ADJUSTING ENTRIES

Learning objectives

➢ Matching principle for income and expense

➢ Need for adjusting entries
➢ Types of Adjusting entries
 Overview

• Accounting serve as the tool of management in making business decisions.

• Primary purpose of accounting
- is to provide management with the useful financial information it needs in
planning, directing and controlling business operations.
• Profitability is one of very important financial information we can get in
accounting
Reminder: In producing income, there is an expense incurred. This relationship
is called Matching Principle or Concept.
Example 1.1
During 2020, the business rendered repair services to one customer for
P3,750. Cash is, however received only in 2021. The supplies used on this job
costing P830 was bought and paid for in 2019.
Required:
1. In what year should the amount of P3,750 be recognized or recorded as
income?
2020, when income is rendered/earned
2. In what year should P830 be recognized as expense?
2020, when expense is incurred/used
 Adjusting entries
•Adjusting is the next step after preparing the preliminary
trial balance. It is the process of updating the overstated or
understated accounts at the end of the accounting period
using adjusting entries.
Causes of overstated or understated accounts
1. For transactions not yet recorded / Accruals
Accrued Income
Accrued Expense

2. For transactions previously recorded / Deferrals

Unearned income/Deferred income
Prepaid expense
Depreciation
Impairment loss/Doubtful accounts
 ACCRUED INCOME

•It is current receivables representing income already earned

but not yet collected.
•An income which earned regardless collected or not, should
be recorded in the book upon rendering service that give rise
to the income.
 PROFORMA ENTRY
12/31/2020
Accrued income/Receivables xxx
Income xxx
 EXAMPLE
• The business received a promissory note with face amount of P4,800
for services rendered on credit on December 16. The note bears
interest at 16% and shall mature on January 30 of the following year.
The accounting period follows the calendar year.
Required:
1. Prepare adjusting entry on December 31.
2. Considering the borrower paid on December 31, what is the entry?
 Face value= 4,800
SOLUTION Interest rate=16%
Term=45 days
(4,800*16%*15/365)=32
1. Adjusting entry
12/31 Accrued Income 32
Interest Income 32
2. Considering the borrower paid on December 31
12/31 Cash 4,832
Interest Income 32
Notes Receivables 4,800
 ACCRUED EXPENSE
• It is current liability representing expense already incurred but not yet
paid.
• An expense is incurred regardless whether paid or not, should be
recorded upon receiving or consummating the benefit give rise to the
expense.
Proforma entry
12/31 Expense xxx
Accrued Expense/Liability xxx
 EXAMPLE

• The monthly rental fee of P10,000 for the leased premises is being paid by
the business on the 7th day of the following month. The last rental payment
was made on December 7. The business uses the calendar year as its
accounting period.
Required: Prepare the adjusting entry on December 31.
12/31
Rent expense 10,000
Accrued rent expense 10,000
To adjust accrued expense
 UNEARNED INCOME

•It is a current liability representing advance collection for an

income not yet earned.
•It is an example of a mixed account which may consist of
both income and liability portion.
 Two method in recognition

1. Income method – unearned income is credited to an income

account on the date of collections
Proforma adjusting entry
Income xxx
Unearned income xxx
2. Liability method – unearned income is credited to a liability
account on the date of collections
Proforma Adjusting Entry
Unearned Income xxx
Income xxx
 EXAMPLE
• On December 1, the business received a total of P18,000 ad
advance collection of income from rent for December, January and
February. The accounting period closes on December 31.
Required: Prepare journal entries on December 1 and December
31.
1. Income method
2. Liability method
SOLUTION
 PREPAID EXPENSE

• It is a current asset representing advance payment for an expense not

yet incurred.
• It is another mixed account which may consist of both expense and
asset portion.
 TWO METHODS IN RECOGNITION
1. Expense Method - prepaid expense is debited to an expense account on
payment date
Proforma Adjusting Entry
Prepaid Expense xxx
Expense xxx

2. Asset Method – prepaid expense is debited to an asset account on payment

date
Proforma Adjusting Entry
Expense xxx
Prepaid Expense xxx
 EXAMPLE

• On October 21, the business bought office supplies worth P5,600. At

the end of the accounting period on December 31, the cost of the
supplies still unused was P1,200.
Required: Prepare journal entries on December 1 and December 31.
1. Asset method
2. Expense method
SOLUTION
 DEPRECIATION
• Systematic allocation of a fixed asset’s cost over the accounting
periods that the asset is expected to be used.
Depreciation methods:
1. Straight-line
2. Sum of the years digits
3. Declining balance
 STRAIGHT LINE METHOD
• It is the simplest and most widely used.

Proforma entry
12/31 Depreciation xxx
Accumulated Depreciation xxx
 EXAMPLE

• An office equipment was bought for P41,000. It is estimated to have a

useful life of 10 years, and a residual value of P1,000. The business
adopts the calendar year as its accounting period.
Required:
1. Compute the annual depreciation
2. Prepare adjusting entry on December 31.
 SOLUTION

12/31
Depreciation (4,000 * (9/12)) 3,000
Accumulated Depreciation 3,000
 IMPAIRMENT LOSS/BAD DEBTS

•It is the uncollectible amounts to be recognized as

expense
•An operating expense representing the portion of
accounts receivable estimated to be possibly
uncollectible or  doubtful in collection. 
 TWO METHODS
1. Allowance method – Account receivables that may be uncollectible
in the future is anticipated in the period that the related credit.
Proforma Entry
12/31 Bad debt expense xxx
Allowance for bad debt xxx
2. Direct Write Off Method – not generally accepted procedure
because it does not provide proper matching between income and
expense.
Proforma Entry
12/31 Bad debt expense xxx
Account receivable xxx
 METHODS OF ESTIMATING BAD DEBTS
1. Percentage of income method – estimate is based on the amount of
Service income for the accounting period.
2. Percentage of account receivables – estimate is based on the
amount of Account receivable at end of the period
3. Aging of receivables method – estimate is based on the age of the
receivables (this will be discuss further in other subject)
 EXAMPLES
In the previous year, the preliminary trial balance on December 31 included the following
accounts.
Accounts receivable 42,500
Allowance for impairment loss 2,700
Service Income 380,000
Required: Prepare the adjusting entry for impairment loss on December 31 under the
following independent assumptions.
1. 0.2% of service income is estimated to be uncollectible
2. 8% of accounts receivable is estimated to be uncollectible
 SOLUTION
1. 0.2% of service income
Doubtful account expense (380,000 * 0.02%) 760
Allowance for Doubtful accounts 760
Thus, the net realizable value of Account receivables is:
Account receivable beginning 42,500
Allowance for doubtful accounts (2,700 + 760) 3,460
Net realizable value 39,040
2. 8% of accounts receivable
The answer that we can get here is the ending balance of allowance for doubtful accounts.
Accounts receivable 42,500 * 8% = 3,400 Allowance for doubtful account at year end
Allowance for doubtful account beginning (2,700)
Doubtful accounts for the year 700

Doubtful accounts 700

Allowance for doubtful accounts 700

Thus, net realizable value of accounts receivable is (42,500 * .92%) 39,100.

 SUMMARY
• Adjusting is the next step to perform after preparing the preliminary trial balance
• Adjusting entries are made to correct the overstated and understated of the
accounts
• Two causes of adjusting entries : Transactions not yet recorded or previously
recorded