps in the
accounting cycle.  A balanced post-closing trial balance does not guarantee the absence of errors.

REVERSING JOURNAL ENTRIES

   Some of the adjusting entries recorded at the end of an accounting period have a significant
effect on otherwise routine transactions that occur in the following accounting period.  In order
to address this effect, certain adjusting entries are reversed by means of journal entries called
reversing journal entries.  A reversing journal entry is an entry with debit and credit accounts
and amounts that are exactly the same as the credit and debit accounts and amounts of an entry
that was prepared earlier. These reversing entries are dated on the first day of the next accounting
period.

Although the preparation of reversing entries is optional, their preparation will yield the
following advantages:

1. The recordings of the future transactions that are closely related to the adjusted items are
greatly simplified (accruals)
2. The preparation of the reversing entry allows the use of consistent accounting methods
(deferrals)

Not all adjusting entries have to be reversed.  Only the following adjusting entries are usually
reversed on the first day of the next accounting period:

1. Accrued income
2. Accrued expenses
3. Unearned income, if the income method is being used
4. Prepaid expenses, if the expense method is being used