Adjusting entries

Adjusting- this is the process of gathering and putting together various data necessary to update
the balances of certain accounts in the books of the company. Adjustments based on compiled
data are then recorded before the financial statements are prepared.

Adjusting Entries- are entries made prior to the preparation of financial statements to update
certain accounts so that they reflect correct balances as of the designated time.

Importance

 These adjustments are necessary so that income and expenses will be reported in the
period they are earned and incurred, respectively; hence, profit will not be misstated.

Accruals or Non-Cash Basis Accounting

 In accounting, the term ‘”accrual” (or to accrue) means to recognize an:

o Income that is already earned but not yet collected; or
o Expense that is already incurred but not yet paid

Accrued Expense

 this is an expense incurred but not yet paid as of the statement of financial position
(balance sheet) date, such as interest accrued on notes payable. Another example is
accrued salaries of employees. An accrued expense is unpaid as of the statement of
financial position date but is matched against income or earnings for the current period.

Adjustment for accrued expense is recorded as follows:

Expense xxx
Payable xxx

Examples:

Problem 1- The ABC Company has an outstanding 90-day, 12% note payable dated December 1,
2020 amounting to P100, 000. The interest is payable upon maturity of the note. The company`s
accounting period or financial year is the calendar year.

Note: Interest for thirty days has accrued on the note as of December 31, 2020 (that is Dec 1 to
Dec 31)

Adjusting Entry:
Interest Expense 1, 000
Interest Payable 1, 000
P100, 000 x 12% x 30/360 = P1, 000

Problem 2- ABC Company pays salaries every Friday, the end of a five-day work week. The
total salaries for the week ending January 3, 2020 are P50, 000.
Note: In this case, the P100, 000 salaries for the week ending January 13, 2020 is for the services
rendered by employees on December 30, December 31, January 1, January 2, and January 3.
Therefore, the company has accrued salaries for two (2) days as of December 31, 2020.

Adjusting Entry:
Salaries Expense 20, 000
Salaries Payable 20, 000
P50, 000 x 2/5 = P20, 000

Accrued Income
 This is income earned but not yet received or collected as of the statement of financial
position (balance sheet) date, such as accrued interest on notes receivable. An accrued
income is not yet collected but is matched with expenses for the current period.

Adjustment for accrued income is recorded as follows:

Receivable xxx
Income xxx

Examples:

Problem 1- ABC Company received a 3-month, 12% note dated December 1, 2020 amounting of
P100, 000. Interest is receivable upon maturity of the note.

Note: As of December 31, 2020, interest for one month (from December 1 to December 31) is
already earned but not yet collected.

Adjusting Entry:

Interest Receivable 1, 000

Interest Income 1, 000
P100, 000 x 12% x 1/12 = P1, 000

Deferrals or Cash- Basis Accounting

 In accounting, the term ‘”deferral” (or to deferred) means to postpone an:
o Income recognition of an advance collection. The advance collection is treated as
liability until earned; or
o Expense recognition of a prepayment. The prepayment is treated as asset until
incurred.

Prepaid Expense
 This is an expense paid or acquired in advance such as insurance premium. Other
examples are rent paid in advance and office supplies purchased. The adjustment relating
to prepaid expense at the end of the accounting period depends on the method used in
recording the initial payment or acquisition.

There are two (2) methods of recording prepayments

1. Asset Method- the payment or purchase is initially debited to an asset account. At the
end of the accounting period, the expired or used portion of the asset is transferred to an
expense account.
 To record the initial payment of expense (Journalizing)
Prepaid Expense xxx
Cash xxx
To record adjustment at the end of the accounting period (Adjusting)
Expense xxx
Prepaid Expense xxx
Note: Amount recorded is the expired or used portion of the prepayment

2. Expense Method- the payment or purchase is initially debited to an expense account. At

the end of the accounting period, the unexpired or unused portion of asset is transferred to
an asset account.

To record the initial payment of expense (Journalizing)

Expense xxx
Cash xxx
To record adjustment at the end of the accounting period (Adjusting)
Prepaid Expense xxx
Expense xxx
Note: Amount recorded is the unexpired or unused portion of the prepayment

Example:

Problem1- On May 1, 2020, ABC Company paid insurance premium of P12, 000 covering a
period of one year beginning on this date.

ASSET METHOD
Date (2020)
Journalizing
May 1 Prepaid Insurance 12, 000
Cash 12, 000

Adjusting
Dec. 31 Insurance Expense 8, 000
Prepaid Insurance 8, 000
P12, 000 x 8/12 = P8, 000

Note: The expired portion of the insurance premium is for the period May 1 to December 31,
2020, or a period of eight (8) months.

EXPENSE METHOD
Date (2020)
Journalizing
May 1 Insurance Expense 12, 000
Cash 12, 000

Adjusting
Dec. 31 Prepaid Insurance 4, 000
Insurance Expense 4, 000
P12, 000 x 4/12 = P4, 000
Note: The unexpired portion of the insurance premium is 4 months; that is, 12 months less the
expired portion of eight (8) months.

Unearned Income
 This is income already collected but not yet rendered as of the statement of financial
position (balance sheet) date, such as rental income collected in advance or subscriptions
received in advance. Unearned income is also known as deferred income. Like prepaid
expense, the adjustment for unearned income at the end of the accounting period depends
on how the initial receipt of cash is recorded.

There are two (2) methods of recording unearned income

1. Liability Method- the collection is initially credited to a liability account; at the end of
the accounting period, the earned portion of the income is transferred to an income
account.

To record the initial payment of expense (Journalizing)

Cash xxx
Unearned income xxx
To record adjustment at the end of the accounting period (Adjusting)
Unearned income xxx
Income xxx
Note: Amount recorded is the earned portion of the prepayment

2. Income Method- the collection is initially credited to an income account; at the end of
the accounting period, the unearned portion of the income is transferred to a liability
account

To record the initial payment of expense (Journalizing)

Cash xxx
Income xxx
To record adjustment at the end of the accounting period (Adjusting)
Income xxx
Unearned Income xxx
Note: Amount recorded is the unearned potion of the prepayment

Example:

Problem 1- On September 1, 2020, ABC Company received P120, 000 representing rental of an
office space for one year beginning on this date.

LIABILITY METHOD
Date (2020)
Journalizing
Sept. 1 Cash 120, 000
Unearned Rent 120, 000

Adjusting
Dec. 31 Unearned Rent 40, 000
Rent Income 40, 000
 P120, 000 x 4/12 = P40, 000

Note: The earned portion is the rent for the period September 1 to December 31 or four (4)
months

INCOME METHOD
Date (2020)
Journalizing
Sept. 1 Cash 120, 000
Rent Income 120, 000

Adjusting
Dec. 31 Rent Income 80, 000
Unearned Rent 80, 000
P120, 000 x 8/12 = P80, 000

Note: The unearned portion is the rent for eight (8) months; that is, twelve (12) months less the
earned portion of four (4) months.

Depreciation and Allowance for Uncollectible Accounts

Depreciation of property, plant, and equipment and other cost allocation

 Depreciation is defined as the systematic allocation of the depreciable amount of an item
of property, plant and equipment over its useful life. Depreciable amount is the cost of
an asset, or other amounts substituted for cost, less its residual value.

Adjustment for depreciation is recorded as follows:

Depreciation Expense xxx

Accumulated Depreciation xxx

Note: The Accumulated Depreciation is a contra asset account; it is reported in the statement of
financial position as a deduction from the related property, plant and equipment account.

The depreciation expense for the period is determined using any of the acceptable method like
straight-line method, diminishing balance method, and units of production method. Straight-line
method is the commonly used by the other business.

Straight-line method formula:

Depreciation expense/ year = Cost – Residual Value

Estimated useful life
If the asset is used for less than a year, the proportionate expense should be calculated, unless
the company adopts a different policy such as providing half-year depreciation in the year of
acquisition of the asset

Example:

Problem 1- ABC Company acquired office equipment on July 1, 2020 for P220, 000. The asset
has an estimated useful life of 4 years and an estimated residual value of P20, 000.
Adjusting Entry

Date

2020
Dec. 31 Depreciation Expense 25, 000
Accumulated Depreciation 25, 000
(P220, 000- P20, 000)/4 x 6/12 = P25, 000

Note: Depreciation expense for 2020 is for 6 months; that is, July 1 to December 31, 2020

2021
Dec. 31 Depreciation Expense 50, 000
Accumulated Depreciation 50, 000
(P220, 000- P20, 000)/4 = P50, 000

Note: Depreciation expense for 2021 is for one year or twelve (12) months.

Uncollectible Accounts
 These represent customers` accounts that may no longer be collected or that may
possibly become bad debts. According to PAS No.39 trade accounts receivable should
be reported in the statement of financial position at amortized cost. Amortized cost is
defined as the amount at which the receivable is measured at the time it was first
recognized minus any payments and minus any reduction for uncollectible.

Adjustment for Uncollectible Account is recorded as follows:

Uncollectible Accounts Expense xxx

Allowance for Uncollectible Accounts xxx

Note: The account “Allowance for Uncollectible Accounts” is a contra asset account; it is
reported on the statement of financial position as a deduction from Accounts Receivable.

PAS No. 39 requires a careful assessment of the collectability of the receivables. Several
considerations have to be taken into account, which will be discussed thoroughly in higher
accounting subject.

The amount of uncollectible accounts expense that will be reported in the income statement is
computed as follows:

Required allowance balance P xxx

Allowance balance before adjustment
(+ debit balance or – credit balance) xxx
Uncollectible accounts expense for the period P xxx

Example:

Problem 1- ABC Company`s trial balance dated December 31, 2020, contains the following
information:
 Accounts Receivable P 150, 000 debit
Allowance for uncollectible accounts 3, 000 credit
Sales P 1, 000, 000 credit

Estimated uncollectible accounts amounted to P 5, 000

Adjusting Entry

Uncollectible Accounts Expense 2, 000

Allowance for Uncollectible Accounts 2, 000

Required allowance balance P 5,000

Allowance balance before adjustment - credit 3,000
Uncollectible accounts expense for the period P 2, 000

Inventories (Periodic Inventory System)

Inventory
 Adjustment for inventory is necessary if the periodic inventory system is used. Under
the periodic inventory system, the company does not record the physical movement of
goods. Purchases of goods are recorded in the nominal account “Purchases”. The
reduction in inventory resulting from sale is not reflected in the books. Thus, the balance
of the inventory at the beginning of the period.

Two methods in recording adjustment related to inventories.

a. First method
o Two entries are prepared: (1) to transfer the beginning inventory balance to the
Income Summary account and (2) to establish ending inventory balance

Adjusting Entries

1. To transfer beginning inventory balance to Income Summary

Income Summary xxx
Inventory (Merchandising Inventory) xxx

2. To record ending inventory balance

Inventory (Merchandising Inventory) xxx
Income Summary xxx

b. Second method
o Under the second approach, a separate cost of goods sold account is set up and the
entry to record the adjustment is as follows:

Adjusting Entry
Inventory (or Merchandising Inventory), end xxx
Purchase Returns and Allowances xxx
Purchases Discount xxx
 Cost of Goods Sold xxx
Inventory (or Merchandising Inventory), beg xxx
Purchases xxx
Freight-In xxx

Note: The balance of the Cost of Goods Sold account is closed to Income
Summary as part of the nominal closing entries

Example:

Problem 1- ABC Company purchase of merchandise inventory on account amounted to P300,

000 in December 1, 2020. In December 31, 2020 a count of merchandise inventory amounted to
P270, 000.

Date (2020)
Journalizing
Dec. 1 Inventory (Merchandising Inventory) 300, 000
Accounts Payable 300, 000
Adjusting

Dec. 31 Income Summary 300, 000

Inventory (Merchandising Inventory) beg 300, 000

Inventory (Merchandising Inventory) end 270, 000

Income Summary 270, 000

Problem 2- ABC Company provided the following account balances on December 31, 2020

Purchases P100, 000

Purchase Returns and Allowances 20, 000
Purchases Discount 10, 000
Inventory (or Merchandising Inventory), beg 50, 000

Freight-In 10, 000

In December 31, 2020 a count of merchandise inventory amounted to P80, 000.

Adjusting
Dec. 31 Inventory (or Merchandising Inventory), end 80, 000
Purchase Returns and Allowances 20, 000
Purchases Discount 10, 000
Cost of Goods Sold 50, 000
Inventory (or Merchandising Inventory), beg 50, 000
Purchases 100, 000
Freight-In 10, 000

P100, 000 + P50, 000 + P10, 000 – P80, 000 –P 20, 000 – P10, 000 = P50, 000