Adjusting entries are passed in the accounts in order to comply with all the relevant accounting concepts and standards and provide a full picture of the financial performance and position of the firm. For example, the accruals concept demands that revenue incurred in a particular period should be matched with expenditure that arose in that period.
Therefore, if for instance, we paid insurance on motor vehicles covering the period from October to September 2007, and the financial year end is December, the insurance for the months from January to September 2007 ought to be deducted from the expense by an adjusting entry in 2006 accounts, irrelevant of the date of payment.
It is very bad if adjusting entries are not properly reflected in the accounts before the preparation of the financial statements. Financial reports are based on certain qualitative characteristics as noted in the International Accounting Standards textbook. Two relevant characteristics for this argument are reliability and faithful representation.
This means that financial statements should be free from material errors and ought to represent all the relevant transactions incurred by the firm. If adjusting entries are not recorded we are deviating from these two characteristics and we are providing inaccurate financial information. Based on such information interested users, like managers and other stakeholders may take wrong decisions.
With respect to limited companies, financial statements have to be audited as required by the Companies Act. If such adjusting entries are missing, the auditors will provide a qualified audit report for such accounts, which may severely endanger the firm’s reputation and lead to uncertainty by shareholders and stakeholders on their investment.
The Essay on Financial statement
Accounting mainly involves analyzing, interpretation and reporting of business transaction records. Accounting provides information for decision making to the management. The purpose of accounting is to maintain proper control of finances of an organization. In other words, accounting is an information system whose purpose is to provide essential information about business financial activities. It ...
References
International Accounting Standards (2000). IAS 1 – Presentation of Financial Statements. London: International Accounting Standards Committee.
Wood F.; Sangster A. (2002). Business Accounting 1. Ninth Edition. Essex: Pearson Education Limited.
