CHAPTER 5

ADJUSTING THE ACCOUNTS

Accrual Basis

This means the accountant records revenues as they are earned as they are earned and expenses as
they are incurred. In cash basis accounting, however, the accountant does not record a transaction until
cash is received or paid. Generally, cash receipts are treated as revenues and cash payments as
expenses.

DEFERRALS AND APPROVALS

Accountants use adjusting entries to apply a accrual accounting to transactions that cover more than
one accounting period. They are two general types of adjustments made at the end of the accounting
period- deferrals and accruals. Each adjusting entry affects a balance sheet accounts (an asset or a
liability account) and an income statement account (income or expense account).

Deferral is the postponement of the recognition of “an expense already paid but not yet incurred” of a
“a revenue already collected but not yet earned”. This adjustments 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.

Deferrals would be needed in two cases:

1. Allocating asset expense to reflect expenses incurred during the accounting period (eg; prepaid
insurance, supplies and depreciation).

2. Allocating revenues received in advance to revenue to reflect revenues earned during the accounting
period (subscription)

Accrual is the recognition of an expense “an expense already incurred but unpaid” or “revenue earned
but not collected”. These adjustments deals with an amount unrecorded in any account; in effect,
increases both a balance sheet and an income statement account. Accruals will be required in two
cases:

1. Accruing expenses to reflect expenses incurred during the accounting period that are unpaid and
unrecorded

2. Accruing revenues to reflect revenues earned during the accounting period that are uncollected and
unrecorded.

Prepaid expenses

Prepaid rent
Transactions: Nov. 1, 2021 - Rented office space and paid three months rent in advance, P21,000.

Original Entry:

PREPAID RENT 21,000

CASH 21,000

December 31, 2021

Adjusting Entry:

RENT EXPENSE 14,000

PREPAID RENT 14,000

Balances: PREPAID RENT - 7,000

RENT EXPENSE - 14,000

PREPAID INSURANCE

Transaction: Nov 5, 2021

Del Mundo paid P24,000 for a one (1) year insurance contract that protects the business from Nov. 1 to
October 31 of the following year.

Original entry:

Prepaid Insurance 24,000

Cash 24,000

Adjusting Entry – December 31, 2021

Insurance EXPENSE 4,000

Prepaid Insurance 4,000

Balances as of Dec 31, 2021

Prepaid 20,000

Insurance expense 4,000

SUPPLIES

Transactions : Del Mundo purchases P1,000 worth of office supplies, placing the purchase on his
account with the store rather than paying cash.

Original Entry:

Supplies 1,000

Accounts Payable 1,000

Del Mundo discovers that he used P500 worth of supplies during November.

Adjusting Entry – Dec. 31, 2021

Supply Expense 500

Supplies 500

Balances:

Supplies (A) 500

Supplies Expense 500

DEPRECIATION OF PROPERTY AND EQUIPMENT

On Nov 3, Del Mundo purchases a P300,000 used truck by paying P200,000 in cash and signing a
P100,000 notes payable.

Nov 3, Del Mundo purchases mechanical lawn movers for P54,000 in cash

Original Entries:
Vehicle 300,000

Cash 200,000

Notes payable 100,000

Equipment 54,000

Cash 54,000

On December 31, 2021:

It is estimated that the truck will have a useful life of five years and salvage value of P30,000, while the
lawn mower, four and half years useful life without salvage value.

Depreciation is computed as:

Truck (300,000-30,000/5/12 x 2mos) 9,000

Equipment (54,000/54 mos x 2 mos) 2,000

Adjusting Entry:

Depreciation Expense 11,000

Accumulated depreciation 11,000

PARTIAL BALANCE SHEET

DEC. 31, 2021

Property Plant and Equipment:

Service Vehicle 300,000

Accumulated Depreciation 9,000

--------------------------- 291,000

Equipment 54,000

Accumulated depreciation 2,000

--------------------------- 52,000
ADJUSTMENTS FOR ACCRUALS

Del Mundo records an expense for the salaries of his partme employee who earned P1,600 during the
last four days of November but will not be paid until Dec. 10.

Adjustment for November 30, 2021

Salaries Expense (P400 x 4 days)1,600

Salaries payable 1,600

ACCRUED INTEREST

Del Mundo’s P100,000 notes payable, which he signed on Nov. 2, carries an 8% interest rate. Del
Mundo uses the formula (for simple interest) below to calculate how much interest expense accrued
during the final 28 days of November.

I = PRT

I = P100,000 x .08 x 28/360 of a year

I = P1,400.00

Adjusting entry as of Nov. 30, 2021

Interest Expense 1,400

Interest payable 1,400

ACCRUED REVENUE

This refer to revenue that has been earned but not recorded.

Transaction:

On November 30, Del Mundo cuts one lawn, and he agrees to mail the customer a bill for P2,500 which
he does on Dec 2.

Adjusting Entry – Nov 30, 2021

Accounts receivable 2,500

Lawn cutting revenue 2,500

ACCRUAL FOR UNCOLLECTIBLE ACCOUNTS

Transaction:

An entity made credit sales of P1,000,000 in 2021 and prior experience indicates an expected 1%
average uncollectible account based on credit sales.

Uncollectible account (1,000,000 x .01) 11,000

Allowance for uncollectible accounts 11,000