​ Accrual: The recognition of an "expense already incurred but unpaid" or "revenue earned

but uncollected."
● Accrued Income: Income earned but not yet collected at the end of the
accounting period, resulting in a receivable.
● Accrued Expenses: Expenses incurred but not yet paid at the end of the
accounting period, leading to a payable.
​ Deferral: The postponement of recognizing "an expense already paid but not yet
incurred" or "revenue already collected but not yet earned."
● Pre-collected Income (Deferred Income): Cash received before services or goods
are delivered.
● Prepaid Expenses (Deferred Expense): Expenses paid in advance, with a portion
or the entire amount not yet expired or consumed.
​ Depreciation: The allocation of the cost of tangible assets (e.g., buildings, machinery,
vehicles) over their estimated useful life, with the allocated cost referred to as
depreciation.
​ Uncollectible Accounts (Doubtful Accounts): An estimated amount of receivables that
may not be collected, used for better income and expense matching.
​ Solvency: The ability of a company to meet its long-term debts and financial obligations,
indicating its ability to continue operations in the future.
​ Liquidity: The ability of a company to pay its short-term obligations on time.
​ Profitability: The capability of a company to generate revenues exceeding its expenses,
indicating its ability to generate profits.
​ Reversing Entry (RE): A journal entry that reverses a related adjusting entry made at the
end of the accounting period, simplifying subsequent period transactions. Typically
prepared at the beginning of the next accounting period.
​ Salvage Value: The estimated amount for which an asset can likely be sold at the end of
its useful life.
​
● Why Adjusting Entries Are Necessary: Adjusting entries are essential to accurately
measure the profit for a period and ensure that asset and liability accounts have correct
balances. This ensures that financial statements reflect the entity's solvency, liquidity,
and profitability fairly.
● When Adjusting Entries Are Prepared: Adjusting entries are typically prepared at the end
of the accounting period. If the balance sheet date is December 31 (calendar year),
adjusting entries are dated December 31. For fiscal years ending in a different month,
adjusting entries correspond to the year-end date.
Effects of Omitting Adjustments:
Accrued Expenses (Failure to Recognize):
● Overstated net profit and owner's equity.
● Understated liability.
Accrued Income (Failure to Recognize):
● Understated net profit and owner's equity.
● Understated asset.
Expired Portion of Prepaid Expenses (Failure to Recognize):
● Overstated net profit and owner's equity.
● Overstated asset.
Earned/Income Portion of Deferred Income (Failure to Recognize):
● Understated net profit and owner's equity.
● Overstatement of liability.
Depreciation (Failure to Recognize):
● Overstated asset.
● Understated expenses and overstated owner's equity.
Doubtful Accounts (Failure to Recognize):
● Overstated asset.
● Understated expenses and overstated owner's equity.
Illustration - Accrued Expenses:
● Expenses recognized when incurred.
● Accrued expenses: unpaid expenses at period-end.
● Adjusting entry: Debit expense, Credit liability.
Illustration - Accrued Income:
● Revenue recognized when earned.
● Accrued income: earned but uncollected revenue.
● Adjusting entry: Debit asset, Credit income.
Prepaid Expenses:
● Some expenses paid in advance.
● Expired portion transferred from asset to expense.
● Failure to adjust leads to misstatements in assets and expenses.

Adjusting Entries and Their Effects:

Supplies (Expense Approach):
● Original Entry: Supplies Expense debited for the full amount.
● Adjusting Entry: Debit Supplies Expense, Credit Supplies for the unused portion.
● Failure to adjust leads to an overstatement of expenses and understatement of equity.
Pre-collected Revenue (Liability Approach):
● Original Entry: Cash received creates Unearned Income (liability).
● Adjusting Entry: Recognize the earned portion by debiting Unearned Income and
crediting Income.
● Failure to adjust leads to an overstatement of liabilities and understatement of income.
Interest-Bearing Note:
● Cash received for interest on a note.
● Original Entry: Notes Receivable credited for the principal, Service Income debited for
the full interest amount.
● Adjusting Entry (Liability Approach): Debit Unearned Interest, Credit Interest Income for
the earned portion.
● Adjusting Entry (Income Approach): Debit Interest Income, Credit Unearned Interest for
the unearned portion.
● Failure to adjust leads to misstatements in either liabilities or income.
Provision for Depreciation (Straight Line Method):
● Allocation of an asset's cost over its estimated useful life.
● Depreciation = (Cost - Salvage Value) / Useful Life.
● Accumulated Depreciation is presented as a reduction to the asset's cost in the
statement of financial position.
● Failure to provide depreciation leads to an overstatement of asset value and
understatement of expenses.
Illustration - Depreciation:
● ABC company acquires a building for P1,000,000 with a P100,000 estimated salvage
value and a 20-year useful life.
● Depreciation Expense: P45,000 per year (P900,000 / 20 years).
● Adjusting Entry: Debit Depreciation Expense and Credit Accumulated Depreciation -
Building for P45,000 each year.
● Failure to adjust leads to inaccurate presentation of asset value and expenses.
Remember that adjusting entries ensure financial statements accurately represent a company's
financial position and performance according to accrual accounting principles.

Building Depreciation:
● Dec. 31, 2019: Building: P1,000,000, Accumulated Depreciation: P45,000, Net Book
Value: P955,000.
● Dec. 31, 2020: Building: P1,000,000, Accumulated Depreciation: P90,000, Net Book
Value: P910,000.
● Dec. 31, 2038: Building: P1,000,000, Accumulated Depreciation: P900,000, Net Book
Value: P100,000.
● Annual Depreciation Expense: P45,000.
Computer Depreciation:
● Dec. 31, 2019: Computer: P45,000, Accumulated Depreciation: P6,000, Net Book Value:
P39,000.
● Dec. 31, 2020: Computer: P45,000, Accumulated Depreciation: P15,000, Net Book
Value: P30,000.
● Dec. 31, 2024: Computer: P45,000, Accumulated Depreciation: P45,000, Net Book
Value: P0.
 ● Annual Depreciation Expense: P6,000 (2019), P9,000 (2020), P9,000 (2021-2023),
P3,000 (2024).
Provision for Doubtful Accounts:
● The company estimates uncollectible accounts at 5% of accounts receivable (P150,000).
● Previous balance of Allowance for Doubtful Accounts (ADA) was P5,000.
● Current year's provision: P2,500.
● Required balance for ADA: P7,500.
● Adjusting Entry: Debit Doubtful Accounts, Credit Allowance for Doubtful Accounts,
P2,500.
● If previous balance is a debit of P10,000, provision is P17,500.
Presentation of Allowance for Doubtful Accounts (ADA):
● ADA is presented in the income statement (doubtful account expense).
● Net realizable value of accounts receivable: P142,500.
Writing Off Worthless Accounts:
● Use the allowance method or the direct method.
● Allowance method: Debit Allowance for DA, Credit Doubtful Account and Accounts
Receivable.
● Direct method: Debit Doubtful Account and Accounts Receivable.
Note:
● GAAP prefers the allowance method, while BIR prefers the direct method for writing off
worthless accounts.