EIJ.d-ofthe- Period Adiu.

stm ents

CHA PTE R 7

END -OF -TH E PERI.O D

AD JUS TM ENT S - . ·
4th Ste p of-t he Accounting Pro ces s)

Learning Objectives:

After studying this chapter, we should be able to:

1. know and underst and the purpose and types of adjusting entries;
2. learn the recording of acquisition and sale of property and equipm ent;
3. learn and underst and the me_thods of inventory valuation .

INTRODUCTION

but to
This topic becomes the drawba ck not only to beginners of accoun ting course
in this
students in the higher accounting subjects as well. Our adequate knowle dge
ting, to
particular topic is needed in order to strengthen our founda tion in basic accoun
job
enhance our prepara tion for the next accounting subjects, for a future bookke eping
titive
opportunities after finishing this course or our prepara tion to take the compe
licensur~ examin ation for Certifie d Public Accountants.

Before we tackle down this topic, it is suggested that we should take a 'Jlashb
ack" of
the followin g topics which we already have discussed:

1. the accounting period

2. the normal bal~nces of accounts
3. the real and nominal accounts

235
.kC{lhgJapgJt~err._7l_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _______

· • h rein at the end of each p .

Th e hfe of the business is divided into equal periods w e . d·· . . enod
f ed to as Peno 1c1ty Conce t
we prepare financial statements This is what we re err . . P er
· h untmg period 15 ·
better known as Time-Period Assumption. The end of t e acco . Often
• •
te rme d b y accountants or accounting pract1t1oner s as cut-off period or cut-off d
. ate
which means the "segregation of all elements or occoun~s belon,g mg to a particuta,
period only". In an accounting period ·of one month for example, th e. las~ date of the
month is the cut-off period. For the month of March, the cut-off pe~iod is ~arch 31,
For this reason, adjusting entries are often called end of th e period adJustments
because adjustments can be done at the end of the month, quarter or end of the Year
which is also called year-end adjustments. ·

ADJUSTING ENTRIES

Adjusting Entries are journal entries which are to be recorded in the General Journal and
are usually prepared at the end of an accounHng period of one year following the
preparation of a Trial Balance.

Purpose of Adjusting Entries

It is our primary objective to present a correct fina.ncial statements which are truly "test-
meters" of the financial condition of the business as of a _particular date and the results
of operation at the end of the accounting period.

Generally, adjusting-entries are prepared for the following reasons:

a) to bring records or balances of accounts updated

b} to properly match revenues against expenses during the period

TYPES OF ADJUSTING ENTRIES

The following are the usual items which require adjusting entries at the end of an
accounting period:

1. Accruals

a. Accrued lncom~ . - · rendered but rot, 'f..t collcc.W

b. Accrued Expenses - tenderer{ u " rt pqid_
2. Deferrals

a) Pre-collection of Income
b) Prepay·ment of Expenses

236
End-o f-the-period Ad ius tments

3. Provision for Depreciation of Property and Equipment or Fixed Asset

4. Provision for Estimated Uncollectible Accounts (Bad Debts)
5. Adjustment on Inventories - this is typical in merchandising and
manufacturing concern.
6. Correction of Erroneous Journ~I Entries

·x
ACCRUALS

(ACCRUED INCOME AND ACCRUED EXPENSE ADJUSTMENTS)

In accounting, the term / 4crua/" means to recognize revenue or income earned

regardless of when it is collected and to record expense incurred whether paid or not.

~ued Income - it is an income that is already earned but not yet collected when the
accounting period ends. The purpose of the adjusting entry is to record the income
ea~ and recognize the corresponding asset account (receivable).

/.ccrued Expense' - it is an expense that is ~Iready incurred but not yet p ~

• accounting ~eriod ends. The purpose of the adjusting entry is to record the expenses
incurred and recognize the corresponding liability account (payable).

To illustrate:

A building owned by Metro Davao Hotel was partly rented by Allied Banking Corporation
th
for PS0,000 per month payable every 5 day of the following month., The rental for the
month of December 20A will be paid on January 5, 20B.

Analysis:

20A and 20B are two different and separate accounting periods. On the part of Metro
Davao Hotel, the revenue was already earned in 20A but collection will be. received in
208. On the part of Allied Banking Corporation, the rental expense was already incurred.
in 20A but payment will be made in 20B. ,.. '
(_

Metro Davao Hotel should record the income earned although not yet received by
debiting Accrued Rent Income and crediting Rental Income. On the other hand, Allied
Bankir\o ,F.orporation s,hould record the expense incurred although not yet paid by the
t 1
1
• '•\tP'1 I \ 1:\ : ' :"'I
debiting Rent \Expense
•,G \O.' t:, 1,1
and ' t redid~g Accrued Re~n E enst: ~FJ [ e;.em~er 31►:,20~ for
~1 '

both. · -

Accrued Rent Income has semblance of a receivable account or it can b~ substituted by

Rent Receivable while Accrued Rent Expense has a semblance of a payable' account or
,,'f, " f't\ .1 ~ ,.
can also be substituted by Rent Payaole. · , ' '
237
Cha ter 7

Metro Davao Hotel records Accrued Rent Income which is a Receivable account and
Allied Banking Corporation records Accrued Rent Expense which is a Payable account.

If both companies' record income and expenses in 20B, both violates the "matching
principle" as this principle calls for the recognition of income received and expense paid
in the period of 20A.

The following were the respective adjusting entries by both companies.

20A Book of Metro Davao Hotel Book of Allied Banking Corp.

Dec. 31 Accrued Rent Receivable PS0,000 Dec. 31 Rent Expense PS0,000

Rent Income PS0,000 Accrued Rent Expense PS0,000
To record rent income that • To record rent expense that
was earned. was incurred.

EFFECTS OF ERROR/OMISSION ON FINANCIAL STATEMENTS

Failure to record Accrued Rent Income or Failure

, to record Rent Expense will
Rent Receivable will understate assets in understate total expenses in the Income ~

the Balance Sheet. Failure to record Rent
Income will understate total income in the
Income Statement and as a consequence,
profit will be understated. Understated
profit will understate Owner's Equity.
Statement. Failure to record Accrued Rent
Expense or Rent Payable will understate the
liability in the Balance Sheet and as a
consequence, profit will be overstated.
Overstated profit · will overstate Owner's
Equi~y.

FINANCIAL STATEMENTS PRESENTATION

Accrued Rent Receivable is a Current Asset account and it is to be presented in the

Balance Sheet while Rent lncom'e is an Income account and it is to be presented in the
Income Statement.
~
--
Rent Expense is an Expense account and it is to be presented in the Income Statement
while Accrued Rent Expense is a Current Liability account which is to be presented in
the Balance Sheet.
 DEFERRAL

(PRE-COLLECTED INCOME AND PR PAID EXPENSE ADJUSTIVl~NTS)

PRECOLLECTION OF INCOME

Pre-collected Income - this is an income that is already collected but not yet earned.
This is exactly the opposite of accrued income. Ther~ are two methods or approaches
that can be used in recording pre-collections, namely:

1.l~come Method - an income account is credited upon collection or receipt of cash .

This method is also called ",nominal approach" because an income is an Income
Statement account and Income Statement accounts are also called nominal
accounts.

2.Liability Method - a Liability qccouat is creditef!. upon collection or receipt of cash.

This method is also called "real approach" because a liability is a·Balance Sheet
account and Balance Sh~et accounts are also called real accounts.

To illustrate:

On October 1, 20A, Cordillera Realty Co. collected Pl2,000 from a tenant representing
an advance co11ection from building rental for one year. The accounting period ends on
December 31, 20A.

The above transaction is recqrded in a comparative journal entry showing both the
Income and Liability methods of recording pre-collections:

COMPARATIVE JOURNAL ENTRIES

Income Method Liability Method

Upon Cash P12,000 Cash Pl2,000

Receipt Rent Income Pl2,000 Unearned Rent Income Pl2,000
of Cash To record collection of To record collection of
On advance rental for the advance rental for the period
Oct. 1, period from Oct. 1, 20A to from Oct. 1, 20A to Oct. 1,
20A. Oct. 1, 20B. 20B.
c;-
"

Analysis:

Under ln,:ome Method, Rent Income Ac~ount has been credited upon receipt of
collection on Oct. 1, 20A which means charging to Income the whole amount of P12,000
while under Liability Method, Unearned Rental Income account has been credited
which m~ans charging to liability the whole amount of Pl2,000. This is what will happen
if the adjusting entry is not prepared.
r- I l '239
Cha te r 7

Regardless of which metho.d i~ ~jsed in recording pre~co~l~ction, the Pl2,0~

0 ~ecomes a
"mixed account" or a mixtur e of both income and J1ab1hty eleme nts at the
.end.o f the
. • l -< I ' • I • ~
period broken down as follows :
JI I

Income or Earned portion is compu ted as follows:

\
P12,000 = Pl,000 x 3 month s = P 3,000
12 mos. '
(Oct. 1, 20A to Dec. 31, 20A)

liabilit y or Unearned portion is computed as follows:

P12,000 = Pl,000 . x 9 month s = P 9,000

12 mos.
(Jan . 1, 208 to Oct. 1, 208}

-
Total pre-collection

The adjusting entry that should be prepared on Dec. 31, 20A will "split-
P12.00 0

up" the nominal

(earned) from real (unearned) accounts. The Liability or Real eleme nt
of P9,000 present
in the Rent Income account must be removed theref rom (by debitin g)
so that 20A will
show a correct amount of Rent Income, P3,000 and records the P9,000
(by crediting) as
Unear ned Rent Income which is a Liability account. -Thus, ·

Adjusting Entry

20A
Dec. 31 Rent Income P9,000
Unearned Rent Income P9,000
To record the unearned portio n
(liability) of rent'al _
collected in advance.

Under the Liability Metho d, the adjusting entry that should be prepar
ed on Dec. 31,
20A will "split-up" the real (unearned) from nominal (earned) accoun t s.
The Income
earned portion or nominal eleme nt of P3,000 present in the Unear
ned Rent Income
account must be removed theref rom (by debitin g) so that 20A will
show a correct
amoun t of Unearned Rent Income, P9,000 and records the P3,000
(by crediting) as
Rer,t !n~ome which is an Income account. Thus, .

~ djus):ing Entry

20A ·
Dec. 31 Unearned Rent Income P3,000
Rent Income P3,000
To record the earned portion
(inc,ome) of rental collected in advance.
240 ,,
E nd-of-t he-peri od Adiusl ments

ty Methods are shown

The comparative adjusting entries under both Income and Liabili
below:

COMPARATIVE ADJUSTING JOURNAL ENTRIES

Adjust ing INCOM E METHO D LIABILITY METH OD
Entry .Rent Income P9,000 Unearned Rent Income .- P 3,000
on Unear ned Rent Income ' P9,000 Rent Income · P3,000
Dec. 31, To record the unearned To record the earned portio n
20A portion (liability) of rental (income) of rental collected
collected in advance. in advance.

are shown below before

The respective general ledger accounts under both metho ds
tive balances:
and after the adjusting entries are being posted with their respec

UNDER INCOME METHOD UNDER LIABILITY METHOD

Before Adjustment Before Adjustment

Rent Income Unearned Rent Income

IP12,000 Oct. I
(Original
·I P12,0 00 Oct. 1
. (Original
Entry) Entry)

After Adjustment After Adjustment ·

Rent Income Unearned. Rent Income

Dec. 31 P 9,000 P12,000 Oct. 1 Dec.31 P3,000 P12,000 Oct. 1

(Original AJE (Original
AJE
Entry) Entry)

P 3 000 P 9.000

Unearned Rent Income Rent Incom e

Ip 9,000 P3.000 Dec. 31

AJE

the Income and Liability

Take note that after the adjustments have been made, both
of P12,000.
Methods showed the breakdown of rental collected in advance

241
!,,C:f!hapgmtmer~
• 7{___ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __

Rent Income P 3,000

Unearned Rent Income 9,000
Total Pre-collection P12.000

EFFECTS OF ERROR/OMISSION ON FINANCIAL STATEMENTS

Under Income Method Under Liability Method -

If adjusting entry is not prepared on
December 31, 20A, the whole amount of
Pl2,000 will be charged to Income when in
fact P9,000 is unearned portion or Liability.
Since the liability portion could not be
recorded without the said adjusting entry,
Income is overstated because the profit that
is closed to Owner's Equity is overstated.
Therefore:
Income Statemen t- Profit is overstated.
Balance Sheet - Liability is understated and
Owner's Equity is overstated.
-
If adjusting entry is not prepared on
December 31, 20A, the whole amount of
P12,000 will be charged to Liability when in
fact, P3,000 is earned portion or Income.
Since the income portion could not be
recorded without the said adjusting entry,
Liability is overstated because the Profit that
is closed to Owner's Equity is understated.
Therefore:
Income Statement - Profit is understated .
Balance Sheet - Liability is overstated and
Owner's Equity is understated.

Financial Statements Presentation

Unearned Rent Income, being a real account will be presented as a current liability in
the liability section of the Balance Sheet, while Rent Income being a nominal account
will be presented together with other income accounts in the income section of the
Income Statement.

· Guide in Preparing Adjusting Journal Entries on Pre-collection

1. If an Income account is credited upon receipt of cash (Income Method), the adjusting
.entry · must recognize the Liability Account. Therefore, you go for the opposite:
"credit the Liability and debit the Income".

2. U a Li~bility account is credited upon receipt of cash (Liability Method), the adjusting
enyry fn_u·st recognize the Income Account. Therefore, you go for the opposite:
"credit t _he Income and debit the Liability".

PREPAYMENT OF EXPENSES

Prepaid Expense -this is an expense that is already paid but not incurred. This is exactly
the opposite of accrued expense. There are two methods or approache s that can be
used in recording prepayments, namely:

242
 -OJ..: :[-t~h~e-__,P_,,e:.:n=
&1--:f!.d~ =--=-..,
. . :·od s=
A=d=iu= t m'-"'ee.L n!c.!:.:ts ~--------- --___:__ _ _ _ _ __:___ _ __

th0
f Expense Me d ; u nd er this method or approach, an expense account is debited
O th
upon pa~:nent e prepaid expense. This method is also called "nominal
approach because an expense is an Income Statemen t accounts and Income
Statemen t accounts are also called nominal accounts.

· expense.
asset account·1s deb"1ted upon payment of the prepaid
_ Method. - an
2· Asset
This me th0 d is also called "real approach" because an asset is a Balance Sheet
account and Balance Sheet accounts are als.o called real accounts.

To illustrate:

On Septembe r 1, 20A, Rajah !luayan Commercial paid an insurance premium covering

the period from Se~tembe r 1, 20A to Septembe r 1, 20B in the amount of P3,6QO. The
accounting period ends on Decemb~r 31, 20A.

The transactio n is recorded in a comparati ve journal entry showing both the Expense
and Asset methods of recording prepayme nts:

COMPARATIVE JOURNAL ENTRIES

Upon EXPENSE METHOD ASSET METHOD
Payment Insurance Expense P3,600 Prepaid Insurance P 3,600
on Cash - P3,600 Cash P3,600
Sept. 1, To record insurance To record insurance
20A. premium paid. premium paid.

Analysis:

Under Expense Method, Insurance Expense account has been debited upon payment on
Sept. 1, 20A which means charging to expense the whole amount of P3,600 while under
Asset Method, Prepaid Insurance account has been debited which means charging to
asset the whole amount of P3,600. This is what will happen if the adjusting entry is not
prepared.

Regardless of which method is used in recording prepayme nt, the P3,600 becomes a
"mixed account" or a mixture of both expense and asset elements at the end of the
Period broken down as follows:

243
 Cha ter 7

Expense or Expired portion compu ted as follows:

P3,600 = P300 X 4 months = Pl,200

12 mos.
(Sept. 1, 20A to Dec. 31, 20A}

Asset or Unex·pired portion compu ted as follows:

P3,600 = P300 x 8 months = P2,400
12 mos.
(Jan. 1, 208 to Sept. 1, 208}
Total prepay ment P3,600

The adjusting entry that should be prepared on Dec. 31, 20A will "split-
up" the nominal
from real accounts. The real or asset eleme nt present in the Insura nce
Expense account
must be removed therefr om so that 20A will show a correc t amoun
t of expense of
Pl,200 and record the P2,400 as Prepaid Insurance which is an Asset. Thus,

ADJUSTING ENTRY:
20A
Dec. 31 Prepaid Expense P2,400
Insurance Expense P2,400
To record the unexpired portion
of insurance premiu m from
Jan. 1, 208 to Sept. 1, 208.

Under the Asset Metho d, the adjusting entry that should be prepar ed
o'n Dec. 31, 20A
will "split-up" the real from nomjnal accounts. The nominal or expens
e eleme nt present
in the Prepaid Insurance account must be removed theref rom so that
20A will show a
correct account of asset of P2,400 and record the Pl,200 as Insura nce
Expen se which is
an Expense account. Thus,

ADJUSTING ENTRY:
20A
Dec.31 Insurance Expense Pl,200
Prepaid Insurance Pl,200
To record the expired portion of
insurance premiu m from Sept. 1, 20A
to Dec. 31, 20A.

The comparative adjusting entries under both Expense and Asset metho
ds are shown on
the next page:

244
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•th'.;!e::.·µ=
. J e=n=·
od= A=d=iu=
s =tn-=te=n=ts,___ _ _ _ _ _ _ _ _ _ _ _ _ __:_ _ _ _ _ __

-
COMPARATIVE ADJUSTING JOURNAL ENTRIES
Adjusting EXPENSE METHOD
ASSET METHOI;)
Entry Prepaid Insurance P2,400 Insurance Expense P 1,200
on Insurance Expense
I Dec. 31, To record unexpired (asset)
P2,400 Prepaid Insurance
To record the expired
Pl,200
I 20A. portion of insurance
(expense) portion of
premium
insurance premium.

The ·respective general ledger accounts under both methods are shown below before
and after the adjusting entries are being posted with their respective balances:

.UNDER EXPENSE METHOD UNDER ASSET METHOD

-
Before Adjustment Before Adjustment

Insurance Expense Prepaid Insurance

Sept. 1 P3,600 Sept. 1 P3,600

(Original (Original
Entry) Entry)

After Adjustment After Adjustment

Insurance Expense Prepaid Insurance

Sept. 1 P3,600 Dec. 31 P2,400 Sept. 1 P3,600 Dec. 31, Pl,200

(Original AJE (Original AJE

Entry) Entry)

Balance P2,400
Balance Pl.200

Insurance Expense

Pl.200
Dec. 1 P2.400
AJE

. t ents have been made, both the Expense method and

Take note that after the adJUS m . f
b kdown of insurance premium payment o P3,600.
Asset method showed the · rea

245
Chapter 7

Insurance Expense Pl,200

Prepaid Insurance 2,400
• Total Prepayment P3,600

EFFECTS OF ERROR/OMISSION ON FINANCIAL STATEMENTS

Under Expense Method Under Asset Method

If adjusting entry is not prepared on Dec. 31,
20A, the whole ambunt of P3,600 will be
charged to Expense when in fact, P2,400 is
the prepaid portion or Asset. Since the asset
portion could not be recorded without the
said adjusting entry, Expense is overstated
and ·Asset is understated. If expense is
overstated, then Profit is understated.
Owner's Equity is also understated because
the amount of Profit that is closed to
Owner's Equity is understated. Therefore: •
If adjusting entry is not prepared on Dec. 31,
20A, the whole amount of P3,600 will be
charged to Asset when in fact,Pl,200 is the
expired portion or Expense. Since the
expense portion could not be recorded
without the .said adjusting entry, Expense is
understated and Asset is overstated. If
Expense is understated, then Profit is
overstated. Owner's Equity is also overstated
because the amount of Profit that is closed to
Owner's Equity is overstated. Therefore:

Income Statement - Expense is overstated Income Statement - Expense is understated

and Profit is understated. and Profit is overstated.

Balance Sheet - Asset is understated and Balance Sheet - Asset is overstated and
Owner's Equity is also understated. Owner's Equity is also overstated.

FINANCIAL STATEMENTS PRESENTATION

Prepaid Insurance, being a real account will be presented as current asset in the asset
section of the Balance Sheet while the Insurance Expense, being a nominal account will
be presented together with other expense accounts in the Expense section of the
Income Statement.

Guide in Preparing Adjusting Journal Entries on Prepayments

1. If an Expense account is debited upon payment (Expense Method), the

adjusting entry must recognize the Asset Account. Therefore, you go for
the opposite: "credit the Expense and debit the Asset".

2. If an Asset account is debited upon payment (Asset Method), the adjusting

entry must recognize the Expense Account. Ther~fore, you go for the
opposite: "credit the Asset and debit the Expense".

246