ACC10

Adjusting Accounts & Preparing FS Discussion and Illustrations

C. Gomez Adjusting Entries

Types of Adjusting Entries

1. Prepaid expenses
a. Asset method
b. Expense method
2. Depreciation
3. Unearned revenue
a. Liability method
b. Revenue method
4. Accrued income
5. Accrued expenses

Prepaid Expenses
 Certain expenses are paid for in advance and are to be consumed/incurred for two or more periods.
 Examples: Insurance, rent, supplies, etc.

Asset method
Proforma entries:
1. On the date of acquisition:

2. On the date adjustment is made:

Expense method
Proforma entries:
1. On the date of acquisition:

2. On the date adjustment is made:

Illustration
Barney Company, a retailer of designer suits for men, decided to rent out the whole 8th floor of Ted Building for its office space. They
signed the contract on April 1, 2010. The agreement provided a monthly rental of P25,000 for 18 months beginning May 1, on which
they paid Ted Building Inc. rent equal to one (1) year. Barney Company’s year-end is on December 31. Prepare the adjusting entries at
year-end.

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 ACC10
Adjusting Accounts & Preparing FS Discussion and Illustrations
C. Gomez Adjusting Entries

1. Asset method
a. Date of purchase

b. Year-end (adjusting entry)

c. T-account

2. Expense method
a. Date of purchase

b. Year-end (adjusting entry)

c. T-account

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 ACC10
Adjusting Accounts & Preparing FS Discussion and Illustrations
C. Gomez Adjusting Entries

Depreciation
 Fixed assets or property, plant, and equipment are assets of the company which are subject to wear and tear due
to consistent physical use.
 Categories of fixed assets include: Office Equipment, Furniture and Fixtures, etc.
 Depreciation, although an expense, never involves cash outlay.
 It is simply the manner the company allocates the cost of an asset over the periods in which the
company expects to use it.
 Recording depreciation is part of the company’s adjusting entries because it is usually prepared at the end of the
period

Key terms to remember

Cost
Accumulated depreciation
Book value
Useful life
Salvage or Scrap value
Depreciable cost
Straight line depreciation
Depreciation expense
Historical cost; the value of the fixed asset in the books of the company equal to the
purchase price or fair market value of the same on the date of acquisition
 Amount of depreciation recorded by the company in relation to a given asset
through its useful life; as the life of the asset progresses, it is depreciated period
after period, and such depreciation is then accumulated in this account.
 A contra-asset account; it is classified together with the fixed assets as
presented on the balance sheet, but it is a reduction from or a negative
amount to the cost of the fixed asset it relates to.
Cost less accumulated depreciation
The period, which may be over a year, in which the company expects the fixed asset
to be beneficial to it
Amount which the company expects to receive when it sells its fixed asset at the end
of its useful life.
Cost less salvage value
Simplest of the many different methods of depreciation; FORMULA: depreciable
cost ÷ useful life
Depreciation as computed using the method chosen by the company

Depreciation of Land
Land, although obviously a fixed asset, is never subject to depreciation. The reason for this is highly logical. Even though
land is used continuously, it can never be said that it suffers wear and tear from its continued use.

Illustration
Barney Company has three fixed asset categories in its books: tailoring equipment and office equipment. Tailoring equipment were
purchased in cash on May 1, 2010, while office equipment were purchased on account on June 15. Following are the pertinent
information on the fixed assets:

Tailoring equipment Office equipment

Cost/Fair market value P75,000 P 45,000
Salvage value P6,000 Zero
Useful life 4 years 3 years

Prepare the adjusting entries to record depreciation at the end of the period.

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 ACC10
Adjusting Accounts & Preparing FS Discussion and Illustrations
C. Gomez Adjusting Entries

1. 2010
a. Date of acquisition

b. Year-end (adjusting entry)

Alternatively, you can make a compound entry to record depreciation expense:

c. T-account

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Adjusting Accounts & Preparing FS Discussion and Illustrations
C. Gomez Adjusting Entries

2. 2011
a. Year-end (Adjusting entry)

Alternatively (compound entry):

b. T-account

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 ACC10
Adjusting Accounts & Preparing FS Discussion and Illustrations
C. Gomez Adjusting Entries

Unearned Revenue
 Under accrual accounting, revenue is recognized when it is earned, whether or not cash is in fact received in
exchange of the sale or service rendered.
 When a company renders a service in advance and the customer pays on a fixed date in the future, “Accounts
receivable” increases (debit) as a result of the recording of revenue (credit).
 However, when a company receives cash (debit) in advance, obligating them to render the service some fixed
date in the future, it is, of course, improper to record the revenue. Instead, a liability arises (credit). This liability
is now what we call “Unearned revenue”.

Liability method
Proforma entries:
1. On the date cash is received from the customer:

2. Year-end (adjusting entry)

Revenue method
1. On the date cash is received from the customer:

2. Year-end (adjusting entry)

Illustration
On October 15, 2010, Barney Company was contracted by a wedding planner to do the suits of the groom, groomsmen, and the
secondary sponsors for Marshall and Lily’s wedding that will be held on February 14, 2011. A total of seven (7) suits were ordered,
priced at P10,000 each. On October 31, Marshall and Lily paid Barney the whole amount of the order. However, at year-end, Barney
had only delivered five (5) suits. The two (2) remaining suits will be delivered on January 2, 2011.

1. Liability method
a. On the date cash was received from Marshall and Lily

b. Year-end (adjusting entry)

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 ACC10
Adjusting Accounts & Preparing FS Discussion and Illustrations
C. Gomez Adjusting Entries

c. T-account

2. Revenue method
a. On the date cash was received from Marshall and Lily

b. Year-end (adjusting entry)

c. T-account

Accruals
 Accrual is a term to denote that a transaction is recorded absent the involvement of cash.
 Accrued income is therefore income already earned, but cash will be received at a later date.
 Accrued expense, on the other hand, is expense already incurred, but will be paid for later on.

Accrued income
 Ordinary revenues, or those which arise from the ordinary revenue-generating activities of a company, are
recognized in the books when the revenue is earned. We do not set up an account named “Accrued revenue”
when we are dealing with ordinary revenues. We record them simply as “Sales” or “Service revenue” so long as
they have been earned.
 Revenues derived from activities not ordinary to the business, usually interest income from investments and
receivables, are recorded using “Accrued (interest) income” when it is earned regardless of receipt of cash.
 When we record accrued income, we set up a receivable (since we are anticipating to collect cash) and the
accrued income itself (since we recognize revenue/income as we earn it).

Proforma entry

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Adjusting Accounts & Preparing FS Discussion and Illustrations
C. Gomez Adjusting Entries

Illustration
On November 3, 2010, Barney sold a suit priced at P12,000 and received a promissory note in return. The promissory amounted to the
selling price of the suits, bore a 10% interest per annum, and was due on November 2, 2011. Prepare the adjusting entry to record
accrued interest income.

1. On the date the note was recorded

2. Year-end (adjusting entry)

Solution Guide:

Accrued expenses
 Expenses are recorded in the books when they are incurred, whether or not they have actually been paid for.
 When recording accrued expenses, we recognize the expense (debit) we are accruing and then we set up a
liability (credit), since we are expecting to pay for the expense at some future date.

Proforma entry

Illustration
On September 30, 2010, Barney bought textiles from Robin Fabrics. For that purchase, Barney issued a promissory note in favor of
Robin. The promissory note, payable on September 30, 2011, amounted to P24,000 with 10% interest.

In addition, at year end, Barney Company has yet to receive its MERALCO billing statement for the month of December. For the past
year, they have consistently had a monthly electricity consumption amounting to P20,000.

Prepare the adjusting entries to record the accrued expenses.

1. Accrued interest expense

a. On the date the promissory note was issued

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Adjusting Accounts & Preparing FS Discussion and Illustrations
C. Gomez Adjusting Entries

b. Year-end (adjusting entry)

Solution Guide:

2. Accrued utilities expense

Adjusting entry:

The Adjusted Trial Balance

This is the trial balance of Barney Company as of December 31, 2010 before any adjusting entry was made:

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 ACC10
Adjusting Accounts & Preparing FS Discussion and Illustrations
C. Gomez Adjusting Entries

REQUIRED: Prepare the ADJUSTED TRIAL BALANCE based on the adjusting entries prepared for Barney Company. Use
the asset method for recording prepayments and the liability method for recording unearned income.

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