MODULE 3: ADJUSTING ENTRIES

LEARNING OBJECTIVES:
At the end of the module, the students should be able to:
1. Enumerate the common end-of-period adjustments.
2. Prepare adjusting entries.

ADJUSTING ENTRIES
Adjusting entries are entries made prior to the preparation of financial statement to update certain accounts so
that they reflect correct balances as of the designated time.

Purpose of Adjusting Entries:

1. To take up unrecorded income and expense for the period.
2. To split mixed accounts into their real and nominal elements.

Adjusting Entries are subdivided into the following:

1. Accruals of income and expense.
2. Recognition of depreciation expense and bad debt expense.
3. Deferrals of income and expenses

ACCRUAL IN ACCOUNTING
Accrual in accounting is a method where revenues and expenses are recorded when they earned or incurred
(based on when economic activity occurs) regardless when the physical money is actually paid or received.

ACCRUALS OF INCOME AND EXPENSES

In accounting, the term “accrual” (or to accrue) means to recognize an:
a. Income that is already earned but not yet collected; or
b. Expense that is already incurred but not yet paid.

Accruals give rise to both income and receivable or both expense and payable.

ILLUSTRATION: ADJUSTING ENTRIES – ACCRUALS OF INCOME AND EXPENSE

RVM Co. is preparing its financial statements for the period ended Dec. 31, 2025. Adjustments are needed for
the following:

CASE 1: ACCRUAL OF INCOME – INTEREST INCOME

RVM Co. received a 12%, P100,000, one year, note receivable on April 1, 2025. ABC uses a calendar year
period. The principal and interest on the note are due on April 1,2026.

CONCEPTS:
a. Notes Receivable give rise to interest income.
b. Interest Income is earned due to the passage of time

CONCLUSION:
Interest Income shall be accrued for the 9 months covering April 1 to December 31, 2025.

The interest income is accrued as follows:

FORMULA:
 i=P r t
Where:
i=interest
P=Principal
r=rate
t=time
(i=Prt: Interest equals principal times rate times time)

 Principal (P) is the P100,000 face amount of the note.

 Rate (r) is the 112% interest rate.
 Time (t) is the expired time of 9 months (April 1-Dec.31, 2025) over the 12 months in a year.

Interest = (P100,000x12%x9/12) = P9,000

ADJUSTING JOURNAL ENTRY:

Date Account Titles Debit Credit
Dec. 31, 2025 Interest Receivable P9,000
Interest Income P9,000
To accrue interest income earned but not yet collected.

CASE 2: ACCRUAL OF INCOME – RENT INCOME

RVM Co. rents out a building to a tenant for a monthly rent of P50,000. As of December 31, 2025, the tenant
has not yet paid the rent for the month of December.

CONCEPT:
Income is recognized when earned rather than when collected – Accrual Basis of Accounting

CONCLUSION:
Rent Income for the month of December shall be accrued on December 31, 2025.

ADJUSTING JOURNAL ENTRY:

Date Account Title Debit Credit
Dec.31, 2025 Rent Receivable P50,000
Rent Income P50,000
To accrue rent income.

CASE 3: ACCRUAL OF EXPENSE – INTEREST EXPENSE

RVM Co. issued a 12%, P100,000, one-year, note payable on October 1, 2025. The principal and interest are
due on October 1, 2026.

CONCEPTS:
a. Note Payable give rise to interest expense.
b. Interest Expense is incurred due to the passage of time.

ANALYSIS:
As of Dec. 31, 2025 (end of accounting period), interest expense is incurred because there is already a
passage of time (Oct.1-Dec.31, 2025), although interest will only be paid in the next accounting period (Oct.1,
2026)

CONCLUSION:
Interest Expense shall be accrued for the 3 months covering Oct.1-Dec.31, 2025.
The Interest Expense is accrued as follows:

Formula:

i=Prt

 Principal (P) = P100,000 face amount

 Rate (r) = 12%
 Time (t) = expired time of 3 months (Oct.1 to Dec. 31, 2025) over 12 months in the year
 Interest = (100,000 x 12% x 3/12) = 3,000

ADJUSTING JOURNAL ENTRY:

Date Account Titles Debit Credit

Dec. 31, 2024 Interest Expense P3,000
Interest Payable P3,000
To accrue interest expense incurred but not yet paid.

CASE 4: ACCRUAL OF EXPENSE UTILITIES EXPENSE

The cost of electricity used for the month of Dec. 31, 2025 is P4,000. The electricity bill was received and paid
in Jan. 2026.

CONCEPT:
Expense is recognized when incurred (used) rather than when paid- accrual basis of accounting

CONCLUSION:
Utilities expense shall be accrued in Dec. 2025.

ADJUSTING JOURNAL ENTRY:

Date Account Title Debit Credit
Dec. 31, 2025 Utilities Expense P4,000
Utilities Payable P4,000
To accrue unpaid liabilities.

CASE 5: ACCRUAL OF EXPENSE: SALARIES EXPENSE

Employee earned total salaries of P100,000 in Dec. 2025. However, the salaries were paid only in Jan. 2026.

ADJUSTING JOURNAL ENTRY:

Date Account Title Debit Credit
Dec. 31, 2025 Salaries Expense P100,000
Salaries Payable P100,000
To accrue salaries expense.
RECOGNITION OF DEPRECIATION EXPENSE

THE CONCEPT OF SYSTEMATIC AND RATIONAL ALLOCATION

Under the concept of systematic and rational allocation, costs that provide economic benefit over several
accounting periods but cannot be directly associated with earning of revenues are recognized as expense over
the periods where the economic benefits are consumed.

The future economic benefit embodied in an asset is the potential to contribute, directly or indirectly flow of
cash and cash equivalents to the entity. ([Link]

ADJUSTING ENTRIES – DEPRECIATION

DEPRECIATION EXPENSE

On Jan.1, 2026, a business acquired equipment for P20,000. The business expects to use the equipment over
the next 4 years.

Ja.1, 2026 entry made:

Date Account Titles Debit Credit
Jan. 1, 2026 Equipment P20,000
Cash P20,000
To record the acquired equipment.

In accounting., depreciation means the allocation of the cost of a depreciable asset over the periods the asset
is used.

Depreciation Expense refers to the gradual reduction in the recorded value of a fixed asset on the balance
sheet from “wear and tear” with time.

The annual depreciation expense is computed as follows:

Depreciation Method: Straight Line Depreciation

Cost P20,000
Divide by: Useful life 4
Annual depreciation expense P 5,000

ADJUSTING JOURNAL ENTRY:

Date Account Titles Debit Credit
Dec. 31, 2026 Depreciation Expense P5,000
Accumulated Depreciation P5,000
To record the depreciation expense for the period.

The carrying amount of the equipment as of Dec. 31, 2025 is determined as follows:
Equipment: P20,000
Accumulated Depreciation (5,000)
Carrying Amount P15,000

RECOGNITION OF BAD DEBT EXPENSE

ADJUSTING ENTRIES – BAD DEBTS EXPENSE

A business has a total accounts receivable of P2,000 on Dec. 31, 2026 before any adjustments. Of the total
amount, it was estimated that P500 is doubtful of collection.
ADJUSTING JOURNAL ENTRY:
Date Account Titles Debit Credit
Dec. 31, 2026 Bad Debt Expense P500
Allowance for Bad Debts P500
To record the bad debts expense for the period.

After recording the adjusting entry, the carrying amount of the receivable is brought equal to the estimated
collectible amount of P1,500.
Accounts Receivable P2,000
Allowance for bad debts (500)
Account Receivable-net P1,500

THE CONCEPT OF IMMEDIATE RECOGNITION

Under the concept of immediate recognition, a cost that produces no future economic benefits or an asset that
ceases to provide future economic benefits is recognized immediately as an expense.

TYPES OF ACCOUNTS IN ACCOUNTING

1. Real Accounts (Permanent Accounts)

Accounts that are not closed at the end of the accounting period. These are extended to the next
accounting period. Real Accounts include all Balance Sheet accounts except the “Owner’s Drawing
Account”.

2. Nominal Accounts (Temporary Accounts)

Accounts that are closed at the end of the accounting period.
Nominal accounts include all income statement accounts, drawing accounts, clearing accounts and
suspense accounts

a. Clearing Accounts
Account used temporarily to store amounts that will eventually be transferred to another account.
An example is the “Income Summary” account which stores amounts of income & expenses during
the period. Balance of “Income Summary” account represents the profit or loss during the period.
The “Income Summary” is closed to Owner’s Capital account.

b. Suspense Account
Account used temporarily to store discrepancies in the accounts pending their analysis and
permanent classification.
Example is the “Cash shortage or overage” account which is temporarily used to record cash
shortages and overages pending their investigation.

3. Mixed Accounts
Accounts that have both real and nominal account components. These accounts are subject to
ADJUSTMENTS.
Mixed Accounts include PREPAYMENTS (Prepaid Assets) and DEFERALS (Unearned Income) that
have both expired and unexpired components.
 The expired portion is the nominal account component while the unexpired portion is the real
account components.
 At the end of the period, adjusting entries are needed to separate these components because
the nominal account component is presented in the income statement while the real account
component is presented in the balance sheet.
METHODS OF RECORDING OF INCOME AND EXPENSE

INCOME

Advance collection of income is initially recorded using either the liability method or income method.

1. Liability Method
Under this method, advanced collections of income are initially credited to liability account. At the end of
the period, the earned portion is recognized as income and the unearned portion remains as liability.

2. Income Method
Under this method, advanced collections of income are initially credited to income account. At the end
of the period, the unearned portion is recognized as liability, while the earned portion remains as
income.

LIABILITY METHOD VS. INCOME METHOD

A business rents out a building to various tenants. On April 1, 2025, the business receives one-year rent in
advance of P120,000 from one of its tenants. Rent per month is P10,000.

ENTRY MADE FOR THE RECEIPT OF ADVANCE RENT

LIABILITY METHOD INCOME METHOD
April 1, 2025 DEBIT CREDIT April 1, 2025 DEBIT CREDIT
Cash P120,000 Cash P120,000
Unearned Rent Income P120,000 Rent Income P120,000
To record the receipt of 1-year rent in advance. To record the receipt of 1-year rent in
advance.

ADJUSTING ENTRIES:
LIABILITY METHOD INCOME METHOD
Dec.31, 2025 Dec. 31, 2025
Unearned Rent Income P90,000 Rent Income P30,000
Rent Income P90,000 Unearned Rent Income P30,000
To recognize the earned rent income received. To recognize the unearned rent income received.

ADJUSTED ACCOUNTS:
LIABILITY METHOD INCOME METHOD
Cash Cash
Unearned Rent Income Rent Income
Rent Income Unearned Rent Income

EXPENSES

Prepayments of expenses are initially recorded using either asset method or expense method.

1. Asset Method
Under this method, prepayments of expenses are initially debited to an asset account. At the end of the
period, the incurred portion (used up or expired) is recognized as expense, while the unused portion
remains as asset.

2. Expense Method
 Under this method, prepayments of expense are initially debited to an expense account. At the end of
the period, the unused portion (not yet incurred or unexpired) is recognized as asset, while the incurred
portion remains as expense.

ASSET METHOD VS. EXPENSE METHOD

JOHN Laundry Services paid one-year office rent in advance for P120,000 on October 1, 2025.

ENTRY MADE FOR THE PREPAYMENT RENT

ASSET METHOD EXPENSE METHOD
Oct. 1, 2025 DEBIT CREDIT Oct. 1, 2025 DEBIT CREDIT
Prepaid Rent P120,000 Rent Expense P120,000
Cash P120,000 Cash P120,000
To record the prepayment of 1-year rent. To record the prepayment of 1-year rent.

ADJUSTING ENTRIES:
ASSET METHOD EXPENSE METHOD
Dec.31, 2025 Dec. 31, 2025
Rent Expense P30,000 Prepaid Rent P90,000
Prepaid Rent P30,000 Rent expense P90,000
To recognize the expire portion of the insurance. To record the unexpired portion of the
insurance.

ADJUSTED ACCOUNTS:
ASSET METHOD EXPENSE METHOD
Prepaid Rent Rent Expense
Rent Expense Prepaid Rent
Cash Cash

REFERENCE:
FINANCIAL ACCOUNTING AND REPORTING
(fundamentals)
2023 Edition
By: Zeus Vernon B. Millan

INSTRUCTOR: RPAMBID