ADJUSTING ENTRIES- Prepaid expenses & Unearned Income

PREPAID EXPENSES
a. ASSET METHOD
-when an asset account is debited at the time the payment is made.

Upon payment Upon adjustment (should be)

Debit Credit Debit Credit
Asset xx Expense xx
Cash xx Asset xx

b. EXPENSE METHOD
- when an expense account is debited at the time the payment is made.

Upon Upon adjustment (should be)

payment
Debit Credit Debit Credit
Expense xx Asset xx
Cash xx Expense xx

Sample Problem 1:

On December 1, the business paid rent for three months in advance amounting
to P 6,000. December 31 is the end of the accounting period. This means that
the monthly rent is P 2,000 so that the composition of the total amount is as
follows

Rent paid forthree months- P 6,000

(December 1 to February 28)
=P 6,000/3
=P 2,000 per month

Used Rent(December1-31) Unused Rent (January and February)

1 month only= P
2,000 2 months= P2,000*2=4,000
P
EXPENSE (Nominal) ASSET (REAL )

If AssetMethod was used,

Upon payment -December 1 Upon adjustment (should be)- December 31

Debit Credit Debit Credit
Prepaid Rent 6,000 Rent Expense 2,000
Cash 6,000 Prepaid Rent 2,000

To check if the adjustment is correct,

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 Prepaid Rent

Dec. 1 6,000Dec. 31 2,000 Adjusting Journal Rent Expense

entry Dec. 31 AJE 2,000
 2,000
 4,000

If Expense Method was used,

Upon payment -December 1 Upon adjustment (should be)- December 31
Debit Credit Debit Credit
Rent Expense 6,000 Prepaid Rent 4,000
Cash 6,000 Rent Expense 4,000

To check if the adjustment is correct,

Rent Expense

Dec. 1 6,000 Dec. 31 4,000 Adjusting Journa

l Prepaid Rent
entry Dec. 31 AJE 4,000
 4,000
 2,000

Sample Problem 2:
The following item appears on the unadjusted trial balance on Dec 31:

Debit Credit
Supplies Expense 500
Requirement: Prepare the adjusting entry if the unused supplies on December 31 per
physical count total P 200.

Analysis:

a. The expense method must have been used because the expense account appears on the
unadjusted trial balance. (BEFORE ADJUSTMENT)
Upon payment
Debit Credit Dec. 31 Unadjusted 500
Supplies Expense 500
500
Cash 500
Supplies Expense

b. Composition of should be amounts

Unused supplies (December 31) : P 200
Supplies expense= 500-200 Unused supplies= P 300

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 EXPENSE (Supplies expense)
Before Ajustment Supplies expense P 500 Dr
Should be Amount of Income, Dec 31 300 Dr
Difference: The amount for adjusting entry 200 Cr

ASSET (Supplies unused)

Before Ajustment Unearned rent income 0
Should be Amount of Income, Dec 31 200 Dr
Difference: The amount for adjusting entry 200 Dr

Upon adjustment
(Adjusting journal entry)
Debit Credit
Supplies 200
200
Supplies
Expense
Sup
plies
Supplies Expens
e
Dec. 31 AJE 200 Dec. 31 Unadj 500 Dec. 31 AJE 200
 200
 300

UNEARNED INCOME
a. INCOME METHOD
-when the cash is received, it is credited to “Income or Revenue” account.

Upon COLLECTION Upon ADJUSTMENT (should be)

Debit Credit Debit Credit
Cash xx Income xx
Income xx Liability xx

b. LIABILITY METHOD
- when the cash is received, it is credited to “Unearned Revenue”, a liability
account.

Upon COLLECTION Upon ADJUSTMENT (should be)

Debit Credit Debit Credit
Cash xx Liability xx
Liability xx Income xx

Sample Problem 1:

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 On December 1, a 60-day note for P30,000 was received from a customer
together with the total interest for sixty days of P 300. December 31 was the
end of the accounting period. Therefore, as of that date, the interest for
twenty days (December 11- 31) represents the currently earned income while
the interest for the remaining forty days (Term of note at 60 days less 20 days
for the earned income period) is the unearned income.

Interest Income on Note

= Prt = 30,000 x 6% x 60/360
=P300

Earned Interest Income Unearned Interest Income

 P300 x 20/60= P 100  P300 x 40/60= P 200
INCOME (Nominal account) LIABILITY (Real account)

If Income Method was used,

Upon collection -December 11 Upon adjustment (should be)- December 31
Debit Credit Debit Credit
Cash 300 Interest income 200
Interest income 300 Unearned interest income 200

To check if the adjustment is correct,

Interest income Unearned interest income

Dec. 31 AJE 200

Dec. 31 AJE  200

200 Dec. 11 300

 100

If Liability Method was used,

Upon collection -December 1 Upon adjustment (should be)- December 31
Debit Credit Debit Credit
Cash 300 Unearned interest income 100
Unearned interest income 300 Interest income 100

To check if the adjustment is correct,

Unearned interest income

Dec.31 AJE 100 Dec. 11 300

 200

Interest income

Dec. 31 AJE

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 100

 100

Sample Problem 2: The following item appears on the unadjusted trial balance on
December 31:
Debit Credit
Rent income 9,000
Requirement: Prepare the adjusting entry if the rentals were received on
December 1 for three months in advance.

Analysis:
a. The income method must have been used because the income account appears on the
unadjusted trial balance. (BEFORE ADJUSTMENT)
Upon collection
Rent Debit Credit income Dec. 31 Unadj. 9,000
Cash 9,000
9,000
Rent income 9,000

b. On December 31, the composition of the total amount received of P9,000 is as follows:

Total amount collected/ received in advance: P9,000 (from Dec to February)

Income per month: 9,000/3 months= P 3,000
Income portion: Rental for the Month of December = P 3,000
Liability portion: Rentals for the month of January and February (2 x P 3,000)= P 6,000

INCOME(Rent income)
Before Ajustment Rent Income P 9,000 Cr
Should be Amount of Income, Dec 31 3,000 Cr
Difference: The amount for adjusting entry 6,000 Dr

LIABILITY (Unearned rent income)

Before Ajustment Unearned rent income 0
Should be Amount of Income, Dec 31 6,000 Cr
Difference: The amount for adjusting entry 6,000 Cr

Upon adjustment (AJE)

Debit Credit
Rent income 6,000
Unearned rent income 6,000

After posting the adjusting entry:

Rent income
AJE 6,000 Dec. 31 Unadj. 9,000

 3,000
Unearned Rent income

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 Dec. 31 0

AJE 6,000
 6,000

……..Next Accruals, Depreciation and Doubtful Accounts

Reference:

Fundamentals of Accounting I by Acop Josephine, et al. 2010 edition

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