Book 3: Chapters 2+3+4

+
Book 5: Chapter 1

The Adjusting Process

Accrual Basis of Accounting

Revenue reported when earned

Expense reported when incurred
Properly matches revenues and
expenses in determining net
income
Requires adjusting entries at the
end of period
Types of Adjusting Entries:
1- Inventory
2- Prepayments (expenses paid in advance).
3- Accruals (Accrued Expenses)
4- Accrued Revenues(Accrued income)
5- Revenues received in advance. (unearned Revenue).

6- Depreciation
7- Irrecoverable receivables
 (1)
Inventory
Closing inventory
is a current asset (debit) in the balance
sheet , and a deduction (credit) in the
income statements.
Adjusting ENTRY:

Dr. Closing inventory (Balance sheet)

Cr. Closing inventory (Income statement)
 (2)
Prepayments
Prepayments :
Expenses paid in advance. (Prepaid expenses)

At payment date:
Dr. ………Expense
Cr. Bank

The Adjusting ENTRY:

Dr. Prepayments
Cr. ………..Expense
Example
On January 1, 2019, Scott Company paid $3,000 for three
years of insurance.

At Payment date: January 1

Dr. Insurance Expense 3,000
Cr. Bank 3,000
 What adjustment is required?
We need an adjusting entry at the end of the year to report:

1. Identify amounts of prepaid insurance on the balance sheet and

2. correct amount of insurance expense on the income statement.

The Adjusting ENTRY: (at the end of period)

Dr. Prepayments 2,000

Cr. Insurance expense 2,000
 EFFECT ON

Income Statement Balance sheet

Insurance expense Prepayments =

= 3000-2000 = 1000 2000

Note: Prepayments show in Balance sheet in Current assets section

 (3)
Accruals
Accruals (Accrued expenses):

Expenses incurred in a period but have

not been paid or recorded in the accounts

The Adjusting ENTRY:

Dr. ……… Expense
Cr. Accruals (Accrued expense)
Example 1
Barton, Inc. pays its employees every Friday. Year-end,
12/31/2017, falls on a Wednesday. As of 12/31/2017, the
employees have earned salaries of $15,000 for Monday
through Wednesday of the week ended 1/02/2018.

Answer
until the end of 2017(Wednesday),the salaries ($15,000) will
not be paid. Meaning it’s accrued

The Adjusting ENTRY: (at the end of period)

Dec. 31 Salaries Expense 15,000

Accruals (accrued expenses) 15,000
To accrue three days' salary
 EFFECT ON

Income Statement Balance sheet

Salaries expense will increase

Accruals= 15,000
15,000

Note: Accruals show in Balance sheet in Current Liabilities section

Example 2:
Assume that the total payments made in the
year to 31/10/2019 for electricity total
$8,000. the estimated electricity expense for
1 November 2019 to 31 December 2019 would
be $2,000 and will not be paid until the end of
2019.
Answer:
The Adjusting ENTRY: (at the end of period:
31 December)
Dr Cr
Electricity Expense 2,000
Accrued Expense (Accruals) 2,000
 EFFECT ON

Income Statement Balance sheet

Electricity expense will increase

2,000 , so the total electricity Accruals ( Accrued Expense)
expense in income statement will = 2,000
be = 8,000 + 2,000 = 10,000

Note: Accruals show in Balance sheet in Current Liabilities section

 (4)
Accrued Revenues
(income)
Accrued Revenues
Revenues that have been earned in the year but
not received in the year.

The Adjusting ENTRY:

Dr. Accrued Revenue

Cr. ……… Revenue
 Example
A business has a contract to provide IT maintenance services to a
client on a time basis, but only invoices them at the end of every six
months. If the maintenance company had a financial year ending on 31
December but started a $60,000 contract with a client on 1 November
20191, the client would not be invoiced for the $60,000 until 30 April
2020.

Answer
The amount of revenue earned but will not be received until the end
of the year is from 1 November 2019 till 31 December 2020 : 2
Months

Accrued Revenue = 60,000 × 2/6 = 20,000

The Adjusting ENTRY:

Dr. Accrued Revenue(Income) 20,000
Cr. Maintenance Revenue 20,000
 EFFECT ON

Income Statement Balance sheet

Accrued Revenue
Maintenance Revenue (Accrued Income)
20,000 20,000

Note: Accrued Revenue (Accrued Income) show in Balance sheet in

Current Assets section
 (5)
Revenues received
in advance
Revenues received in advance
Revenue received in the year that relates to
subsequent period
At collection date:

Dr. Bank
Cr. ……. Revenue

The Adjusting ENTRY:

Dr. ……. Revenue
Cr. Revenue Received in advance
Example
A Publisher had a financial year that ended on December
2013. A customer bought an annual magazine subscription for
$120 cash for the year on 1 April 2013.
Required:
A- Journal entry for sale of the magazine subscription
on 1 April 2013.
B- adjusting entry at the year end.
Answer
At collection date: 1 April 2013:
Dr. Bank 120
Cr. Subscription Revenue (Income) 120
The Adjusting ENTRY:31 December 2013
Revenue received in advance for the period from 1 January 2014
till 31 march 2014 = 3 month = 120 × 3/12 = 30

Dr. Subscription Revenue 30

Cr. Revenue Received in advance 30
 EFFECT ON

Income Statement Balance sheet

Revenue received in
Subscription Revenue advance
= 120 – 30 = 90 30

Note: Revenue received in advance show in Balance sheet in Current

Liabilities section
 (6)
Depreciation
 Land

Land has an infinite life; therefore,

it does not depreciate.
 Building

A building has a limited life, so it must be depreciated.

The contra account used in the adjusting entry is
Accumulated Depreciation—Building
 Equipment

Because equipment has a limited life, it

depreciates. The contra account used is
Accumulated Depreciation—Equipment
Depreciation
Buildings, equipment, and vehicles (long-lived/plant assets)
are recorded as assets.
Companies record a portion of the cost of these assets as
an expense (depreciation) during each period of the asset’s
useful life.

The Adjusting ENTRY:

Dr. Depreciation Expense

Cr. Accumulated Depreciation
1-Calculating Depreciation using straight-line method

Annual Cost - Salvage (residual) Value

Depreciation =
Estimated useful life of the asset

0R 
Annual Depreciation =
(Cost of the asset - Salvage Value)× Depreciation rate (given)

Example: Depreciation on the equipment is provided at 10% per

annum on the straight line basis. Cost of equipment $120,000.
Answer

Annual depreciation = 120,000  10% = $ 12,000

Example
On January 1, 2007, Barton, Inc. purchased
equipment for $62,000 cash. The equipment has an
estimated useful life of five years and Barton
expects to sell the equipment at the end of its life
for $2,000 cash.
What adjustment is required?

. 2007 $62,000 - $2,000

Depreciation = = $12,000
Expense 5
Dec. 31 Depreciation Expense 12,000
Accumulated Depreciation - Equipment 12,000
To record equipment depreciation

Accumulated depreciation is
a contra asset account.

Equipment Depreciation Expense

1/1 62,000 12/31 12,000

Balance Income
Accumulated Depreciation
sheet statement
12/31 12,000

Balance
sheet
 Barton balance sheet would
show the equipment at cost,
less the accumulated
depreciation.

Equipment $62,000
Less (-)
Accumulated depreciation 12,000
$50,000

Net Book
value
2-Calculating Depreciation using Reducing Balance method:

Annual
= (Cost - Accumulated depreciation) × Depreciation rate
Depreciation

Net Book Value

Same Adjusting Entry:

Dr. Depreciation Expense

Cr. Accumulated Depreciation
Example 1: Depreciation on the motor vehicle is provided at 25%
per annum on the reducing balance basis. Cost of motor vehicle
$57,000 and balance of accumulated depreciation account is $11,400
Answer

Annual depreciation = (57,000 – 11,400)  20% = $ 9,120

Example 2:
A business buys a truck for $57,000. It is considered to have a residual value
of approximately $18,700 at the end of its useful life in the business. The
truck is to be depreciated over 5 years using the reducing balance method of
depreciation. Assume a depreciation rate per year is set at 20%.

Answer

Year Beginning BV Depreciation Depreciation Accumulated

Ending BV
Rate Expense Depreciation
4=
5=1-3
1 2 3 = 12 Previous 4 +3
1 $57,000 0.20 $11,400 $11,400 $45,600
2 45,600 0.20 9,120 20,520 36,480
3 36,480 0.20 7,296 27,816 29,184
4 29,184 0.20 5.837 33,653 23,347
5 23,347 0.20 4,669 38,322 18,678
 (7)
Irrecoverable
Receivables
Irrecoverable receivables:
 Receivables are amounts due from credit customers .
 Irrecoverable receivables are debts that will not be
paid (Bad Debts), and which therefore have to be
written off as a debit in the income statement.
 So Irrecoverable receivables are recorded in the
income statement as an expense, and deducted from
receivables in the balance sheet.

1- Writing off irrecoverable receivables :

Dr. Irrecoverable receivables Expense (income statement account)
Cr. Receivables (balance sheet account)
 Example:
The Company decided to write off the a debt of $300 from a
customer, Peter Hinds at 31 December 2019. The total receivables at
this date, including Peter’s, amounted to $4,600
Answer:
Dr. Irrecoverable receivables Expense 300
Cr. Receivables 300
EFFECT ON

Income Statement Balance sheet

Irrecoverable receivable expense = Receivables

300 = 4,600 – 300 = 4,300

Note: Receivables show in Balance sheet in Current Assets section

2- Subsequent recovery of an irrecoverable receivable
Sometimes a debt written off as an irrecoverable receivable will be
recovered or partly recovered.
Example:
a debt of $1,000 has been written off as an irrecoverable receivable.
Six months later it is announced that the company will recover $200
of the $1,000.
Answer:

At the announcement date

3- Allowance for irrecoverable receivables
Allowance for irrecoverable receivables means that the asset called
receivables is of uncertain value and adjustments need to be made in
the accounts to cover the possibility of some debts becoming bad in
the future.
The allowance will be calculated as a percentage of Net Receivables
balance after writing off irrecoverable debts.

At the end of each accounting year the allowance for irrecoverable

receivables will be recalculated and the balance on the allowance for
irrecoverable receivables will be increased or reduced as necessary. It
is the increase or decrease in the allowance that will be taken to the
income statement. In the balance sheet the full new allowance will be
deducted from receivables.
The Adjusting ENTRY:
To increase the allowance
Dr. Irrecoverable receivables Expense xx
Cr. Allowance for irrecoverable receivables xx

To Decrease the allowance

Dr. Allowance for irrecoverable receivables xx

Cr. Irrecoverable receivables Expense xx
Example:
At the end of M. Wilson’s first year of trading she lists all the amounts due
from customers, which total $165,800. After writing off an irrecoverable
receivable of $200, she estimates (after taking advice from a friend
operating in the same trade) that 1% of her customers will not pay the
amounts owing.

The Required allowance = (165,800 – 200 )× 1% = 165,600 × 1%

= 1,656

The balance of the allowance The required allowance

0 1,656
Difference + 1,656

Dr. Irrecoverable receivables Expense 1,656

Cr. Allowance for irrecoverable receivables 1,656
 EFFECT ON

Income Statement Balance sheet

Receivables 165,600
Irrecoverable receivable expense = 165,800 - 200
200 + 1,656 = 1,856 (-) (-)
Allowance for 1,656
Irrecoverable receivables
= Net Receivables 164,944

Note: Receivables show in Balance sheet in Current Assets section

Example 2:
Following on from the previous example, at the end of year 2, M. Wilson has
amounts owing from customers of $285,250. One customer has written to
her to say that due to financial difficulties he is unable to pay his account of
$250.

The Required allowance = (285,250 – 250 )× 1% = 285,000× 1%

= 2,850

The balance of the allowance The required allowance

1,656 2,850
Difference + 1,194

Dr. Irrecoverable receivables Expense 1,194

Cr. Allowance for irrecoverable receivables 1,194
 EFFECT ON

Income Statement Balance sheet

Receivables 285,000
Irrecoverable receivable expense = 285,250 - 250
250 + 1,194 = 1,444 (-) (-)
Allowance for 2,850
Irrecoverable receivables
= Net Receivables 282,150

Note: Receivables show in Balance sheet in Current Assets section

Exercise ( V. Important)
Following on from the example above, at the end of year 3,
M. Wilson has amounts owing from customers of $190,000.
One customer has been declared bankrupt therefore the
amount owing from her of $400 will have to be written off
as an irrecoverable receivable. The accounting policy of
writing off 1% of customers’ balances still applies.

Required:

Prepare the adjusting entry at the end of year 3 and show

the effect on Income statement and balance sheet.
Exercises
Ex :1
John Black has extracted a trial balance from his general ledger for the year ended 30 June 20X5
Required:
a- Make the end-of-period adjustments entries , without a journal narrative.
b- Mr Black income statement for the year ended 30 June 20X5
c- Mr Black balance sheet as at 30 June 20X5
 Answer
(a) The Adjusting Entries:
1.The closing inventory is $10,500.
Dr: Closing inventory (balance sheet) 10,500
Cr: Closing inventory (income statement) 10,500
2. The electricity bill accrual for June of $300.
Dr: Heating and lighting Expense 300
Cr: Accrual. 300
3 Rent of $3,000 has been paid for the quarter commencing 1 June.
A prepayment for two months is $3,000 × 2/3 = $2,000.

Dr: Prepayments 2,000

Cr: Rent expense 2,000
4 Depreciation:
Annual Depreciation of Motor vehicle - Reducing balance:
= ( $32,480 - $14,210 ) × 25 % = 4,568
Dr: Depreciation Expense 4568
Cr: Accumulated depreciation- Motor vehicle 4568
5 Depreciation:
Annual Depreciation of Furniture - straight-line :
= 6,100 × 10 = 610
Dr: Depreciation Expense 610
Cr: Accumulated depreciation- Furniture 610
6 It is estimated that $850 of receivables will not be recovered.
Dr: Irrecoverable receivables Expense 850
Cr: Receivables. 850
EX :2 – Making end-of-period adjustments for Manu’s Mirrors
Below is the trial balance of Manu’s Mirrors at 31 March 20X1.

$ $
Trading account:
Sales 428,600
Opening inventory 25,800
Purchases 240,000
Carriage inwards 2,100
Other expenses:
Rent 24,000
Heating and lighting 3,400
Advertising expense 2,800
Wages 8,000
Discounts allowed 4,100
Carriage outwards 1,800
Balance sheet accounts:
Equipment at cost 40,000
Equipment - accumulated 4,000
Motor vehicle at cost 80,000
Motor vehicle - accumulated 20,000
Receivables 36,200
Allowance for receivables 3,000
Bank 28,000
VAT liability 3,400
Payables 25,800
Bank loan 20,000
Capital 25,000
Drawings 33,600
529,800 529,800
The following information is relevant for the end-of-period adjustments.
1 The closing inventory at 31 March 20X1 is valued at $28,200.
2 Depreciation on the equipment is provided at 10% per annum on the straight
line basis.
3 Depreciation on the motor vehicle is provided at 25% per annum on the
reducing balance basis.
4 Manu estimates that $2,200 due from customers will be irrecoverable and
must be written off.
5 The allowance for receivables is to be set at 8% of net receivables at31
March 20X1.
6 Rent includes a prepayment of $2,000.
7 Advertising expense includes a prepayment of $400.
8 The heating bill will arrive on 8 April and about $500 is expected to relate to
the period until 31 March.
9 The bank loan is repayable in 10 years’ time. Interest payable on the loan is
6% and will be paid once per year.
Required:
Make the end-of-period adjustments using double-entry bookkeeping
entries without a journal narrative.
Ex 3: Financial statements for Manu’s Mirrors
Using the trial balance and other information provided in Activity 1.1:

a) Prepare the income statement for Manu’s Mirrors for the year ended 31 March 20X1.
b) Prepare the balance sheet for Manu’s Mirrors as at 31 March 20X1.
c) Show the appropriate workings.
(a) Income statement

24000-2000

3400+500

2800-400

2200-280
b) Balance sheet
Activity 1.3 – Financial statements for Naomi’s Frames
Naomi’s Frames Trial balance as at 5 April 20X5
£ £
Trading account:
Sales 295,000
Opening inventory 19,200
Purchases 199,000
Carriage inwards 1,850
Other revenue and expenses:
Subscription income 1,200
Rent 15,500
Heating and lighting 4,000
Advertising expense 2,500
Motor expenses 4,450
Discounts allowed 1,600
Carriage outwards 1,100
Balance sheet accounts:
Equipment 12,000
Equipment – accumulated depreciation 3,600
The following information is relevant.
1 The closing inventory at 5 April 20X5 is valued at £18,200.
2 The subscription income of £1,200 received relates to the period from 6 August 20X4 to
5 August 20X5.
3 Depreciation on the equipment is provided at 10% per annum on the straight line basis.
4 Depreciation on the motor vehicle is provided at 25% per annum on the reducing balance
method.
5 Naomi estimates that £1,100 due from customers will be irrecoverable and must be written
off.
6 The allowance for receivables is to be set at 5% of net receivables at 5 April 20X5.
7 Rent includes a prepayment of £3,000.
8 Advertising expense includes a prepayment of £500.
9 The heating bill will arrive on 10 April and about £200 is expected to relate to the period
until 5 April.
10 The bank loan is repayable in 8 years’ time. Interest payable on the loan is 9% and will
be paid once per year.

Required:
1. Prepare the income statement for Naomi’s Frames for the period ended 5 April 20X5
2. Prepare the balance sheet for Naomi’s Frames as at 5 April 20X5
3. present all your workings
Answer:
Ex :4 -HOME WORK
A four-column table for Farah Company follows. The first two columns contain partial unadjusted
trial balance for the company as of July 31, 2015. The last two columns contain partial adjusted
trial balance as of the same date.
Unadjusted Adjusted
Trial Balance Trial Balance
Cash $ 34,000 $ 34,000
Accrued revenue 14,000 22,000
Prepaid insurance (Prepayments) 0 2,000
Office equipment 84,000 84,000
Accum. Depreciation—Office equip. $ 14,000 $ 20,000
Accounts payable 9,100 9,100
Interest payable (Accruals) 0 1,000
Salaries payable (Accruals) 0 7,000
Long-term notes payable 52,000 52,000
Farah, Capital 40,000 40,000
Farah, Withdrawals 5,000 5,000
Consulting fees earned (Revenues) 123,240 131,240
Depreciation expense—Office equip. 0 6,000
Salaries expense 67,000 74,000
Interest expense 1,200 2,200
Insurance expense 5000 3,000
Rent expense 14,500 14,500
Activity 1.3 – Financial statements for Naomi’s Frames
Naomi’s Frames Trial balance as at 5 April 20X5
£ £
Trading account:
Sales 295,000
Opening inventory 19,200
Purchases 199,000
Carriage inwards 1,850
Other revenue and expenses:
Subscription income 1,200
Rent 15,500
Heating and lighting 4,000
Advertising expense 2,500
Motor expenses 4,450
Discounts allowed 1,600
Carriage outwards 1,100
Balance sheet accounts:
Equipment 12,000
Equipment – accumulated depreciation 3,600
The following information is relevant.
1 The closing inventory at 5 April 20X5 is valued at $18,200.
2 The subscription income of $1,200 received relates to the period from 6 August 20X4 to
5 August 20X5.
3 Depreciation on the equipment is provided at 10% per annum on the straight line basis.
4 Depreciation on the motor vehicle is provided at 25% per annum on the reducing balance
method.
5 Naomi estimates that $1,100 due from customers will be irrecoverable and must be written
off.
6 The allowance for receivables is to be set at 5% of net receivables at 5 April 20X5.
7 Rent includes a prepayment of $3,000.
8 Advertising expense includes a prepayment of $500.
9 The heating bill will arrive on 10 April and about $200 is expected to relate to the period
until 5 April.
10 The bank loan is repayable in 8 years’ time. Interest payable on the loan is 9% and will
be paid once per year.

Required:
1. Prepare the income statement for Naomi’s Frames for the period ended 5 April 20X5
2. Prepare the balance sheet for Naomi’s Frames as at 5 April 20X5
3. present all your workings
Answer:
Ex :4 -HOME WORK
A four-column table for Farah Company follows. The first two columns contain partial unadjusted
trial balance for the company as of July 31, 2015. The last two columns contain partial adjusted
trial balance as of the same date.
Unadjusted Adjusted
Trial Balance Trial Balance
Cash $ 34,000 $ 34,000
Accrued revenue 14,000 22,000
Prepaid insurance (Prepayments) 0 2,000
Office equipment 84,000 84,000
Accum. Depreciation—Office equip. $ 14,000 $ 20,000
Accounts payable 9,100 9,100
Interest payable (Accruals) 0 1,000
Salaries payable (Accruals) 0 7,000
Long-term notes payable 52,000 52,000
Farah, Capital 40,000 40,000
Farah, Withdrawals 5,000 5,000
Consulting fees earned (Revenues) 123,240 131,240
Depreciation expense—Office equip. 0 6,000
Salaries expense 67,000 74,000
Interest expense 1,200 2,200
Insurance expense 5000 3,000
Rent expense 14,500 14,500