ADJUSTING ENTRIES

Adjusting entries are made in order for: 1 Revenues to be recorded in the period in which they are earned, and for...... 2 Expenses to be recognized in the period in which they are incurred.
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ADJUSTING ENTRIES
Adjusting entries are required each time financial statements are prepared. Adjusting entries can be classified as 1 prepayments (prepaid expenses or unearned revenues) or 2 accruals (accrued revenues or accrued expenses)

TYPES OF ADJUSTING ENTRIES

Prepayments 1 Prepaid Expenses - expenses paid in cash and recorded as assets before they are used or

consumed
2 Unearned Revenues - revenues received in cash and recorded as liabilities before they are earned

TYPES OF ADJUSTING ENTRIES

Accruals 1 Accrued Revenues - revenues earned but not yet received in cash or recorded 2 Accrued Expenses - expenses incurred but not yet paid in cash or recorded

ILLUSTRATION 3-3

TRIAL

BALANCE
PIONEER ADVERTISING AGENCY, INC. Trial Balance October 31, 20XX
Cash Advertising Supplies Prepaid Insurance Office Equipment Notes Payable Accounts Payable Unearned Revenue Clark, capital Clark, drawing Service Revenue Salaries Expense Rent Expense Debit P 15,200 2,500 600 5,000 Credit

The Trial Balance is the starting place for adjusting entries.

P 5,000 2,500 1,200 10,000 500 10,000 4,000 900 P 28,700 P 28,700

PREPAYMENTS
Prepayments are either prepaid expenses or unearned revenues. Adjusting entries for prepayments are required to record the portion of the prepayment that represents 1 the expense incurred or 2 the revenue earned in the current accounting period.

ILLUSTRATION 3-4
ENTRIES FOR PREPAYMENTS

ADJUSTING

Adjusting Entries Prepaid Expenses

Asset Unadjusted Credit Balance Adjusting Entry (-) Expense Debit Adjusting Entry (+)

Unearned Revenues
Liability Debit Adjusting Entry (-) Unadjusted Balance Revenue Credit Adjusting Entry (+)

PREPAID EXPENSES
Prepaid expenses are expenses paid in cash and recorded as assets before they are used or consumed. Prepaid expenses expire with the passage of time or through use and consumption. An asset-expense account relationship exists with prepaid expenses.

PREPAID EXPENSES
Prior to adjustment, assets are overstated and expenses are understated. The adjusting entry results in a debit to an expense account and a credit to an asset account. Examples of prepaid expenses include supplies, insurance, and depreciation.

ADJUSTING ENTRIES FOR PREPAYMENTS

SUPPLIES
Adjustment
October 31, an inventory count reveals that P1,000 of P2,500 of supplies are still on hand.

Journal Entry

Date Oct. 31

Account Titles and Explanation Advertising Supplies Expense Advertising Supplies To record supplies used

Debit Credit 1,500 1,500

Posting

Advertising Supplies Oct. 5 2,500 Oct. 31 1,500 31 1,000

Advertising Supplies Expense Oct. 31 1,500

ADJUSTING ENTRIES FOR PREPAYMENTS

INSURANCE
Adjustment
October 31, an analysis of the policy reveals that P50 of insurance expires each month.

Journal Entry

Date Oct. 31

Account Titles and Explanation Insurance Expense Prepaid Insurance To record insurance expired

Debit 50

Credit 50

Posting

Pr t. 4

ai I 6

ra t.

I t.

ra

DEPRECIATION
Depreciation is the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner.

DEPRECIATION
Depreciation is an estimate rather than a factual measurement of the cost that has expired. In recording depreciation, Depreciation Expense is debited and a contra asset account, Accumulated Depreciation, is credited
Depreciation Expense
Accumulat D r ciatio

xxx

xxx

DEPRECIATION
In the balance sheet, Accumulated Depreciation is offset against the asset account. The difference between the cost of the asset and its related accumulated depreciation is referred to as the carrying value of the asset.

ADJUSTING ENTRIES FOR PREPAYMENTS

DEPRECIATION
Adjustment
October 31, depreciation on the office equipment is estimated to be P480 a year, or P40 per month.

Journal Entry

Date Oct. 31

Account Titles and Explanation Depreciation Expense Accumulated Depreciation - Office Equipment To record monthly depreciation

Debit Credit 40 40

Posting

Accum ulated Depreciation Office Equipm ent Oct. 31 40

D ct.

r ciatio 4

UNEARNED REVENUES
Unearned revenues are revenues received in cash and recorded as liabilities before they are earned. Unearned revenues are subsequently earned by rendering a service to a customer. A liability-revenue account relationship exists with unearned revenues.

UNEARNED REVENUES
Prior to adjustment, liabilities are overstated and revenues are understated. The adjusting entry results in a debit to a liability account and a credit to a revenue account. Examples of unearned revenues include rent, magazine subscriptions, and customer deposits for future services.

ADJUSTING ENTRIES FOR PREPAYMENTS

UNEARNED REVENUES
Adjustment
October 31, analysis reveals that, of P1,200 in fees, P400 has been earned in October.

Journal Entry

Date Oct. 31

Account Titles and Explanation Unearned Revenue Service Revenue To record revenue for services provided

Debit 400

Credit 400

Posting

Oct. 31

Unearned Revenue 400 Oct. 2 31

1,200 800

Service Revenue Oct. 31 31

10,000 400

ACCRUALS
The second category of adjusting entries is accruals. Adjusting entries for accruals are required to record revenues earned and expenses incurred in the current period. The adjusting entry for accruals will increase both a statement of financial position and an income statement account.

ILLUSTRATION 3-10
ENTRIES FOR ACCRUALS

ADJUSTING

Adjusting Entries Accrued Revenues

Asset Debit Adjusting Entry (+) Revenue Credit Adjusting Entry (+)

Accrued Expenses
Expense Debit Adjusting Entry (+) Liability Credit Adjusting Entry (+)

ACCRUED REVENUES
Accrued revenues may accumulate with the passing of time or through services performed but not billed or collected. An asset-revenue account relationship exists with accrued revenues. Prior to adjustment, assets and revenues are understated. The adjusting entry requires a debit to an asset account and a credit to a revenue account.

ADJUSTING ENTRIES FOR ACCRUALS ACCRUED

REVENUES
Adjustment
October 31, the agency earned P200 in fees for advertising services that were not billed to clients before October 31.

Journal Entry

Date Oct. 31

Account Titles and Explanation Accounts Receivable Service Revenue (To accrue fees earned but not billed or collected)

Debit 200

Credit 200

Posting

Acc unts Receiv ble Oct. 31 200

Service Revenue Oct. 31 31 31 31

10,000 400 200 10,600

ACCRUED EXPENSES
Accrued expenses are expenses incurred but not yet paid or recorded. A liability-expense account relationship exists Prior to adjustment, liabilities and expenses are understated The adjusting entry results in a debit to an expense account and a credit to a liability account

ADJUSTING ENTRIES FOR ACCRUALS ACCRUED

INTEREST
Adjustment
October 31, the portion of the interest to be accrued on a 3-month note payable is calculated to be P50.

Journal Entry

Dat ct.

Account Titl and lanation Int r t nse Interest Paya le (To accrue interest on notes aya le)

it Cr dit 50 50

Posting

Oct.

Interest 50

ense

I t r

tP t.

ADJUSTING ENTRIES FOR ACCRUALS ACCRUED

SALARIES
Adjustment
October 31, accrued salaries are calculated to be P1,200.

Journal Entry

Date Oct.

Account Titles and lanation alaries ense alaries Payable (To record accrued salaries)

Debit Credit 1, 00 1, 00

Posting

2 31 31

es Expense 000 1 200 5 200

es c

be 31

1 200

ILLUSTRATION 3-16 OF ADJUSTING ENTRIES

T pe of A d ju st e n t A ccount R e la tio n s ip

SUMMARY

A c c o u n ts b e fo r e A d ju st e n t

A d ju stin E n tr

1 Prepaid expenses 2 Unearned revenues 3 Accrued revenues 4 Accrued expenses

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Assets and expenses Liabilities and revenues Assets and revenues Expenses and liabilities

Assets overstated Expenses understated Liabilities overstated Revenues understated Assets understated Revenues understated Expenses understated Liabilities understated

Dr. Expenses Cr. Assets Dr. Liabilities Cr. Revenues Dr. Assets Cr. Revenues Dr. Expenses Cr. Liabilities

ADJUSTED TRIAL BALANCE

An Adjusted Trial Balance is prepared after all adjusting entries have been journalized and posted. It shows the balances of all accounts at the end of the accounting period and the effects of all financial events that have occurred during the period. It proves the equality of the total debit and credit balances in the ledger after all adjustments have been made. Financial statements can be prepared directly from the adjusted trial balance.

ILLUSTRATION 3-19
TRIAL BALANCE AND ADJUSTED TRIAL BALANCE COMPARED
PIONEER ADVERTISING AGENCY, INC. Trial Balances October 31, 20XX
Before Adjustment Debit Credit P 15,200 2,500 600 5,000 P 5,000 2,500 1,200 10,000 500 10,000 4,000 5,200 1,500 900 50 50 40 P 30,190 After Adjustment Debit Credit P 15,200 200 1,000 550 5,000 P 40 5,000 2,500 50 800 1,200 10,000 500 10,600

Cash Accounts Receivable Advertising Supplies Prepaid Insurance Office Equipment Accumulated Depreciation - Office Equipment Notes Payable Accounts Payable Interest Payable Unearned Revenue Salaries Payable Clark, capital Clark, drawing Service Revenue Salaries Expense Advertising Supplies Expense Rent Expense Insurance Expense Interest Expense Depreciation Expense

900

P 28,700

P 28,700

P 30,190

Appendix:Alternative Treatment
Some businesses use an alternative treatment for prepaids and unearned revenues. Instead of debiting an asset at the time an expense is prepaid, the amount is charged to an expense account. Instead of crediting a liability at the time cash is received in advance of earning it, the amount is credited to a revenue account. This treatment of prepaid expenses and unearned revenues will ultimately result in the same effect on the financial statements as initial entries to balance sheet accounts and then adjusting entries.

ALTERNATIVE ADJUSTMENTS FOR PREPAYMENTS

SUPPLIES
Adjustment
October 31, an inventory count reveals that P1,000 of $2,500 of supplies are still on hand.

Journal Entry

Date Account Titles and Explanation Oct. 31 Advertising Supplies Advertising Supplies Expense To record supplies inventory
Advertising Supplies Oct. 31 1,000

Debit Credit 1,000 1,000

Posting

Adve rtising S upplie s E x pe nse Oc t. 5 2 ,5 0 0 Oc t. 3 1 1 ,0 0 0 31 1 ,5 0 0

ALTERNATIVE ADJUSTMENTS FOR PREPAYMENTS

UNEARNED REVENUES
Adjustment
October 31, analysis reveals that, of P1,200 in revenue, P400 has been earned in October.

Journal Entry

Date Oct. 31

Account Titles and Explanation Service Revenue Unearned Revenue To record unearned revenue

Debit 800

Credit 800

Posting

Unearned Revenue Oct. 31

800

Oct. 31

Service Revenue 800 Oct. 2 31

1,200 400

ILLUSTRATION 3A-7
RELATIONSHIPS FOR PREPAYMENTS

SUMMARY OF BASIC

Type of Adjust ent

Account Relationship

Reason for Adjust ent

Account alances before Adjust ent

Adjustin Entry
Dr Expenses

1 Prepaid Expenses

Assets and Expenses

2 Unearned Revenues

Liabilities and Revenues

a Prepaid expenses Assets overstated initially recorded in Expenses understated asset accounts have been used. b Prepaid expenses Assets understated initially recorded in Expenses overstated expense accounts have not been used. a Unearned revenues Liabilities overstated initially recorded in Revenues understated liability accounts have been earned. b Unearned revenues Liabilities understated initially recorded in Revenues understated revenue accounts have not been earned.

Cr Assets

Dr Assets

Cr Expenses

Dr Liabilities Cr Revenues

Dr Revenues Cr Liabilities