Fundamentals of

Accountancy Business
and Management 1
Quarter 4 – Module 1:
Preparing Adjusting Entries

At the end of this module, you are expected to learn how to prepare adjusting
entries for the following: (ABM_FABM11-IV-a-d-33)

a. depreciation;
b. bad debts;
c. accruals;
d. deferrals; and
e. prepayments.

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 Lesson

1 Preparing Adjusting Entries

At the end of the accounting period, some accounts in the general ledger
would require updating. The journal entries that bring the accounts up to date are
called adjusting entries. One purpose of adjusting entries is for income and
expenses to be reported in the correct period.

After preparing the trial balance at the end of the period, adjusting entries
are also made at the end of each accounting period. Adjusting entries make it
possible to report correct amounts on the statement of financial position and on the
income statement. All adjusting entries affect at least one income statement
account and one statement of financial position account.
What are adjusting entries?

 These are journal entries that are prepared in order to generate correct data
at the end of the accounting period.
 These are then recorded in the general journal and posted in the ledger
accounts so that information in the ledger accounts will then be brought to
correct balances.
 These are done to depict sensible financial statements.

Accountants and bookkeepers make adjustments because accounts could

have been understated and overstated. There are some portions of an asset which
could have been expired and there may be some portions of a liability which could
have been paid.

Adjusting Entry for Depreciation

When an entity acquired long-lived assets such as buildings, service vehicles,

computers or office furniture, it is basically buying or prepaying for the usefulness
of that asset.
Therefore, a portion of the cost of the asset should be recorded as expense in
each accounting period.
To compute for depreciation, you will be using a formula. The components of
the formula are explained below.
1. Asset cost is the amount an entity paid to acquire the depreciable asset.
2. Estimated salvage value is the amount that the asset can be probably
sold for at the end of its estimated useful life.

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3. Estimated useful life is the number of periods that an entity can make
use of the asset.

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 Straight-line method computation for depreciation

Asset Cost – Estimated Salvage Value

Estimated Useful Life

Journal entry
Date Account Titles and Explanations Debit Credit
YYYY Depreciation Expense P XXXXXXX
MMDD Accumulated Depreciation P XXXXXXX
To record depreciation

Depreciation Expense is the account title used to record the amount of devaluation
of a property in an accounting period.
Accumulated Depreciation is a contra-asset account used in recording the
amount of depreciation of an asset.
If you will not record the adjustments for depreciation, the value of the particular
asset will be overstated (the amount is higher than its correct value), and expenses
will be understated (the amount is lower than its correct value).
Let us have an example for better understanding.

Case No. 1: The owner of RDS Company paid Php160,000.00 cash to purchase a
delivery van (surplus) on January 1. The van was expected to have a three-year life
and a Php10,000.00 salvage value. Depreciation is computed on a straight-line
basis. Prepare the adjusting entry for the year ended December 31, 2020.

Transaction: To record the depreciation of delivery van

Analysis: Assets decreased (decrease in the book value of the asset). Owner’s equity
decreased (depreciation expense).
Rules: Decrease in assets are recorded by credits. Decrease in owner’s equity are
recorded by debits.
Entries: Owner’s equity is decreased by debits to depreciation expense-service
vehicle. Assets are decreased by crediting a contra-asset account which is
Accumulated Depreciation- Service Vehicle.

Adapted from: Basic Accounting and Financial Reporting (Ballada, 2019)

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 Date Account Titles and Explanations Debit Credit
2020
Dec. 31 Depreciation Expense- Service Vehicle P 50,000.00
Accumulated Depreciation – Service P 50,000.00
Vehicle
To record depreciation of service vehicle

Using the straight-line method in computing for the depreciation of the service
vehicle for the period is Php 50,000.00.

Asset Cost Php 160,000.00

Less: Estimated Salvage Value 10,000.00
Depreciable Cost 150,000.00
Divided by: Estimated Useful Life 3 years
Depreciation Expense for the Year Php 50,000.00

Case No. 2: The owner of RDS Company paid Php 160,000.00 cash to purchase a
delivery van (surplus) on January 1. The van was expected to have a three-year life
and a Php 10,000.00 salvage value. Depreciation is computed on a straight-line
basis. Prepare the adjusting entry for the month ended January 31, 2019.

It has the same analysis but take note that the required adjusting entry for
depreciation is for the period of one month. If this is the situation, divide the
depreciation expense for the year.

Depreciation Expense for the Year Php 50,000.00

Divided by 12 months 12
Depreciation Expense for the Month Php 4,166.67

Date Account Titles and Explanations Debit Credit

2019
Jan. 31 Depreciation Expense- Service Vehicle P 4,166.67
Accumulated Depreciation – Service Vehicle P 4,166.67
To record depreciation of service vehicle

Adjusting Entry for Bad Debts Expense or Doubtful Accounts Expense

Businesses may allow some of their customers to purchase goods and acquire
services on credit. Based from various owners’ experiences, some of their customers
did not pay their obligations. Therefore, to recognize those accounts which are
doubtful, accountants recognized it as expense. Accountants estimate the percentage
of receivables which may be considered doubtful.

Using the percentage of the receivable in provisioning (estimating) the

allowance for doubtful accounts, the journal entry is shown on the next page.

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 Journal entry
Date Account Titles and Explanations Debit Credit
YYYY Doubtful Accounts Expense P XXXXXXX
MMDD Allowance for Doubtful Accounts P XXXXXXX
To record provision for doubtful accounts

Doubtful Accounts Expense or Bad Debts Expense refers to the amount of

accounts receivable that is estimated as uncollectible and is recognized as expense
in the current accounting period.
Allowance for Doubtful Accounts or Allowance for Bad Debts is a contra-asset
account used to record the amount of doubtful accounts considered as a deduction
to the total accounts receivable.
If you will not record the adjustments for doubtful accounts, assets will be
overstated (the amount is higher than its correct value) and expenses will be
understated (the amount of expenses is lower than its correct value).
Let us have an example for better understanding.
Case No. 3: Based on the experience of Orani Service Company, 2% of the
outstanding Accounts Receivable amounting to Php 2,000,000.00 is considered
doubtful. Record the adjusting entry for uncollectible accounts for the year ended
December 31, 2019.

Transaction: To record the allowance for uncollectible accounts

Analysis: Assets decreased (decrease in the book value of the asset, Accounts
Receivable). Owner’s equity decreased (Uncollectible Accounts Expense).
Rules: Decrease in assets are recorded by credits. Decrease in owner’s equity are
recorded by debits.
Entries: Owner’s equity is decreased by debits to Doubtful Accounts Expense.
Assets are decreased by credits to contra-asset account Allowance for Doubtful
Accounts (Bad Debts and Uncollectible Accounts are terms synonymous to
Doubtful Accounts).
Adapted from: Basic Accounting and Financial Reporting (Ballada, 2019)

Date Account Titles and Explanations Debit Credit

2019
Dec. 31 Doubtful Accounts Expense P 40,000.00
Allowance for Doubtful Accounts P 40,000.00
To record allowance for doubtful accounts

To compute for doubtful accounts:

Outstanding Accounts Receivable Php 2,000,000.00

Multiplied by percentage of allowance 2%
Amount of Doubtful Accounts Php 40,000.00

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Adjusting Entry for Accruals
Under accrual accounting, the accountant recognized income and expenses as they
are earned and incurred. The adjustments are based on this principle.
Accrued Revenue or Accrued Income arises when the business renders services or
delivers goods to its clients, but collections have not yet been received.
Journal Entry
Date Account Titles and Explanations Debit Credit
YYYY Receivable Account P XXXXXXX
MMDD Revenue Account P XXXXXXX
To record advance receipt of revenue

Accountants used to debit receivable account because the payment for the
services rendered is yet to be received while revenue account is credited as a
recognition for the income earned though it is not still paid by the customer.
Accrued Expenses arise when businesses incur expenses but not yet paid.
Examples of these are salaries, taxes, and interest.
Journal Entry
Date Account Titles and Explanations Debit Credit
YYYY Expense Account P XXXXXXX
MMDD Payable Account P XXXXXXX
To record depreciation

An expense account is to be debited by accountants in recognition to the

expense that has been incurred but is not yet paid while payable account is to be
credited because that particular expense is yet to be paid.
Let us have examples for better understanding.

1. Accrued Revenues

Case No. 5: RDS Laundry Services rendered a rush laundry services to a client on
June 30, 2019 amounting to Php 35,000.00. The services have been earned but
unbilled.

Transaction: To record accrual of unrecorded revenues

Analysis: Increase in assets. Increase in owner’s equity.
Rules: Increase in assets are recorded by debits. Increase in owner’s equity are
recorded by credits.
Entries: Increase in assets is recorded by a debit to Accounts Receivable. Increase
in owner’s equity is recorded by a credit to Laundry Revenues.
Adapted from: Basic Accounting and Financial Reporting (Ballada, 2019)

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Date Account Titles and Explanations Debit Credit
2019
June 30 Accounts Receivable P 35,000.00
Laundry Revenues P 35,000.00
To record accrual of unrecorded revenues

Case No. 6: The owner of RDS Company invested Php 100,000.00 cash in certificate
of deposit that paid 5% annual interest. The certificate was acquired on January 1
and carried a one-year term to maturity. The adjusting entry for the year ended
December 31, 2020 is shown below:

Date Account Titles and Explanations Debit Credit

2020
Dec. 31 Interest Receivable P 5,000.00
Interest Revenues P 5,000.00
To record accrual of unrecorded revenues

The interest earned for the year is determined by the following formula:
Interest = Principal x Interest Rate x Time Period
=P100,000.00 x 5% x 12/12 (12/12 = 1 year)
=P100,000.00 x 0.05 x 1
= P5,000.00

Case No. 7: The owner of RDS Company invested Php 100,000.00 cash in certificate
of deposit that paid 5% annual interest. The certificate was acquired on May 1 and
carried a one-year term to maturity. The adjusting entry for the year ended December
31, 2020 is shown below:

Date Account Titles and Explanations Debit Credit

2020
Dec. 31 Interest Receivable P 3,333.33
Interest Revenues P 3,333.33
To record accrual of unrecorded revenues

The interest earned for the year is determined by the following formula:

Interest = Principal x Interest Rate x Time Period

=P100,000 x 5% x 8/12 (8/12 =certificate was acquired on May 1)
=P100,000 x .05 x 8/12
= P3,333.33

2. Accrued Expenses

Case No. 8: The owner of RDS Company borrowed Php 500,000.00 by issuing a
one- year note with 10% annual interest to Rural Bank of Malasakit on October 1,
2020. Prepare the adjusting entry for the year ended December 31, 2020.

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 Transaction: To record the accrual of unrecorded expense
Analysis: Increase in liability; Decrease in owner’s equity.
Rules: Increase in liabilities is recorded by credits. Decrease in owner’s equity is
recorded by debits.
Entries: Decrease in owner’s equity is recorded by debiting Interest Expense.
Increase in liability is recorded by crediting Interest Payable.
Adapted from: Basic Accounting and Financial Reporting (Ballada, 2019)

Date Account Titles and Explanations Debit Credit

2020
Dec. 31 Interest Expense P 12,500.00
Interest Payable P 12,500.00
To record accrual of unrecorded expense

The interest incurred for the year is determined by the following formula:

Interest = Principal x Interest Rate x Time Period

=Php 500,000.00 x 10% x 3/12 (3/12 = from October to December)
=Php 500,000.00 x .05 x 3/12
=Php 12,500.00

Case No. 9: Three-day salaries are unpaid as of December 31 2020. Salaries are
Php 75,000.00 for a five-day work week.

Date Account Titles and Explanations Debit Credit

2020
Dec. 31 Salaries Expense P 45,000.00
Salaries Payable P 45,000.00
To record accrual of unrecorded expense

The amount of Php 75,000.00 was divided into five days to arrive at the
salaries to be paid per day and multiplied by three days to compute for the three-day
accrued salaries.

Adjustments for Deferrals

Deferral is the postponement of the recognition of an expense already paid but not
yet incurred or of revenue already collected but not yet earned.
Deferred Revenue or Unearned Revenue refers to revenue already received but not
yet earned.
Income Method is used by accountant, if the account used in the initial entry in
recording revenue is an income account.

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 If the accountant used income method, the adjusting entry will be this way:
Date Account Titles and Explanations Debit Credit
YYYY Revenue Account P XXXXXXX
MMDD Liability Account P XXXXXXX
To record adjustments for deferrals

The initial journal entry for income method is:

Date Account Titles and Explanations Debit Credit
YYYY Cash P XXXXXXX
MMDD Revenue Account P XXXXXXX
To record adjustments for deferrals

The accountant recognized all cash payments as revenue even if there is still
some portion of it which have not yet been rendered. That is the reason why the
adjustment will be a deduction from the revenue account and an addition to the
liability account. If the accountant will not adjust the accounts, revenue account will
be overstated and liability account will be understated.

Liability Method is used by accountant if the account used in the initial entry in
recording revenue is a liability account.
If the accountant used liability method the adjusting entry will be this way:
Date Account Titles and Explanations Debit Credit
YYYY Liability Account P XXXXXXX
MMDD Revenue Account P XXXXXXX
To record adjustments for deferrals

The initial journal entry for liability method is:

Date Account Titles and Explanations Debit Credit

YYYY Cash P XXXXXXX
MMDD Liability Account P XXXXXXX
To record adjustments for deferrals

The accountant records all cash payments as liability though there are some
portions of that payment which have been rendered and must be recognized as
income.
If the accountant will not record an adjusting entry, the liability account will
be overstated and revenue account will be understated.
Let us have examples for better understanding.
Case No. 10: On July 1, 2019, Matapat Company received a check amounting to
Php 48,000.00 for two-year rent paid in advance. The accountant may record a
credit unearned rent revenue (liability) or rent revenue (income) depending on the
accounting policy of the company.

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 The initial journal entry could be between the two:

1. Liability Method
Date Account Titles and Explanations Debit Credit
2019
July 1 Cash P 48,000.00
Unearned Rent Revenue P 48,000.00
To record the payment for 2-year rental

2. Income Method
Date Account Titles and Explanations Debit Credit
2019
July 1 Cash P 48,000.00
Rent Revenue P 48,000.00
To record the payment for 2-year rental

At the end of the year, an adjusting entry has to be made to establish the
correct balances of the unearned rent revenue and rent revenue accounts. The
amount of Php 48,000.00 represents the 2-year rental deposited. To compute for the
monthly rental, divide the total amount by 24 and the result is Php 2,000.00.

The necessary adjusting entries are as follows depending on the method

used in recording.

1. Liability Method

Date Account Titles and Explanations Debit Credit

2019
Dec. 31 Unearned Rent Revenue P 12,000.00
Rent Revenue P 12,000.00
To record adjusting entry for rent

As of December 31, 2019, there is already six months of rent which has been
earned. That is the reason why the accountant needs to establish the revenue
account amounting to Php 12,000.00 and deduct the same amount to the previously
established liability account.

2. Income Method

Date Account Titles and Explanations Debit Credit

2019
Dec. 31 Rent Revenue P 36,000.00
Unearned Rent Revenue P 36,000.00
To record adjusting entry for rent

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 Eighteen (18) months of the total rent payment has not been earned as of
December 31, 2019 . That is the reason why the accountant needs to deduct Php
36,000.00 (Php 2,000.00 a month X 18 months) from the previously recorded
revenue in order to arrive at the correct amount of revenue earned for the period.
Unearned Rent Revenue is established at the end of the period to reflect the amount
of liability the company still has to earn.

Adjustments for Prepaid Expenses

Prepaid Expense is an expense already paid in advance but not yet incurred.
Asset Method is used by accountant if the account used in the initial entry in
recording revenue is an asset account.
If the accountant used asset method, the adjustments will be this way:
Date Account Titles and Explanations Debit Credit
YYYY Expense Account P XXXXXXX
MMDD Asset Account P XXXXXXX
To record adjustments for prepayments

The initial journal entry is:

Date Account Titles and Explanations Debit Credit
YYYY Asset Account P XXXXXXX
MMDD Cash P XXXXXXX
To record supplies bought

The accountant recorded all the purchase of a prepaid asset as an asset. The
adjustment is to reduce the amount of recorded asset because there are some
portions of that asset which have been used up already and by debiting an expense
account, the adjustment recognizes the portion that has been used up.

Expense Method is used by the accountant if the account used in the initial entry
in recording revenue is an expense account.
If the accountant used expense method, the adjustment will be this way:
Date Account Titles and Explanations Debit Credit
YYYY Asset Account P XXXXXXX
MMDD Expense Account P XXXXXXX
To record adjustments for prepayments

The initial journal entry is:

Date Account Titles and Explanations Debit Credit
YYYY Expense Account P XXXXXXX
MMDD Cash P XXXXXXX
To record supplies bought

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 The accountant recorded purchase of a prepaid expense as an expense.
Therefore, the accountant must credit the expense account being debited because
there are still portions that are not used and by debiting an asset account, the
accountant establishes the portion that is not yet expired or used.

Let us have examples for better understanding.

Case No. 11: On October 1, 2019, Malinis Company acquired a three-year insurance
policy for Php 36,000.00 paid in advance. The accountant may record a debit of
Prepaid Insurance (asset) or Insurance Expense (expense) depending on the
accounting policy of the company.

The initial journal entry could be between the two:

1. Asset Method

Date Account Titles and Explanations Debit Credit

2019
Oct. 1 Prepaid Insurance P 36,000.00
Cash P 36,000.00
To record the acquisition of 3-year insurance

2. Expense Method

Date Account Titles and Explanations Debit Credit

2019
Oct. 1 Insurance Expense P 36,000.00
Cash P 36,000.00
To record the acquisition of 3-year insurance

At the end of the year, an adjusting entry has to be made to establish the
correct balances of the prepaid insurance and insurance expense accounts. The
amount of Php 36,000.00 represents the three-year insurance coverage. To compute
for the monthly insurance, divide the total amount by 36 and the result is Php
1,000.00.

The necessary adjusting entries are as follows depending on the method

used in recording.

1. Asset Method

Date Account Titles and Explanations Debit Credit

2019
Dec. 31 Insurance Expense P 3,000.00
Prepaid Insurance P 3,000.00
To record the adjustments in insurance

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 As of December 31, 2019, three months of the three-year insurance coverage
has been incurred. The accountant deducted Php 3,000.00 by crediting Prepaid
Insurance and established an Insurance Expense account which represents the
portion of the insurance which has been incurred.

2. Expense Method

Date Account Titles and Explanations Debit Credit

2019
Dec. 31 Prepaid Insurance P 33,000.00
Insurance Expense P 33,000.00
To record the adjustments in insurance

As of December 31, 2019, there is still 33 months of the three-year insurance

coverage still not incurred. The accountant debited Prepaid Insurance amounting to
Php 33,000.00 to recognize the unexpired portion of the asset and credited Insurance
Expense to deduct the unexpired portion of the asset.

What I Can Do

1. As of January 1, 2017, an equipment costing Php 600,000.00 still has a useful

life of five years with a Php 60,000.00 salvage value at the end of five years.
Record the depreciation for the month ended.
Date Account Titles and Explanations Debit Credit

2. On September 1, 2018, the company bought a one-year fire insurance policy

amounting to Php 24,000.00. The accountant initially recorded it as Prepaid
Insurance. Prepare the adjusting entry for the year ended December 31,
2018.
Date Account Titles and Explanations Debit Credit

3. Mario issued a promissory note amounting to Php 200,000.00 with 5%

interest per annum. Mario records all interest every month. Prepare the
adjusting entry for the month of September 2017.
Date Account Titles and Explanations Debit Credit