UNIVERSIDAD DE STA.

ISABEL
Elias Angeles St., Naga City

REVIEW ON BASIC ACCOUNTING

LESSON NO 3. ADJUSTING ENTRIES

REVENUE AND EXPENSE RECOGNITION PRINCIPLES

 Revenue Recognition Principle. Revenue should be recognized when earned.

Revenue is recognized when it is probable that economic benefits will flow to the
enterprise and these economic benefits can be measured reliably.

 Expense Recognition Principle. Expense should be recognized when incurred.

Expenses are recognized when it is probable that a future economic benefit

related to the decrease in an asset or an increase of a liability has arisen, and
that the decrease in economic benefits can be measured reliably.

TWO TYPES OF ADJUSTMENTS

Each adjusting entry affects a balance sheet account (or an asset or liability account)
and an income statement account (income or expense account). There are two general
types of adjustments: deferrals and accruals.

DEFERRALS
 It refers to the postponement of the recognition of an expense already paid but
not yet incurred, or of revenue already collected but not yet earned.
 This deals with an amount already recorded in a balance sheet account; the
entry in effect decreases the balance sheet account and increases an income
statement account.
 There are two cases of deferrals:
 Allocating assets to expense to reflect expenses incurred during the
accounting period (prepaid insurance, supplies and depreciation).
 Allocating revenues received in advance to revenue to reflect revenues
earned during the accounting period (subscriptions)

ACCRUALS
 It refers to the recognition of an expense already incurred but unpaid or revenue
earned but uncollected.
 This deals with an amount unrecorded in any account; the entry, in effect,
increases both a balance sheet account and an income statement account.
 There are two cases of accruals:
 Accruing expenses to reflect expenses incurred during an accounting
period that are unpaid and unrecorded.
  Accruing revenues to reflect revenues earned during the accounting
period that are uncollected and unrecorded.

ADJUSTMENTS FOR DEFERRALS

ALLOCATING ASSETS TO EXPENSE

 Entities often make expenditures that benefit more than one period.
 There expenditures are generally debited to an asset account and at the end of
each accounting period; the estimated amount that has expired during the period
is transferred from the assets account to an expense account.

1. Prepaid Expenses
 This refers to expenses paid in advance and are classified as an asset, not an
expense.
 At the end of an accounting period, a portion or all of these prepayments may
have expired.
 The portion that has expired becomes an expense, which may have expired
either with the passage of time of through use and consumption.

TWO METHODS FOR RECORDING PREPAID EXPENSES

Asset Method Expense Method

a. Upon Payment: a. Upon Payment:
Prepaid Account (Asset) xx Expense Account (Expense) xx
Cash xx Cash xx

b. Adjustment at the end of the Accounting b. Adjustment at the end of the Accounting
Period: Period:
Expense (expired portion) xx Prepaid Expense (unexpired portion) xx
Prepaid Account xx Prepaid Account xx

2. Depreciation of Property, Plant and Equipment

 When an organization acquired long-lived assets such as building, service
vehicles, com
 puters or office furniture, it is buying or prepaying for the usefulness of that asset.
 These assets help generate income for the entity. Therefore, a portion of the
cost of the assets should be reported as an expense in each accounting period.
 Proper accounting requires for the allocation of the cost of the asset over its
estimated useful life.
 The estimated amount allocated to any one accounting period is called
depreciation or depreciation expense.
 The three factors involved in computing depreciation expenses are as follows:

a. Asset cost is the amount an entity paid to acquire the depreciable asset.
 b. Estimated salvage value is the amount that the asset can probably be sold for
at the end of its estimated useful life.
c. Estimated useful life is the estimated number of periods that an entity can
make use of an asset.

 Formula for Determining the amount of depreciation expense:

Asset Cost XX
Less: Estimated Salvage Value XX
Depreciable Cost XX
Divided by: Estimated Useful Life XX
Depreciation Expense XX

 Journal Entry to record depreciation expense:

Depreciation Expense XX
Accumulated Depreciation XX

 When recording depreciation expense, the asset account is not directly reduced.
 Instead, the reduction in a contra account called Accumulated Depreciation.
 A contra account is used to record reductions in a related account and its normal balance
is the opposite that of the related account.

ALLOCATING REVENUES RECEIVED IN ADVANCE

 There are times when an entity receives cash for services or goods even before
service is rendered or goods are delivered.
 The liability is referred to is unearned revenue.
 There are two methods to record unearned revenues:

TWO METHODS FOR RECORDING UNEARNED REVENUES

Liability Method Income Method

a. Upon Receipt of Cash: a. Upon Receipt of Cash:
Cash xx Cash xx
Unearned Revenue xx Revenue xx

b. Adjustment at the end of the Accounting b. Adjustment at the end of the Accounting
Period: Period:
Unearned Revenue xx Revenue xx
Revenue(earned portion) xx Unearned Revenue (liability portion) xx
 ADJUSTMENTS FOR ACCRUALS

ACCRUED EXPENSES
 An entity often incurs expenses before paying them.
 If the accounting period ends on a date that does not coincide with the scheduled
cash payment date, an adjusting entry is needed to reflect the expense incurred
since the last payment

 Journal Entry to record accrued expense:

Expense account XX
Payable account XX

ACCRUED REVENUE
 An entity may provide services during the period that are neither paid for by client
nor billed at the end of the period.
 Any revenue that has been earned but not recorded during a period calls for an
adjusting entry that debits an asset account and credits an income account.
 Journal Entry to record accrued revenue:

Account Receivable XX
Revenue Account XX

ACCRUAL FOR UNCOLLECTIBLE ACCOUNTS

1. Entities often allow clients to purchase on credit.

2. Some of these accounts will never be collected, thus the need to reflect these as
charges against income.
3. Expense is recognized for the estimated uncollectible accounts in the current period.
4. Journal Entry to record estimated uncollectible accounts for receivables which is
doubtful of collection:

Uncollectible Accounts Expense XX

Allowance for Uncollectible Accounts XX

5. Journal Entry when it is considered uncollectible:

Allowance for Uncollectible Accounts XX

Accounts Receivable XX