Module 3: Adjusting Entries
Adjusting Entries
- journal entries that need to be prepared at the end of reporting
period in order to update the balance of some accounts.
- Effects if not Prepared:
▪ overstatement of assets = understatement of expenses
▪ overstatement of expenses = understatement of assets
▪ understatement of expenses = understatement of liabilities
▪ understatement of income/revenue=understatement of assets
▪ overstatement of liabilities=understatement of income/revenue
▪ overstatement of income/revenue=understatement of liabilities
- Includes the Following:
▪ Prepaid Expenses (still an asset)
✓ expenses already paid but not yet incurred, used or
utilized at the end of the reporting period
✓ also known as Deferred Expense
✓ portion of the assets like supplies and prepaid rent actually
used must be recognized as expense, while portion
unused must be shown as an asset
▪ Unearned Revenue (still a liability)
✓ revenue or income already received from the customers
but not yet earned
✓ also known as Deferred Revenue/Income or Pre-collected
Revenue/Income
✓ portion of cash received in advance is recognized as
income when earned while portion still unearned must be
reported as a liability
▪ Accrued Expenses (liability)
✓ expenses already incurred but not yet paid as of the
reporting date
✓ assets or services which have been already used or
consumed by the business entity during reporting period
but unpaid as of end of reporting period
✓ Accrual Principle: expenses incurred even though unpaid
must be recognized in the period of incurrence (being
unpaid a corresponding liability must also be recognized)
✓ GAAP requires the application of accrual basis rather than
cash basis
✓ Examples: accrued salaries expense, accrued interest
expense, accrued utility expense, etc.
▪ Accrued Income
✓ revenue or income already earned but not yet received or
collected
✓ income is earned when services are already rendered to
customer during reporting period but corresponding
payment for such services has not yet been received at
the end of reporting period
✓ GAAP requires the application of accrual basis rather than
cash basis
✓ Example: accrued interest income
▪ Depreciation
✓ process of allocating the cost depreciable tangible assets
used in business over its estimated useful life in years in
accordance with systematic and rational allocation
principle of accounting
✓ cost depreciable property, plant and equipment must be
periodically charged to expense through a systematic and
rational allocation method
✓ Depreciation Expense: periodic allocation
✓ Depreciation Method: straight-line method
✓ Annual Depreciation Expense = (Cost – Salvage Value) ÷
Estimated Useful Life in Years
✓ includes items on property, plant and equipment such as
building, equipment, furniture and fixtures, etc.
▪ Bad Debts/Doubtful Accounts
✓ amount of accounts receivable that becomes worthless or
estimated to be uncollectible
✓ also known as doubtful accounts, uncollectible accounts,
or impairment loss
✓ accounts receivable must be reported at amortized cost
(Net Realizable Value)
✓ Amortized Cost = Accounts Receivable Balance –
Allowance for Bad Debts
✓ Direct Write-off Method (Not GAAP)
debiting expense (bad debts) and crediting accounts
receivable
doubtful accounts expense is recognized when
specific accounts receivable have been ascertained
to be worthless (therefore removed)
method is not acceptable in financial accounting
though only acceptable method as far as Bureau of
Internal Revenue regulations is concerned
✓ Allowance Method (Estimates Only)
recognition of doubtful accounts expense is by way of
estimation
accounts receivable are not written-off or removed
from the books, instead, an allowance is set-up
against the accounts receivable
by setting allowance of doubtful accounts, signals
readers of financial statements that portion of
accounts receivable reporter may not be collected
estimation amount of doubtful accounts, surrounding
circumstances like past experiences, economic
condition, among others, must be considered
Percentage of Sales
Percentage of Accounts Receivable
o also known as balance sheet approach
o doubtful accounts expense is determined by
computing first required balance of allowance for
doubtful accounts to be reported in statement of
financial position
o required balance of allowance for doubtful
accounts is computed by multiplying pre-
determined rate to balance of accounts
receivable at the end of period
o doubtful accounts expense would now be
computed by getting difference between required
balance of allowance for doubtful accounts and
balance of allowance for doubtful accounts
before adjustment
Aging of Receivables
o doubtful accounts expense is computed with due
consideration of the age of receivable
o Age of Receivable: starts from moment it is
created, meaning, from the time contract of sale
is perfected that is generally when the goods are
delivered by seller to buyer
o does not necessarily follow once a receivable is
created, It is already due because the seller may
grant buyer certain period of time (usually days)
to make payment, or so-called credit terms
o only after lapse of credit term without receivable
being collected it is considered as past due
o longer time receivables remain uncollected or
outstanding, higher risk would not be collected
o more accurate & reliable compared to other two
- Asset Method (Prepaid Expense)
▪ transaction will be recorded as a debit to an asset account like
“Supplies”, or “Prepaid Rent and credit to “Cash” or “Accounts
Payable” as the case may be
▪ at the end of reporting period, an adjusting entry will be
prepared to recognize the used or expired portion of an asset
as an expense, thereby debiting an expense account and
crediting an asset account equal to the amount used or expired
▪ failure to do so: asset will be overstated and expense will be
understated
▪ Example: On October 1, 2019, Office Supplies amounting to
P80,000 were purchased for cash. At December 31, 2019, the
end of the reporting period, the amount of supplies used was
P30,000
ASSET METHOD
Date Particulars Debit Credit
Oct. 1 Of f ice Supplies 80,000
Cash 80,000
Dec. 31 Of f ice Supplies Expense 30,000
Of f ice Supplies 30,000
- Expense Method (Prepaid Expense)
▪ transaction will be recorded by debiting an expense account
and crediting “Cash” or “Accounts Payable” as case may be
▪ at the end of the reporting period, adjusting entry will be
prepared to recognize the unused or unexpired portion of the
previously recorded expense, thereby debiting an asset
account and crediting the expense account equal to the
amount of unused or unexpired
▪ failure to do so: expense will be overstated and asset will be
understated
▪ Example: On October 1, 2019, Office Supplies amounting to
P80,000 were purchased for cash. At December 31, 2019, the
end of the reporting period, the amount of supplies used was
P30,000.
EXPENSE METHOD
Date Particulars Debit Credit
Oct. 1 Of f ice Supplies Expense 80,000
Cash 80,000
Dec. 31 Of f ice Supplies 50,000
Of f ice Supplies Expense 50,000
- Liability Method (Unearned Revenue)
▪ receipt of advanced payment from the customer will be
credited to a liability account
▪ transaction will be debited to “Cash” and a credit to “Unearned
Revenue” account
▪ at the end of reporting period, adjusting entry will be prepared
to recognize the earned portion of an unearned revenue as an
income or revenue, thereby debiting an “unearned revenue”
account and crediting the “revenue”
▪ failure to do so: liability will be overstated and revenue will be
understated
▪ Example: On October 1, 2019, received P120,000 from
customer as advanced payment for rent of an office space for
12 months beginning October 1, 2019.
LIABILITY METHOD
Date Particulars Debit Credit
Oct. 1 Cash 120,000
Unearned Rent Income 120,000
Dec. 31 Unearned Rent Income 30,000
Rent Income 30,000
- Revenue/Income Method (Unearned Revenue)
▪ receipt of advanced payment from customer will be credited to
an income or revenue account
▪ transaction will be debited to “Cash” and a credit to “Revenue”
account
▪ at the end of reporting period, an adjusting entry will be
prepared to recognize the unearned portion of the previously
recorded revenue as a liability, thereby debiting an “revenue”
account and crediting “unearned revenue” account
▪ if failed to do so: revenue will be overstated and liability will be
understated
▪ Example: On October 1, 2019, received P120,000 from
customer as advanced payment for rent of an office space for
12 months beginning October 1, 2019.
REVENUE/INCOME METHOD
Date Particulars Debit Credit
Oct. 1 Cash 120,000
Rent Income 120,000
Dec. 31 Rent Income 90,000
Unearned Rent Income 90,000
- Example (Accrued Expenses): At the end of reporting period,
following items have been incurred during the year but not yet paid:
▪ Salaries of the employees, P100,000
▪ MERALCO bill, P24,000
▪ PLDT bill, P6,000
▪ Interest on loans with the Bank of PI, P12,000
ACCRUED EXPENSES
Date Particulars Debit Credit
(1) Salaries Expense 100,000
Salaries Payable 100,000
(2) Electricity Expense 24,000
Utilities Payable 24,000
(3) Telephone Expense 6,000
Utilities Payable 6,000
(4) Interest Expense 12,000
Interest Payable 12,000
- Example (Accrued Income): On August 1, 2019, RCBC Co.
received a one-year, 10%, P100,000 face value notes from
customer for services rendered.
ACCRUED INCOME
Date Particulars Debit Credit
Aug, 1 Notes Receivable 100,000
Service Income 100,000
Dec. 31 Interest Receivable 4,167
Interest Income 4,167
(100,000 x 10% x 5/12)
- Example (Depreciation Expense): On April 1, 2019, RCBC
Company acquired a brand new delivery truck with acquisition cash
price of P1,400,000. The truck has an estimated useful life of 10
years after which it can be sold for P200,000.
▪ Historical Cost = 1,400,000; Salvage Value = 200,000; Useful
Life = 10 years
▪ Annual Depreciation Expense = (1,400,000 – 200,000)/10
= 120,000 (Per Month = 10,000)
DEPRECIATION
Date Particulars Debit Credit
Apr 1 Delivery Truck 1.4M
Cash 1.4M
Dec.
Depreciation Expense 90,000
31
Accumulated Depreciation 90,000
(Nine Months)
- Example (Bad Debts, Asset Method): RR Company has the
following data before making adjustment for doubtful accounts at
December 31, 2020:
▪ Sales: 10,000,000
▪ Accounts Receivable: 2,000,000
▪ Allowance for Doubtful Accounts: 160,000
It Is estimated that 10% of the accounts receivable is uncollectible
Required Balance of Allowance for Doubtful Accounts:
P2,000,000 x 10% = P200,000
Doubtful Accounts Expense = Required Balance – Allowance for
Doubtful Accounts before adjustment
Doubtful Accounts Expense = P200,000 – 160,000 = P40,000
BAD DEBTS
Date Particulars Debit Credit
Doubtf ul Accounts Expense 40,000
Allowance f or Doubtful
40,000
Accounts
- Example (Bad Debts Expense, Aging of Receivables):
How much is the required allowance balance at December 31,
2020? Answer: 97,000
Module 4: Worksheet, Closing Entries, Post-closing Trial Balance and
Reversing Entries
Worksheet
- preparation at the end of reporting period starts after unadjusted
trial balance is prepared
- dated “for the period ended or for the year ended”
- a ten-column worksheet provides for the following columns:
1. Account Titles and Corresponding Account Code (must be
arranged in the following order: Assets; current then non-
current, Liabilities; current then non-current, Equity, Revenues,
and Expenses)
2. Unadjusted Trial Balance (Debit and Credit)
3. Adjustments (Debit and Credit)
4. Adjusted Trial Balance (Debit and Credit)
5. Income Statement (Debit and Credit)
6. Statement of Financial Position or Balance Sheet (Debit and
Credit)
Unadjusted Trial Balance
- copy account titles from trial balance and enter amount under debit
or credit of Unadjusted Trial Balance column
Adjustments
- enter necessary adjusting entries on appropriate debit or credit
columns
- get total of adjustments column (to check whether debit and credit
is equal)
Adjusted Trial Balance
- for accounts without adjustment, simply enter amounts from
unadjusted trial balance to adjusted trial balance
- add or deduct adjustments to/from unadjusted balance as case
may be
- adjustments on same side will be added, while different side will be
deducted
- account balance will be shown on greater side of account
- get total adjusted trial balance column (to ensure that the total debit
and credit remain equal after adjustments are made)
Income Statement and Balance Sheet
- from adjusted trial balance, enter amount to appropriate financial
statement column
- revenue and expenses are entered to income statement column
while asset, liability and equity accounts are entered under
statement of financial position column
- get total of all columns
- get difference of total debit and credit both in income statement and
in statement of financial position
- difference of total debit and credit in income statement must be
same as difference in statement of financial position
- however, if total credit in income statement is greater than total
debit, total debit in balance sheet is greater than total credit and
vice versa
- difference is the amount of profit or loss
- add difference to lower total amount, get total, debit should be
equal to credit
Closing Entries and Post-closing Trial Balance
- Closing Entries: are those journal entries needed to be prepared at
end of reporting period after financial statements are prepared, to
close balance of all nominal and temporary accounts
- to close account means to make its balance equal to zero (includes
closing the balance of revenue or income, expenses and drawing
accounts)
- account balances of these accounts will be closed to Income and
Expense Summary account or simple Income Summary account
and then Income Summary will be closed to drawing account and
finally from drawing account to capital account
- closing process is done by debiting accounts with credit balances
and crediting accounts with debit balances
- Proforma Closing Entries for Service Business
Post-closing Trial Balance
- trial balance prepared after books have been closed, to ensure that
debits are still equal to credits
- only real accounts will be seen in post-closing trial balance
- balances of these accounts will serve as beginning balances in next
accounting period
Reversing Entries
- journal entries prepared at beginning (dated as of first day) of
reporting period to reverse some adjusting entries prepared at end
of previous period
- step is only optional and dispensable
- only the following accounts may be reversed:
1. Accruals (accrued income and accrued expense)
2. Expense Method of Recording Prepayments
3. Income Method of Recording Unearned Revenue
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