ADJUSTING ENTRIES

-are entries made prior to the preparation of financial statements to update certain amounts so that they reflect
correct balances as of the designed time.
-involve at least one balance sheet account and one income statement account
-affect the profit or loss for the period

PURPOSE OF ADJUSTING ENTRIES

-To take up unrecorded income and expenses of the period.
-To split mixed accounts into their real and nominal elements.

Adjusting entries normally involve the ff:

1.ACCRUALS OF INCOME AND EXPENSES
“accrual” or ‘to accrue’ means to recognize an:
a. Income that is already earned but not yet collected; or
b. Expense that is already incurred but not yet paid.
-give rise to both income and receivable (or both expense and payable)

2. RECOGNITION OF DEPRECIATION EXPENSE

The Concept of Systematic and rational allocation
-costs that provide economic benefits over several accounting periods but cannot be directly associated with the
earning of revenues are recognized as expenses over the periods where the economic periods are consumed.
Depreciation-allocation of cost over the useful life of a depreciable asset.

RECOGNITION OF BAD DEBTS EXPENSE

The Concept of Immediate Recognition
-cost that produces no future economic benefits (asset) is recognized immediately as an expense.

Expense Recognition Principles

1.Matching- costs that are directly associated with the earning of revenue are recognized as expenses in the
same period in which the related revenue is recognized.

2.Systematic & Rational Allocation-costs that are not directly associated with the earning of revenue are
recognized as expenses over the periods the economic benefits are consumed.

3.Immediate Recognition- costs that do not provide assets are recognized immediately as expenses.

Real, Nominal and Mixed Accounts

1. Real Accounts (Permanent Accounts)
-accounts that are not closed at the end of the accounting period
-all balance sheet accounts except the ‘Owner’s drawings’ account

2. Nominal Accounts (Temporary Accounts)

-accounts that are closed at the end of the accounting period
-all income statement accounts, drawings account, clearing accounts and suspense accounts
*clearing accounts- account used temporarily to store amounts that will eventually be transferred to another
account.
e.g.: Income Summary
*suspense accounts- accounts used temporarily to store discrepancies in the accounts pending their analysis
and permanent classification.
e.g.: Cash Shortage or Overage

3. Mixed accounts
-accounts that have both real and nominal account components.
-unadjusted prepayments (prepaid assets) and deferrals (unearned income) that have expired and unexpired
components
*expired portion-nominal account component
*unexpired portion-real account component
-adjusting entries are needed to separate these components

Methods of Initial Recording of Income and Expenses

Income
1.Liability method
-advanced collections of income are initially credited to liability account
-the earned portion is recognized as income while the unearned portion remains a liability at the end of the
period

2. Income method
-advanced collections of income are initially credited to income account
-the unearned portion is recognized as liability while the earned portion remains an income at the end of the
period.

Expenses
1.Asset method
-prepayments of expenses are initially debited to asset account
-the incurred portion (used up or expired) is recognized as expense while the unused portion remains as asset.

2. Expense method
- prepayments of expenses are initially debited to expense account
- the unused portion (not yet incurred or unexpired) is recognized as asset while the used portion remains as
expense.

ACCRUALS
-to recognize income that is already earned but not yet collected
-to recognize expense that is already incurred but not yet paid

DEFERRALS
-to postpone the income recognition of an advance collection, it is treated as liability until earned.
-to postpone the expense recognition of a prepayment, it is treated as asset until incurred
 ACCOUNTING CYCLE OF A SERVICE BUSINESS
The Worksheet
-analytical device used to facilitate the gathering of data for adjustments, the preparation of financial statements,
and closing entries

To combine amounts,
-debit + debit = add
-credit + credit = add
-debit and credit, or vice versa = subtract

Cross-Footing
-procedure to compute for the adjusted balances of accounts in the adjusted trial balance
-involves adding or subtracting amounts horizontally

Footing
-procedure to compute the totals of the columns
-involves adding or subtracting amounts vertically

Financial Statements
-means by which information accumulated and processed in financial accounting is periodically communicated
to the users
-end products of the accounting process

Statement of Financial Position or Balance sheet

-shows the assets, liabilities and equity
-dated ‘as of the end of the reporting period’

Statement of Profit or Loss (Income Statement)

-shows the income and expenses and consequently the profit or loss
-dated ‘For the period ended’

Closing Entries
-entries prepared at the end of the accounting period to “zero out” all nominal accounts in the ledger
-all income accounts are debited
-all expense accounts are credited
-balance of Income Summary is closed to the Owner’s drawings account
-any balance in Owner’s drawings account is closed to the Owner’s capital

Post-Closing Trial Balance

-prepared to check the equality of debits and credits in the general ledger after closing entries
-contains only real accounts
*closing entries-debits and credits in the closing entries are placed here
*post-closing trial balance-the amounts in the Adjusted Trial Balance are cross-footed with the amounts in the
Closing entries columns.

Reversing Entries
-entries usually made on the first day of the next accounting period to reverse certain adjusting entries in the
immediately preceding period

PURPOSES:
1.To facilitate the recording of cash receipts and disbursements in the next accounting period;
2. To promote convenience in recording the next period’s year-end adjustments for accruals and;
3. To promote consistency of accounting procedure.

*Adjusting Entries that may be reversed:

-accruals for income or expense
-prepayments recorded using expense method
-advance collections using income method

*closed account-an account that has no balance

*open account- an account that has a balance