Unit II Preparation of the Statement of Comprehensive Income

Lesson 3b
ADJUSTING THE ACCOUNTS
What is an adjusting journal entry?
 An entry made at the end of the period to update some accounts.

When the trial balance is ready, we can now prepare the financial statements…BUT MAKE SURE THAT THE
ACCOUNTS ARE UPDATED/ADJUSTED because at the end of the year, there are accounts that need to be
updated/adjusted:
 Accrued income – income already earned but not yet received, unrecorded income
Adjustment: Receivable xxx
Income xxx

Example: On December 31, 2022, P10,000 worth of taxi services were rendered but not yet received.
Accounts receivable 10,000
Taxi services income 10,000

 Accrued expenses – expenses already incurred but not yet paid, unrecorded expense
Adjustment: Expense xxx
Payable xxx
Example: Meralco bill for the month of December 31, 2022 amounted to P5,000 was received and paid
in January 2023.
Utilities expense 5,000
Utilities payable 5,000

 Deferred/Unearned income – income already received but not yet earned. When the payment was received,
maybe recorded as a liability (unearned income) or as an income.
If recorded as a liability, the adjustment would be to recognize the income and derecognize the liability
Unearned income
Income
Example: On August 1, the company received P60,000 from a corporate client for a one-year taxi services to
be rendered beginning August 1, 2022. The company recorded the amount received as a liability.
Entry on Aug. 1 Cash 60,000
Computation:
Unearned taxi services 60,000
60,000 / 12 = 5,000 per month
Adjustment: Unearned taxi services 25,000 5,000 x 5 = 25,000 earned
Taxi services income 25,000 (August – December 2022)

If recorded as an income, the adjustment would be to recognize the liability and derecognize the income
Income
Unearned income
Following the same example, but the company recorded the amount received as an income
Entry on Aug. 1 Cash 60,000 Computation:
Taxi services income 60,000 60,000 / 12 = 5,000 per month
Adjustment: Taxi services income 35,000 5,000 x 7 = 35,000 unearned
Unearned taxi services 35,000 (January – July 2023)
 Prepaid expense – expenses already paid but not yet incurred. When the payment was made, may be
recorded as an asset (prepaid expense) or as an expense.
If recorded as an asset, the adjustment would be to recognize the expense and derecognize the asset.
Expense
Prepaid expense
Example: In August, 2022, the company paid P120,000 for a one-year office rental beginning September 1,
2022. The company recorded the amount paid as an asset.
Entry on Aug. 20 Prepaid rent 120,000 Computation:
Cash 120,000 120,000 / 12 = 10,000 per month
Adjustment: Rent expense 40,000 10,000 x 4 = 40,000 expensed
Prepaid rent 40,000 (September – December 2022)

If recorded as an expense, the adjustment would be to recognize the asset and derecognize the expense.
Prepaid expense
Expense
Following the same example, but the company recorded the amount paid as an expense.
Entry on Aug. 20 Rent expense 120,000 Computation:
Cash 120,000 120,000 / 12 = 10,000 per month
Adjustment: Prepaid rent 80,000 10,000 x 8 = 80,000 prepaid
Rent expense 80,000 (January – August 2023)

 Bad debts expense / doubtful accounts expense / uncollectible accounts expense – when the company
grant credits to customers, some customers do not always pay what they promised, or do not pay on time.
The uncollectible accounts receivable is called bad debts. There are two methods of adjusting for bad debts:
The direct write-off method and the allowance method.
Direct write off – at the end of the year the company shall determine how much of the account receivables
cannot be collected. If it is CERTAIN, that the accounts cannot be collected the adjustment is to recognize a
bad debts expense and remove the accounts from the accounts receivable.
Bad debts expense xxx
Accounts receivable xxx
Example: On December 31, 2022, it was discovered that the account of customer C, who owes the company
P25,000 was proven to be uncollectible.
Adjustment: Bad debts expense 25,000
Accounts receivable 25,000
Allowance – at the end of the year the company shall make an estimate how much of the account
receivable are EXPECTED to be uncollectible. Based on the estimate, the company will make an adjusting
journal entry to recognize the uncollectible accounts and provide an allowance for such.
Adjustment: Bad debts expense xxx
Allowance for bad debts xxx
Example: On December 31, the company estimates that P15,000 of its account receivables may be
uncollectible.
Adjustment: Bad debts expense 15,000
Allowance for bad debts 15,000
 Assignment for research:
1. What are the methods of estimating bad debts?
2. What is the accounting procedure for bad debts write off?
3. What is meant by bad debts recovery? Give an illustrative example.

 Depreciation expense (pertaining to property, plant and equipment) – the portion of the asset cost that is
considered consumed or used up during the period. When an asset is purchased, say an equipment for
P50,000. It will be initially recorded as an asset. Since it will be used in the business, it is assumed that the
value of the asset is decrease due to the wear and tear condition (even by just the passage of time, it is
assumed that a certain value of the property is lost). This value that is considered consumed or used up is
recorded as an expense. The adjusting entry is to recognize an expense and accumulate the expense from
period to period until the property is considered worthless (fully depreciated).
Depreciation expense xxx
Accumulated depreciation xxx
Example: On January 1, 2022, the company purchased an equipment for P65,000. The equipment has a
useful life of 5 years and a salvaged value of P5,000.
The formula to compute the depreciation (straight-line method)
Cost – Salvaged value 65,000 – 5,000
Annual depreciation = ------------------------------------------ = ----------------------- = 12,000
Estimated useful life 5

Adjustment: Depreciation expense – equipment 12,000

Accumulated depreciation – equipment 12,000

Another formula if the depreciation rate is given:

Annual depreciation = Rate x (Cost – Salvaged value)

Note: Based on the formula, the amount computed is the depreciation for one year, if the asset
was acquired in the middle of the year, the depreciation in the year of acquisition must be pro-
rated. For example, if the asset was acquired in July 1, only ½ depreciation will be recorded.

PRACTICE EXERCISE
The following information were gathered on December 31, 2022. Give the necessary adjusting journal
entries as of December 31, 2022.
6. Depreciation expense-delivery van 18,747
1. Unrecorded salaries, P145,000. Accumulated depreciation-delivery van 18,747
(250,000 x 10% = 25,000) /12 = 2,083 x 9 months)
2. Accrued interest on notes from customers, P15,000.
3. Accrued interest on notes to suppliers, P30,000.
4. Equipment was acquired on June 1, 2022 for 100,000. The useful life of the equipment is 6 years, at the
end of which it is expected to be sold for 10,000.
5. A room of the building is being leased to a tenant for P7,500 a month. On December 31, 2022, the
tenant is 2 months in arrears in the payment of rent.
6. Depreciation of delivery van is 10% per annum. The ledger shows a balance of the delivery van account
is P250,000. The van was acquired on April 1, 2022.
7. On December 1, 2022, a customer issued a 60-day, 18% note for P60,000. The principal and the
interest will be collected on the maturity date.