1.3 The Accounting Process: Journals, Worksheet, Adjusting, Closing, and Reversing Entries
Key Takeaways
The accounting cycle runs from analyzing transactions through journalizing, posting, trial balances, adjustments, statements, closing, and optional reversing entries.
Every adjusting entry pairs one income statement account with one statement of financial position account and never involves Cash.
Prepayments and unearned income may be recorded by the asset/liability method or the expense/income method, but both must produce the same adjusted balances.
Reversing entries suit accruals and deferrals recorded under the expense or income method, not depreciation, allowances, or asset-method prepayments.
A trial balance proves only equality of debits and credits; omissions, wrong-account postings within the same type, and offsetting errors pass undetected.
The Accounting Process: Journals, Worksheet, Adjusting, Closing, and Reversing Entries
FAR topic 2.2 tests whether a candidate can move a set of transactions through the complete accounting cycle and repair the balances that come out of it. Board problems rarely ask for a full cycle; instead they plant one missed accrual, one prepayment recorded under the "wrong" method, or one reversing entry, and ask for corrected profit or a corrected account balance. This section also covers prepaid expenses and other assets (FAR topic 4.7), because prepayments are adjusted through the same entries.
1. The Steps of the Accounting Cycle
| Step | Activity | Output |
|---|---|---|
| 1 | Identify and analyze transactions from source documents (invoices, receipts, contracts) | Documented transactions |
| 2 | Journalize in the general journal or a special journal | Chronological record |
| 3 | Post to the general ledger and subsidiary ledgers | Account balances |
| 4 | Prepare the unadjusted trial balance | Proof of equal debits and credits |
| 5 | Record adjusting entries (often through a worksheet) | Accrual-basis balances |
| 6 | Prepare the adjusted trial balance and financial statements | Statements of financial position, income, changes in equity, cash flows |
| 7 | Record closing entries | Nominal accounts reset to zero |
| 8 | Prepare the post-closing trial balance | Only real (permanent) accounts remain |
| 9 | Record reversing entries (optional) on the first day of the new period | Simplified routine bookkeeping |
A trial balance proves only that debits equal credits. It does not detect an omitted transaction, a transaction posted to the wrong account of the same type, or two offsetting errors.
2. Special Journals, Subsidiary Ledgers, and Control Accounts
Entities with many similar transactions use special journals so that totals, not individual entries, are posted to the general ledger:
| Journal | Records | Typical Column Totals Posted |
|---|---|---|
| Sales journal | Sales of merchandise on account | Dr. Accounts Receivable, Cr. Sales |
| Purchases journal | Purchases on account | Dr. Purchases (or Inventory), Cr. Accounts Payable |
| Cash receipts journal | All cash inflows | Dr. Cash, Dr. Sales Discounts; Cr. Accounts Receivable, Cash Sales, Other |
| Cash disbursements journal | All cash outflows (check register) | Cr. Cash, Cr. Purchase Discounts; Dr. Accounts Payable, Expenses, Other |
| General journal | Everything else: adjusting, closing, reversing, correcting, and unusual entries | Posted individually |
Individual customer and supplier balances live in subsidiary ledgers. The general ledger holds a single control account (Accounts Receivable, Accounts Payable) whose balance must equal the sum of its subsidiary ledger. A difference points to a posting error in one of the two.
3. Adjusting Entries
Adjusting entries apply the accrual basis at period-end. Each one affects one income statement account and one statement of financial position account, and none of them touches Cash.
| Type | Situation | Adjusting Entry |
|---|---|---|
| Accrued expense | Expense incurred, not yet paid or recorded (unpaid salaries, interest) | Dr. Expense, Cr. Payable |
| Accrued income | Income earned, not yet collected or recorded (interest receivable, unbilled fees) | Dr. Receivable, Cr. Income |
| Prepaid expense | Cash paid in advance for future benefit | Asset method: Dr. Expense, Cr. Prepaid (for the used part). Expense method: Dr. Prepaid, Cr. Expense (for the unused part) |
| Unearned income | Cash collected before it is earned | Liability method: Dr. Unearned, Cr. Income (earned part). Income method: Dr. Income, Cr. Unearned (unearned part) |
| Depreciation and amortization | Allocation of the cost of long-lived assets | Dr. Depreciation Expense, Cr. Accumulated Depreciation |
| Doubtful accounts | Expected credit losses on receivables | Dr. Impairment Loss, Cr. Allowance |
The two recording methods for prepayments must end with the same adjusted balances; only the adjusting entry differs.
Prepaid Expenses and Other Assets
A prepaid expense is a current asset because it will be consumed (not converted to cash) within the operating cycle; prepayments that benefit periods beyond twelve months (for example, a three-year insurance premium's non-current portion) are split between current and non-current. "Other assets" commonly include deposits, advances to suppliers for inventory or PPE (classified with the asset being acquired), and deferred charges that meet the asset definition. Office supplies on hand are carried at cost and expensed as used.
4. Worked Example: One Year-End, Two Recording Methods
On October 1, 2026, Lucena Trading paid PHP 360,000 for a 12-month insurance policy and, on November 1, 2026, collected PHP 240,000 from a tenant for six months' rent in advance. Salaries of PHP 45,000 for the last week of December will be paid on January 5, 2027.
| Item | Asset/Liability Method at Initial Entry | Adjusting Entry, Dec. 31, 2026 | Adjusted Balance |
|---|---|---|---|
| Insurance (asset method) | Dr. Prepaid Insurance 360,000 | Dr. Insurance Expense 90,000; Cr. Prepaid Insurance 90,000 (3/12) | Prepaid Insurance 270,000 |
| Insurance (expense method) | Dr. Insurance Expense 360,000 | Dr. Prepaid Insurance 270,000; Cr. Insurance Expense 270,000 (9/12) | Prepaid Insurance 270,000 |
| Rent (liability method) | Cr. Unearned Rent 240,000 | Dr. Unearned Rent 80,000; Cr. Rent Income 80,000 (2/6) | Unearned Rent 160,000 |
| Rent (income method) | Cr. Rent Income 240,000 | Dr. Rent Income 160,000; Cr. Unearned Rent 160,000 (4/6) | Unearned Rent 160,000 |
| Salaries | None | Dr. Salaries Expense 45,000; Cr. Salaries Payable 45,000 | Salaries Payable 45,000 |
Whatever method is used, 2026 profit includes insurance expense of PHP 90,000, rent income of PHP 80,000, and salaries expense of PHP 45,000.
5. Closing and Reversing Entries
Closing entries transfer the balances of nominal accounts to retained earnings (or capital): revenues and gains are debited, expenses and losses are credited, the difference goes through Income Summary, and dividends or drawings are closed directly to retained earnings or capital. After closing, only real accounts appear in the post-closing trial balance.
Reversing entries are optional. Made on the first day of the next period, they are the exact reverse of certain adjusting entries so that routine entries can be recorded without splitting amounts. They are appropriate for:
- Accruals (accrued expenses and accrued income); and
- Prepayments recorded under the expense method and unearned income recorded under the income method, because those adjustments create a real account that the next period's routine entry would otherwise ignore.
They are not made for depreciation, doubtful accounts, or prepayments recorded under the asset or liability method. In the example above, a January 1, 2027 reversing entry (Dr. Salaries Payable 45,000; Cr. Salaries Expense 45,000) lets the January 5 payroll be recorded simply as Dr. Salaries Expense, Cr. Cash; the net 2027 expense is correct.
Important
A reversing entry never changes a period's reported profit if all later entries are made consistently. Board questions test whether a missed reversal causes double-counting: if the entity records the full January payment as expense without having reversed the accrual, 2027 salaries expense is overstated by PHP 45,000 and Salaries Payable remains overstated.
6. Correcting Errors Found Before Closing
Errors discovered before the books are closed are corrected with a correcting entry in the general journal rather than by erasure. The fastest method is to compare the entry that was made with the entry that should have been made and record the difference. For example, a PHP 20,000 cash purchase of office equipment recorded as Dr. Repairs Expense, Cr. Cash is corrected by Dr. Office Equipment 20,000, Cr. Repairs Expense 20,000 (followed by any depreciation adjustment). Errors of prior periods that are discovered after closing are prior period errors under PAS 8 and are corrected retrospectively through opening retained earnings.
On August 1, 2026, a company paid PHP 180,000 for rent covering August 2026 to January 2027 and debited Rent Expense for the full amount. What adjusting entry is required on December 31, 2026?
Debit Prepaid Rent PHP 30,000; credit Rent Expense PHP 30,000
Debit Rent Expense PHP 150,000; credit Prepaid Rent PHP 150,000
Debit Prepaid Rent PHP 150,000; credit Rent Expense PHP 150,000
No adjusting entry is needed because the payment was already expensed
Which of the following adjusting entries is ordinarily suitable for a reversing entry at the start of the next period?
The recording of depreciation on office equipment
The expiration of prepaid insurance originally recorded as an asset
An increase in the allowance for expected credit losses
An accrual of interest earned on a note receivable but not yet collected
A company collected PHP 120,000 on December 1, 2026 for 12 months of consulting services beginning that day and credited Service Revenue. No adjustment was made at year-end. What is the effect on the December 31, 2026 financial statements?
Revenue is overstated and liabilities are understated by PHP 110,000
Revenue and liabilities are both understated by PHP 110,000
Revenue is overstated and liabilities are understated by PHP 10,000
There is no misstatement because cash was received in December
Sections you finish are checked off in the contents.