Step 4 in the Accounting Cycle: The Adjustments

Nature of the Adjusting Process The Adjusting Process

 The accounting period concept requires that  Under the accrual basis, some of the accounts
revenues and expenses be reported in the need updating at the end of the accounting
proper period. period for the following reasons:

Recognition concepts or principles - Some expenses are not recorded daily.

 Revenue recognition concept
- The accounting concept supporting the
reporting of revenues when they are earned
regardless of when cash is received is called
the
 Expense recognition concept
- The accounting concept supporting the
reporting of expenses when they are
incurred regardless of when cash is paid is
called the.
- Some revenues and expenses are incurred
as time passes rather than as separate
transactions.
- Some revenues and expenses may be
unrecorded.
 The analysis and updating of accounts at the
end of the period before the financial
statements are prepared is called the adjusting
process.
 The journal entries that bring the accounts up
to date at the end of the accounting period are
called adjusting entries.

 Matching concept/principle

- The accounting concept supporting

reporting revenues and related expenses in
the same period is called the

Accounting bases of recording

 Cash basis

- revenues and expenses are reported on the

income statement in the period in which
cash is received or paid.

- Tax purposes

 Accrual basis

- revenues are reported on the income

statement in the period in which they are
earned.

- PAS (Philippine Accounting Standards)

 Types of Adjustments
DEFERRALS

Prepaid expenses - are the advance payment of future expenses and are recorded as assets when cash is paid.

Ex.
Prepaid rent
Prepaid insurance
Supplies
Unearned revenues - are the advance receipt of future revenues and are recorded as liabilities when cash is received.

Ex.
Unearned rent
Unearned fees
Unearned services
ACCRUALS

Accrued revenues - are unrecorded revenues that have been earned and for which cash has yet to be received.

Ex.
Accounts receivable
Interest Receivable
Rent Receivable
Fees Receivable
Accrued expenses - are unrecorded expenses that have been incurred and for which cash has not yet been paid.

Ex.
Interest Payable
Salaries Payable
Utilities Payable
Rent Payable
DEPRECIATION

Fixed assets, or plant assets, (Property, plant and equipment) - are physical resources that are owned and used by a
business and are permanent or have a long life.
As time passes, a fixed asset loses its ability to provide useful services. This decrease in usefulness is called depreciation

Depreciation Expense

 All fixed assets, except land, lose their usefulness and , thus, are said to depreciate.
 As a fixed asset depreciates, a portion of its cost should be recorded as an expense.
 This periodic expense is called depreciation expense.
 The fixed asset account is not decreased (credited) when making the related adjusting entry. This is because
both the original cost of a fixed asset and the depreciation recorded since its purchase are reported on the
balance sheet.
 Instead, an account entitled Accumulated Depreciation is increased (credited).
 Accumulated depreciation accounts are called contra accounts, or contra asset accounts.
PROVISION FOR UNCOLLECTIBLE

Uncollectible Receivables

 Regardless of how careful a company is in granting credit, some credit sales will be uncollectible.
 The operating expense recorded from uncollectible receivables is called:
- bad debt expense,
- uncollectible accounts expense, or
- doubtful accounts expense.

 Some indications that an account may be uncollectible include the following:

- The receivable is past due.
- The customer does not respond to the company’s attempts to collect.
- The customer files for bankruptcy.
- The customer closes its business.
- The company cannot locate the customer.

direct write-off method - accounting for uncollectible receivables records bad debt expense only when an account is
determined to be worthless

allowance method - records bad debt expense by estimating uncollectible accounts at the end of the accounting period.
Estimating Uncollectibles

 The allowance method requires an estimate of uncollectible accounts at the end of the period.
 Methods used to estimate the amount debited to Bad Debt Expense.

- Percent of sales method

- Percentage of receivables
- Analysis of receivables method (Aging)

Summary of Adjustment Process

Adjusted Trial Balance

The purpose of the adjusted trial balance is to verify the equality of the total debit and credit balances before the
financial statements are prepared.