Correcting Accounting Entries

Correcting Entries

• Errors in recording transactions should be corrected as soon as they are discovered by journalizing and posting correcting entries.
• Correcting entries can be made at anytime, not just at the end of an accounting period.
• The accounting cycle does not include a specific step for correcting entries as they are only made if an error was made.
• To determine the correcting entry, compare the incorrect entry with the entry that should have been made.
• Errors may also be corrected by reversing the incorrect entry and then preparing the correct entry.
• Some errors are not found until after closing temporary accounts, and a correcting entry that corrects an error from a prior period is called a prior period adjustment.
• Adjusting entries are an integral part of the accounting cycle, unlike correcting entries.
• Adjusting entries are journalized and posted at the end of the accounting period only, whereas correcting entries are recorded and posted whenever necessary.
• Adjusting entries always affect at least one balance sheet account (other than cash) and one income statement account, however, correcting entries can affect any type of account.

Classified Balance Sheet

• Lists different classifications in a classified balance sheet.

Current Assets

• Cash and other assets that will be converted to cash, sold, or used up in the business within one year of the balance sheet date.
• Some companies use a period longer than one year if their operating cycle is longer than one year.
• The operating cycle is the time it takes to start with cash and end with cash when producing revenues.
• Common types of current assets: cash, short-term investments, receivables, inventories, supplies, and prepaid expenses.
• Current assets are usually listed in the order of their liquidity; that is, in the order in which they are expected to be converted into cash.

Long-Term Investments

• Investments in debts such as loans, notes, bonds, mortgages or shares in another corporation that is expected to be held for many years.
• These assets are classified as long-term because they are not readily marketable or expected to be converted into cash within one year.
• Most companies report long-term investments as a single amount in the balance sheet, and show details in the notes that accompany the statements.
• If an investment does not specify whether it is short-term or long-term, assume it is a long-term investment.

Property, Plant, and Equipment

• Long-lived, tangible assets that are used in the production of goods or services and are not intended for sale.
• This category includes land, buildings, equipment, and furniture.
• Items are normally listed in the balance sheet in order of permanency.
• Land is usually listed first, because it has an indefinite life.
• Assets which are depreciated should be reported at their carrying amount (cost minus accumulated depreciation).
• Property, plant, and equipment items are depreciated over their useful lives except Land which has an indefinite life.

Intangible Assets

• Long-lived assets that do not have physical substance.
• Includes patents, copyrights, trademarks, trade names, and licenses, giving a company rights and privileges .
• Intangible assets with finite useful lives are amortized; those with indefinite lives are not.
• Amortization is the term used for intangible assets.

Goodwill

• Doesn’t have physical substance.
• Results from the acquisition of another company when the price paid for the company is higher than the fair value of the purchased.
• Goodwill is shown on a separate line item on the Balance Sheet.

Current Liabilities

• Obligations that are expected to be settled within one year from the balance sheet date or in the company’s normal operating cycle, whichever is longer.
• Examples include notes payable, accounts payable, salaries payable, interest payable, sales taxes payable, unearned revenues, and current maturities of non-current liabilities.
• Current liabilities are often listed in order of liquidity, starting from the liabilities that will be due first.

Non-Current Liabilities

• Obligations expected to be paid after one year.
• Examples include bonds payable, mortgages payable, notes payable, lease liabilities, and deferred income tax.
• Many companies report non-current liabilities as a single amount in the balance sheet, and show details in the notes that accompany the statements.

Equity

• The content of equity varies with the form of business organization.
• In a proprietorship, there is one capital account under the heading Owner’s Equity.
• In a partnership, there is a capital account for each partner under the heading Partners’ Equity.

Liquidity

• Current assets and current liabilities provide an important measure of a company’s liquidity, or ability to pay debts as they come due.
• Two common ways of expressing this measure of liquidity include working capital, the current ratio, and the acid-test ratio.

Working Capital

• Calculated as current assets minus current liabilities.
• Indicates a company’s ability to pay its short-term debts.

Current Ratio

• Calculated as current assets divided by current liabilities.
• A higher current ratio indicates better liquidity.

Acid-Test Ratio

• Calculated as (Cash + Short-term Investments + Receivables) divided by current liabilities.
• Measures a company’s immediate short-term liquidity.

Worksheet Preparation

• Step 1: Prepare a trial balance on the work sheet.
• Step 2: Enter the adjustments in the adjustment columns.
• Step 3: Enter the adjusted balances in the adjusted trial balance columns.
• Step 4: Extend the adjusted trial balance amounts to the appropriate financial statement columns.
• Step 5: Total the statement columns, calculate the profit (or loss), and complete the worksheet.

Reversing Entries

• Made at the beginning of the next accounting period and are the exact opposite of the adjusting entries made in the previous period.
• Most often used to reverse accrued revenues and accrued expenses.
• Simplifies the recording of subsequent transactions related to an adjusting entry.
• Preparation is an optional bookkeeping procedure that is not a required step in the accounting cycle.
• Reversing entries do not change the amounts reported in the financial statements.