Accounting Reversing Entries and Closing Books

Reversing Entries

• A step in the preparation of financial statements that simplifies the recording of certain transactions
• Used when an adjustment entered in a previous period increases an asset account on the SFP, such as accrued expenses, prepaid expenses, accrued income, deferred income, and depreciations
• For example, an entry for prepaid expenses would be reversed because it would increase an asset account; the original debit would be reversed to create a credit

Closing the Books

• Process of preparing the financial statements
• The standard of uniformity requires that all temporary accounts are brought to zero at the end of the period
• Nominal accounts are closed to the income summary account
• The steps in the closing process are:
  • First, close all income accounts
  • Second, close all expense accounts
  • Third, close the balance of the IS account to the drawing/dividends accounts
  • Fourth, close the drawing/dividends account to the equity account

The Standard (IFRS and GAAP)

• PFRS are guiding principles, not laws
• Paragraphs and pronouncements in bold and plain have equal authority
• Bold pronouncements dictate principles, while plain text provides supporting principles
• The FSRSC is currently the setting body in the Philippines
• The FSRSC’s main function is to prepare interpretations of PFRS for approval by PIC
• The IASB is the successor of the IASC
• The chairman and members of the IASB are appointed by the PRC upon BOA and the APO
• The standard-setting process includes:
  • Consideration of IASB pronouncements
  • Formulation of a task force to advise the FRSC
  • Issuance for comment on exposure drafts
  • Consideration of all comments received within the comment period
  • Approval of a standard or an interpretation by a majority of FSRSC members

Cash and Cash Equivalents

• Refers to money, readily available for unrestricted use
• Used as a medium of exchange
• Consists of cash on hand and undeposited collections
• Undeposited collections include both currencies and deposits

Inventory Estimation Methods

• Used to estimate the value of inventory when a physical count is impossible
• Reasons for using inventory estimation methods include:
  • Preparing interim financial statements
  • Proving the accuracy and reasonableness of a physical count
  • Estimating inventory lost in a disaster (e.g., fire)
• Some common methods include:
  • Gross Profit Method: Assumes that the gross profit ratio remains relatively consistent across periods
  • Retail Method: Used for the large quantities of rapidly changing goods that are commonly found in the retail industry

Investment in Equity Securities

• Represents a share in a company's ownership
• Includes common stock, preferred stock, rights, and options to acquire shares
• The substance of a security is more important than its legal form in classifying it as equity or debt

Debt Securities

• Represents a creditor relationship with an entity
• Features include:
  • Maturity Value
  • Interest Payments
  • Date of Maturity
• Includes:
  • Corporate bonds
  • BSP Treasury shares
  • Government securities
  • Commercial papers
  • Redeemable preference shares
• The substance of a security, not its legal form or structure, determines whether it will be classified as equity or debt

Valuation Adjustments

• Adjusting journal entries are used to adjust accounts to reflect the correct balances at the end of the period
• Adjusting journal entries can be classified into:
  • Accruals: Reflects the actual amount of expense or income that has accrued during the period even if it has not yet been paid or received
  • Deferrals: Reflects the actual amount of expense or income that has been paid but not recorded for the period
  • Estimates: Reflects the estimated expenses or income that are likely to be incurred during the period. such as depreciation or bad debts

Worksheet/Adjusted Trial Balance

• Used for preparing the adjusted trial balance before preparing the financial statements
• Includes the adjusted account balances and helps to ensure that the accounts are in balance
• The worksheet is a 10-column document, but it is not a formal accounting record
• The worksheet's output is the adjusted trial balance

Inventory (IAS 2)

• Includes:
  • Goods held for sale in the ordinary course of business
  • Goods in the process of production for such sale
  • Materials and supplies
• Initial Measurement:
  • Include all costs associated with getting the inventory ready for sale
  • Costs incurred in the acquisition, conversion, and other costs directly related to bringing the inventory to its present location and condition are included
  • Costs not included in the cost of inventory include:
    • Abnormal waste
    • Selling costs
    • Administrative costs
    • Storage costs
• Subsequent Measurement (Lower of Cost and Net Realizable Value - LCNRV):
  • Inventory is recorded at the lower of its cost or its net realizable value
  • NRV is the estimated selling price less the estimated costs of completion, disposal, and other costs to make the sale
• Write-downs:
  • A loss is recognized when the cost of an item exceeds its NRV. This loss can be direct or indirect
  • Direct Loss: Recognized when the cost exceeds NRV.
  • Indirect Loss: Recognized separately, creating an allowance and a separate loss on inventory

Purchase Commitments

• Follow the conservatism principle and NRV recognition
• Accounts payable is fixed, but purchases can go down but never go above the contract terms.
• Gains can be recovered up to the extent of a loss.
• Purchase commitments can be cancellable or noncancellable:
  • Cancellable Purchase Commitments: Can be canceled, no journal entries are needed
  • Noncancellable Purchase Commitments: Entity is obligated to perform the Purchase Commitment

Derecognition of Trade Receivables

• A trade receivable is derecognized when:
  • Contractual rights to receive cash expires
  • The financial asset is transferred, and the company is no longer responsible for the transfer
• Gain or loss = Net proceeds – Book value

Presentation of Receivables

• Presented as one line item for Trade and Other Receivables under current assets
• Long-term receivables are reported as Long-term investments or non-current assets

Disclosures for Receivables

• Nature of receivables
• Credit risk exposures
• Information regarding interest rate risk exposures
• Receivable financing terms and conditions
• Fair values, interest income, accrued interest, and impairment losses

This quiz covers the essential concepts of reversing entries and the process of closing the books in accounting. It explains how reversing entries simplify financial statement preparation and outlines the steps necessary for closing temporary accounts. Test your understanding of these crucial accounting procedures.