The Role of Adjusting Entries in Accounting - Essay Example

The adjusting entries Task Introduction The financial ment gives an overview of the financial position of the company. It also contains an overview of the company’s business activities and internal processes. The contents of the financial statements are claims, made by the managing directors, of the company financial position. Users of the financial statements rely on its contents for various purposes. For that reason, it is imperative that companies avail the statements. There is some criticism regarding the adjusting entries made to the financial statements. Critics argue that the adjusting entries cause unnecessary delays yet they turn out to be immaterial in the long-term. The paper seeks to show the extent of the critics’ irrationality. The preparation of the financial statements The financial statements are prepared to help the users make an informed decision. There are various users of the financial statement with different needs as follows: The first kind of people who use financial information is investors. Investors provide capital to the company and are concerned about the levels of risk, and return on the investments. They need financial information to help them decide whether they should buy or sell shares of a particular company. They also need the information that enables them to assess the ability of a company to pay a cash dividend. The second category of people is employees. Employees need to know whether their employer is financially stable. They use this data to evaluate the employer’s ability to implement a fair remuneration package, provide retirement benefits and be able to offer employment chances (McCartney 2004, pp. 2-7). Lenders use financial information to access the ability of a company to pay promptly both the principal and interest on loans. Suppliers and other trade creditors need the financial information to enable them to determine whether they will receive their accrual payments without default. Customers are interested in financial information to determine the life span of an enterprise, especially when they have a long-term association with a company such as the presenting solutions to both short and long-term problems. Government and their agencies use the financial information to regulate the activities of an organization and to determine tax policies. They also use the information to compute national income. Lastly, the public use financial information to determine the trends and recent development activities of an enterprise; to help them assess the possibility of a significant economic contribution to an organization (Dang, Marriott & Marriott 2006, pp. 2-4). Based on the uses mentioned above of the financial statements, the completeness, accuracy and currency of the information are imperative. The provision of incomplete information causes the risk of making decisions without considering the full picture of the company’s financial position. It is common for information relating to a particular financial period to be made available at the end of the fiscal period. In that case, in order to ensure the provision of complete financial information, Adjusting entries are necessary irrespective of how long it takes. Therefore, it is unreasonable to mention that the adjusting entries are unnecessary (Porter 2012, pp. 1-2). The accounting principles The preparation of the financial statement is based on a framework referred to as the accounting principles. The following are a portion of the principles: accrual concept, conservatism concept, consistency concept, Economic entity concept, cost concept, full disclosure concept, going concern concept, matching theory, going concern principle and revenue recognition policy. The notion of the accrual principle requires that the recording of the accounting transactions must be for the period of their occurrence. In addition, the policy requires that the financial statement presents the transactions that occurred during the period of its preparation rather than delaying or accelerating the recognition of the related cash flows. The conservatism principle encourages the acceleration of recognizing expenses and liabilities, but advises against doing the same for revenues (Basic Accounting Principles 2015, par. 1-13). The consistency principle implies that firms maintain the implementation of the current policy until such time that a better policy is formulated. The concept discourages the tendency of continual change in the accounting principle. The cost principle states that the initial cost should be the basis of valuing assets, equity investments and liabilities. The economic entity principle states that the accounting transactions of a firm should be separated from the owner’s or affiliates’. The implementation of the policy was to prevent mixing of such information. The full disclosure principle encourages the provision of all the information that might influence the users’ comprehension of the financial statement (Basic Accounting Principles 2015, par. 1-13). The going concern principle implies that the operation of a company is to continue to the predictable future period. Thus, expenses such as depreciation should be deferred (should not be recognized in their year of occurrence, but at a later date. The materiality principle states that the accounting transactions should be recorded in the financial statements if the omission of which has a significant influence on the decision made by the users of such information. Based on the accounting principle mentioned above, the full disclosure, and the materiality principle encourages the presentation of information that might influence the users perception of the company. However, users have different needs and, therefore, rely on different sets of information. Consequently, it is difficult to identify the degree of usefulness of various sets of information to the users. Therefore, it is advisable to include all the sets of information relating to the company activities during a financial period. For that reason, if adjusting entries is the only way to ensure the inclusion of all the information in the financial statement, it is a necessary process no matter how long it takes (Porter 2012, pp. 1-2). Audit Risks An audit risk is the possibility that an auditor will fail to identify a misstatement, error, omission or fraud when reviewing the financial statement. The primary function of an auditor is to ensure that the content of the financial statements is accurate and fair (Samaha & Hegazy 2010, pp. 3-6). Adjusting entries are made to avoid omission and misstatement. In addition, the adjusting entries are made to guarantee the presentation of a true picture of the company through the financial statement. Therefore, in order to avoid omission and misstatements, Adjusting entries are necessary (Thompson & Ward 1993, pp. 2-5) Conclusion The adjusting entries ensure that the preparation of the financial statements is in accordance with the relevant accounting principles. Second, it ensures that the users of financial statements are provided with complete information about the company. Third, adjusting entries helps minimize audit risks, fraud, omission, and misstatements. Therefore, it is a necessary procedure for the preparation of the financial statements. List of References Basic Accounting Principles 2015, Viewed 30 April 2015, http://www.accountingtools.com/basic-accounting-principles Dang, D.S., Marriott, N. & Marriott, P. 2006, "Users perceptions and uses of financial reports of small and medium companies (SMCs) in transitional economies", Qualitative Research in Accounting and Management, vol. 3, no. 3, pp. 218-235. McCartney, S. 2004, "The Use of Usefulness: An examination of the user needs an approach to the financial reporting conceptual framework", Journal of Applied Accounting Research, vol. 7, no. 2, pp. 52-79. Porter, J.C. 2012, "How Adjusting Entries Affect the Quality of Financial Reporting: The Case of Frosty Co", Issues in Accounting Education, vol. 27, no. 2, pp. 493-524. Samaha, K. & Hegazy, M. 2010, "An empirical investigation of the use of ISA 520 "analytical procedures" among Big 4 versus non-Big 4 audit firms in Egypt", Managerial Auditing Journal, vol. 25, no. 9, pp. 882-911. Thompson, J.H. & Ward, B.H. 1993, "Statistical risk control strategies used to evaluate substantive audit tests", Managerial Auditing Journal, vol. 8, no. 4, pp. 3. Read More