Ateneo de Zamboanga University

ACCOUNTANCY ACADEMIC ORGANIZATION

A School of Management and Accountancy Student Government

THE ADJUSTING PROCESS

I. Background Concepts
Companies naturally want to have regular reports as to the progress they have made. Thus,
accountants divide the economic life of a business into artificial time periods as a guide. This
assumption is known as the time period assumption.

A. Fiscal and Calendar Years

Accounting period that companies may adopt are:

Annual Periods
● Fiscal Year - The accounting time period of one year in length

● Calendar Year – Period of time equal in length to that of the year in the calendar conventionally
in use.

Interim periods
● Monthly time period

● Quarterly time period

B. Accrual- vs. Cash-basis Accounting

Accrual-basis accounting is all about recording transactions in the periods in which the
events occur. Revenues are recognized as services are performed. Expenses are recognized as these
are incurred.

Cash-basis accounting is all about recording transaction when cash is received or given
away. Revenues are recognized when cash is received. Expenses are recognized when cash is paid.

Cash-basis accounting is not in accordance with generally accepted accounting principles

(GAAP). It tend to produce misleading financial statements. It fails to record revenue when the
services were already performed but have yet to receive cash for them. As a result, expenses are not
properly matched with revenues.
.
C. Recognizing Revenues and Expenses

Time Period Assumption

Economic life of business can be divided

into artificial time periods

Revenue Recognition Principle Expense Recognition Principle

Recognize revenue in the accounting Match expenses with revenues in the

period in which the performance period when the company makes efforts
obligation is satisfied to generate those revenues

Revenue and Expense Recognition

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 Ateneo de Zamboanga University
ACCOUNTANCY ACADEMIC ORGANIZATION
A School of Management and Accountancy Student Government

II. Nature
A. The Adjusting Process – is when entries are adjusted prior to the preparation of financial
statements to update certain accounts so that they reflect correct balances as of the
designated time.
Some accounts require updating for the following reasons:
1. Some expenses are not recorded daily.
2. Some revenues and expenses are incurred as time passes rather than as separate
transactions.
3. Some revenues and expenses may be unrecorded.

B. Types of Accounts Requiring Adjustments

Two main types of accounts requiring adjusting entries:
1. Accruals- in accounting, the term “accrual” (or to “accrue”/accumulate) means to
recognize an:
a. Income that is already earned but not yet collected (Accrued revenues);or
b. Expense that is already incurred but not yet paid (Accrued expenses).

- Accruals give rise to both income and receivable (or both expense and payable).
- In accruals, all adjusting entries involve at least one balance sheet account and
one income statement account.
- In accruals, all adjusting entries affect the profit or loss for the period.

2. Deferrals- in accounting this means to defer or to delay recognizing certain revenues or

expenses on the income statement until a later, more appropriate time. Deferrals are often
applied to:
a. Income- advanced collections of income may initially be recorded using either the
(1)liability method or (2) income method.
● Liability method- under this method, cash receipts from items of income are
initially credited to a liability account. At the end of the period, the earned
portion is recognized as income while the unearned portion remains as
liability.
● Income method- under this method, cash receipts from items of income are
initially credited to an income account. At the end of the period, the unearned
portion is recognized as liability while the earned portion remains as income.
b.Expenses- payments of expenses may initially be recorded using either the (1)asset
method or (2)income method
● Asset method- under this method, cash disbursements for items of expenses
are initially debited to an asset account. At the end of the period, the incurred
portion (‘used up’ or ‘expired’) is recognized as expense while the unused
portion remains as asset.
● Expense method- under this method, cash disbursements for items of
expenses are initially debited to an expense account. At the end of the period,
the unused portion (‘not yet incurred’ or ‘unexpired’) is recognized as asset
while the incurred portion remains as expense.

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 Ateneo de Zamboanga University
ACCOUNTANCY ACADEMIC ORGANIZATION
A School of Management and Accountancy Student Government

III. Recording Adjusting Entries – Illustrations

Case #1 Accrual of income- Interest income
ABC Co. received a 12%, 100,000, one-year, note receivable on April 1, 20x1. ABC uses a calendar
year period. The principal and interest on the note are due on April 1, 20x2.

Adjusting Journal Entry:

December Interest Receivable 9,000
31, 20x1 Interest Income 9,000
Notes:
● The adjusting entry is dated as at the end of the reporting period (i.e December 31, 20x1).

● “Interest receivable” is debited because the interest is yet to be collected in the future (i.e. on
April 1, 20x2).
● In 20x1, interest income is recognized only for the expired period (time passed) of April 1 to
December 31, 20x1. Interest converting the remaining 33 months of January 1 to March 31,
20x2 will be recognized in the next accounting period. This is an application of the time
period concept.
In the next accounting period, the collection of the interest is recorded as follows:
April 1, Cash 12,000
20x2 Interest Income 3,000
Interest Receivable 9,000

Case #2 Accrual of Expense- Interest expense

ABC Co. issued a 12%, 100,000, one-year, note payable on October 1, 20x1. The principal and
interest are due on October 1, 20x2.

Adjusting Journal Entry:

December Interest Expense 3,000
31, 20x1 Interest payable 3,000
Notes:
● Interest payable is credited because the interest is yet to be paid in the future (i.e., Oct. 1
20x2).
● In 20x1, interest expense is recognized only for the expired period (time passed) – October 1
to December 31, 20x1. Interest covering the remaining 9 months of January 1 to October 31,
20x2 will be recognized in the next accounting period.
In the next accounting period, the collection of the interest is recorded as follows:
April 1, Interest payable 3,000
20x2 Interest expense 9,000
Cash 12,000

Case #3 Deferrals of Income- Liability vs Income method

A business rents out its building to various tenants. On April 1, 20x1, the business received one-year
rent in advance of 120,000 from one of its tenants. Rent per month is 10,000.

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 Ateneo de Zamboanga University
ACCOUNTANCY ACADEMIC ORGANIZATION
A School of Management and Accountancy Student Government

The receipt of the advance rent is recorded as follows:

Liability method Income method

April 1, 20x1 April 1, 20x1
Cash 120,000 Cash 120,000
Unearned Rent 120,000 Rent Income 120,000

The adjusting entries on December 31, 20x1 are as follows:

Liability method Income method
December 31, 20x1 December 31, 20x1
Unearned Rent 90,000 Rent income 30,000
Rent Income 90,000 Unearned Rent 30,000

Case #4 Deferrals of Expense- Asset vs. Expense method

A business prepays one-year insurance for 120,000 on October 1, 20x1.

The receipt of the advance rent is recorded as follows:

Asset method Expense method
October 1, 20x1 October 1, 20x1
Prepaid insurance 120,000 Insurance Expense 120,000
Cash 120,000 Cash 120,000

The adjusting entries on December 31, 20x1 are as follows:

Asset method Expense method
December 31, 20x1 December 31, 20x1
Insurance expense 30,000 Prepaid Insurance 90,000
Prepaid insurance 30,000 Insurance Expense 90,000

Summary on Accruals and deferrals:

Accrual
● To recognize income that is already
earned but not yet collected.
● To recognize expense that is already
incurred but not yet paid.
Deferral
● To postpone the income recognition of an
advance collection. The advance
collection is treated as liability until
earned.
● To postpone the expense recognition of a
prepayment. The prepayment is treated
as asset until incurred.

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MERGEFORMA
 Ateneo de Zamboanga University
ACCOUNTANCY ACADEMIC ORGANIZATION
A School of Management and Accountancy Student Government

Case #5 Depreciation
A building with an estimated useful life of 30 years finished construction on June 1, 20x1. The cost
of the building is 4.8 million pesos with an estimated salvage value of P300,000.

Adjusting Journal Entry:

December Depreciation Expense 87,500
31, 20x1 Accumulated Depreciation- Building 87,500

● In 20x1, depreciation expense is recognized only for the expired period (time passed) – June
1 to December 31, 20x1.
● The accumulated depreciation account is credited because it is a contra asset account. Thus, it
will be deducted from its related asset.

Case #6 Doubtful Accounts

Accounts Receivable shows a balance of P100,000. It is estimated that 8% of this is uncollectible.
Give the adjusting journal entry on December 31, 20x1 for the provision of the estimated
uncollectible account.

Adjusting Journal Entry:

December Bad Debts Expense 8,000
31, 20x1 Allowance for Bad Debts 8,000

● The allowance for bad debts account is credited because it is a contra asset account. Thus, it
will be deducted from its related receivable.

IV. Recording Adjusting Entries – Practice Problems

a. Prepaid Expenses
The December 31, 2014, unadjusted trial balance of Liverpool Co. indicates a balance in the supplies
account of $1,900. In addition, the prepaid insurance account has a balance of $3,600.
Assume that on December 31 the amount of supplies on hand is $450 and that the debit balance of
$3,600 in Liverpool Co’ prepaid insurance account represents a December 1 prepayment of insurance
for 12 months.

b. Unearned Revenues
The December 31, 2014, unadjusted trial balance of Boston Inc. indicates a balance in the unearned
rent account of $510. This balance represents the receipt of three months’ rent on December 1 for
December, January and February. Show the adjusting entry at the end of December.

c. Accrued Revenues
Assume that EsurientZita. signed an agreement with Reteche Co. on December 15. The agreement
provides that EsurientZita will answer computer questions and render assistance to Reteche Co.’s
employees. The services will be billed to Reteche Co. on the fifteenth of each month at a rate of $20
per hour. As of December 31, EsurientZita had provided 25 hours of assistance to Reteche Co.

d. Accrued Expenses

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MERGEFORMA
 Ateneo de Zamboanga University
ACCOUNTANCY ACADEMIC ORGANIZATION
A School of Management and Accountancy Student Government

GreatGatsby pays its employees biweekly. During December, GreatGatsby paid wages of $950 on
December 13 and $1,200 on December 27. As of December 31, GreatGatsby owes $250 of wages for
Monday and Tuesday, December 30 and 31.
December
Sun Mon Tue Wed Thu Fri Sat
1 2 3 4 5 6 7
8 9 10 11 12 13 14
15 16 17 18 19 20 21
22 23 24 25 26 27 28
29 30 31

e. Depreciation Expense
The estimated amount of depreciation on equipment for the current year is $120. Journalize.

**Key notes on Depreciation:

● Depreciation is the process of allocating the cost of an asset to expense over its useful life.

● Depreciation is an allocation concept, not a valuation one. It allocates an asset’s cost to the
periods in which it is used. Depreciation does not attempt to report the actual change in the
value of the asset.
● Accumulated Depreciation is a contra asset account that keeps track of the total amount of
depreciation expense taken over the life of the asset

**Formulas :
Cost - Salvage Value_
Useful Life Depreciable cost – Accumulated Depreciation = Book Value

IV. Summary of Adjustment Process

Asset Method
a. Prepaid Expenses
Expense xx
Asset xx
b. Unearned Revenues
Liability xx
Revenue xx
c. Accrued Revenues
Asset xx
Revenue xx
d. Accrued Expenses
Expense xx
Liability xx
e. Depreciation
Expense xx
Contra Asset xx

Expense Method
a. Prepaid Expenses

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 Ateneo de Zamboanga University
ACCOUNTANCY ACADEMIC ORGANIZATION
A School of Management and Accountancy Student Government

Asset xx
Expenses xx
b. Unearned Revenues
Revenue xx
Liability xx

**No expense methods for accruals as no entries occur before companies make these types of
adjusting entries

V. Adjusted Trial Balance - prepared after all adjusting entries have been journalized and posted.
It shows the balances of all accounts at the end of the accounting period and the effects of all
financial events that have occurred during the period. It proves the equality of the total debit and
credit balances in the ledger after all adjustments have been made. Financial statements can be
prepared directly from the adjusted trial balance.

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