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LESSON 01

Adjusting Entries
LEARNING OBJECTIVES
Discuss the concept of
adjusting entry
LEARNING OBJECTIVES
Identify the purposes of
adjusting entry
LEARNING OBJECTIVES
Identify the major
classifications of
adjusting entry
RECALL
Do you remember the first
half of the Accounting
Cycle?
THE ACCOUNTING CYCLE
Identifying
Journalizing
Posting
Trial Balance
Adjusting Entries
Financial Statements
Closing Entries
Post-Closing Trial Balance
Reversing Entries
ADJUSTING ENTRIES

These are made usually in the end of


the accounting period to update the
account. In other words, adjusting
entries are prepared merely to update
the balances of the accounts.
ADJUSTING ENTRIES
Adjusting entries can never be equated
with correcting entry.
Example

A business purchased office supplies in


form of 10 reams of bond paper at
₱300 per ream, or a total amount of
₱3000 on September 1, 2016.
Journal Entry

Office supplies 3,000


Cash in bank 3,000
Adjusted Journal Entry

Office supplies expense 2100


Office supplies 2100
Overview of the Accounting Process

1) Journal
2) Postings
3) Adjusting entries
IMPORTANT CONCERNS: 13

»1. Accounting period


»The normal balances of accounts
»The real and nominal accounts
PURPOSES OF ADJUSTING
ENTRIES
 Update balances of some
accounts
 Match properly the revenues
against expenses during the
period
 Communicate to intersested
users the information about the
business operation throught
financial statements
CUT-OFF PERIOD

This refers to the accounting period


where all accounting elements are
sorted or segregated.
CUT-OFF PERIOD
1) Calendar year

2) Fiscal year
CUT-OFF PERIOD

The relevance of cut-off period in relation


to adjusting entry is that this is the only
time adjusting entries are prepared. This is
the primary reason why adjusting entries
are called “end of the period adjustments”.
KINDS OF ADJUSTING ENTRIES
ACCRUALS
ACCRUALS

1) Accrual of Expenses
2) Accrual of Income
Accrued Expenses

Expenses that have been incurred but


are not yet paid as of the cut-off date.
These are recognized in the period
regardless of the date of payment.
Accrued Expenses
Examples:

1) Unpaid salaries
2) Unpaid interest expense
3) Unpaid utilities
Pro-forma Adjusting Entry

Expensesaccount xxx
Accrued Expenses/
Expense Payable xxx
Pro-forma Adjusting Entry

Expense account xxx


Liablility account xxx
Example
For the month of December 2016, Gray
Electronic Repair Services used a total of
$1,800 worth of electricity and water. The
company received the bills on January 10,
2017. When should the expense be recorded,
December 2016 or January 2017?
Answer

December 2016.
Example:
On December 30,2016, the Angel Consultancy hired
a daily wage worker for the maintenance of the
office. Angel follows the calendar year as the
accounting period. The daily wage of the worker is
P300 or a weekly salary of P1800 for six days except
Sundays. Angel Consultancy adopts a weekly salary
scheme, and pays every Saturday.
Example:

Lets assume in the calendar that December


30,2016 falls on Monday. This would imply that
December 31,2016 falls on Tuesday which is the
end of the accounting period.

What are the implications?


They imply the following:

1.Starting Dec 30,2016 salaries expense are


incurred daily

2.Cut-off accounting records is December 31,2016

3.Payment of weekly salary is on January 4,2017


30

Salaries Expense 600


Salaries Payable 600
Accrued Income

Income that is earned but not yet


received or collected.
Pro-forma Entry

Receivable/Accrued Income xxx


Income account xxx
Pro-forma Adjusting Entry

Accrued revenue xxx


Revenue account xxx
Example
Jayvee’s Hotel admitted a tenant who will occupy
a room with a monthly rate of P12000 on
December 20, 2016 for 6 months. Princess will
be paid every 20th of the month.

How much is the rental income to be recognized


on December 31,2016?
Answer

Accrued Rental Income 4000


Revenue Income 4000
DEFERRALS
DEFERRALS

1) Prepaid expense
2) Unearned revenue
Prepaid Expenses
1) Prepaid insurance
2) Prepaid advertising
3) Prepaid rent
4) Prepaid interest
5) Supplies on hand
Prepaid Expenses

1) The prepayment has been partly


utilized, or
2) The prepayment has been fully
utilized.
2 Methods of Recording
Prepayments

1) Expense method
2) Asset method
Expense Method

The term “expense” implies that this


method uses Expense account at the
time of payment.
Expense Method
Nature of Transaction Expense account title
Payment of advertising Advertising expense
Payment of insurance Insurance expense
Payment of rent Rent expense
Payment of supplies Supplies expense
Payment of interest Interest expense
EXAMPLE:
On March 1, 2016, Jocelyn
Watch Repair Shop paid the
rental for six months amounting
to P30 000. The business follows
the calendar year.
Journal Entry

Rent expense 30000


Cash On hand 30000
Example #2 45

»On September 1, 2016, Abby Repair Services paid


the rental for one year amounting to P72 000. The
business follows the calendar year:

Rent Expense 72 000


Cash on Hand 72000
ADJUSTING ENTRY 46

Prepaid Rent 48 000


Rent Expense 48 000
Pro-forma Entry for Prepayment 47

Transactions Journal Entries and


Adjusting Entries
Payment of expenses at Expenses xxxx
the time of payment Cash xxxx
Adjusting entry on Cut-off Prepaid Expense xxxx
date Expenses xxxx
Asset Method

The term “asset” implies that this


method uses asset account at the time
of payment.
Asset Method
Nature of Transaction Asset account title
Payment of advertising Prepaid advertising
Payment of insurance Prepaid insurance
Payment of rent Prepaid rent
Payment of supplies Unused supplies
Payment of interest Prepaid interest
EXAMPLE 50

On March 1,2016, Jocelyn Watch Repair Shop paid the rental for
six months amounting to P30 000. The business follows the calendar
year.

Prepaid Rent 30 000


Cash On Hand 30 000
ADJUSTING ENTRY: 51

Rent Expense 30 000


Prepaid Rent 30 000
DEFERRALS
UNEARNED REVENUE
Are advance cash collection for services expected to be
renderes in the future
Unearned Revenue

1) Commission colected in advance


2) Interest collected in advance
3) Rental collected in advance
4) Advertising collected in advance
2 Methods of Recording Precollections

1) Revenue/Income method
2) Liability method
Revenue Method

The term “revenue” implies that this


method uses Revenue account at the
time of collection.
Revenue Method
Nature of Transaction Revenue account title
Commission paid in advance Commission revenue

Interest paid in advance Interest revenue

Rent paid in advance Rental revenue

Advertising paid in advance Advertising revenue


Example:

On April 1,2016, HYZEL Broadcasting station


received P36,000 from a customer for the
advertisement. This transaction gives rise to
a liability for the business to render
advertising service for the next six months.
Journal Entry

Cash on hand 36 000


Advertising Income 36 000

What is the adjusting entry on December 31,2016?


EXAMPLE #2
On April 1,2016, HYZEL Broadcasting 60
Station received P90 000 from a customer
for the advertisement of a product. The
amount is intended to cover the next 15
months period starting April 2016.

Cash on hand 90 000


Advertising Income 90 000
»Is there a need to update Advertising
Income?

»What is the adjusting entry on the


December 31, 2016, if any?
The adjusting entry 62

Advertising Income 36 000


Precollected or Unearned
Advertising Income 36 000
Liability Method

The term “liability” implies that this


method uses Liability account at the
time of collection. This is also called as
the real approach.
Liability Method
Nature of Transaction Liability account title
Commission paid in advance Unearned commission revenue

Interest paid in advance Unearned interest revenue

Rent paid in advance Unearned rental revenue

Advertising paid in advance Precollected advertising revenue


Journal Entry

Cash in bank xxx


Unearned revenue xxx
Adjusted Journal Entry

Unearned revenue xxx


Revenue account xxx
EXAMPLE: 67

On April 2016, HYZEL Broadcasting station received P36000


from a customer for the advertisement of a product. The amount is
intended to cover a six-month period starting April 2016

Cash in bank 36,000


Unearned Advertising
Revenue 36,000
Adjusted Journal Entry

Unearned Advertising Income 36000


Advertising Income 36000
KINDS OF ADJUSTING ENTRIES
ESTIMATES
ESTIMATES

1) Provision for depreciation


2) Provision for bad debts
DEPRECIATION
DEPRECIATION

The reduction in the value of an asset


because of the passage of time, or
wear and tear.
Example
The value of the asset in 2016 is
₱1,000,000. On account of daily usage,
the value goes down to ₱850,000 by
year 2017. The reduction in value,
₱150,000, is technically called the
depreciation.
DEPRECIATION
Its concept applies to the ff. assets:
1) Building
2) Machinery
3) Furniture and fixtures
4) Office equipment
5) Store equipment
DEPRECIATION

Assets that depreciate are called


Depreciable assets.
Elements of Depreciation

1) Cost
2) Salvage value
3) Useful life
STRAIGHT LINE METHOD

This is based on the assumption that the


cost of asset is equally divided over its
useful or productive life. In other words,
the entire productive life of the asset will
have equal amounts of depreciation.
EXAMPLE

Office Furniture P10,500


Scrap Value 500
Estimated Useful Life 5 years

The asset was acquired on January 2,2007


ADJUSTING ENTRY

Depreciation expense P2,000


Accumulated depreciation – office furniture P2.000
 Straight-line
 Sum-of-a-year’s digit
 Declining balance
 Double declining balance
METHODS
 Output method OF
 Retirement method
 Replacement method
COMPUTING
 Composite method DEPRECIATION
Pro-forma Journal Entry

Depreciation expense – Fixed Assets xxx


Accumulated depreciation – Fixed Assets xxx
Terms

1) Depreciable cost
2) Accumulated depreciation
3) Book value
Depreciable cost
This is equal to the difference between cost and
residual value.

Cost xxx
Less: Estimated residual value xxx
_________________________________________
Depreciable cost xxx
Accumulated depreciation

This is the sum of depreciation in direct relation


with the expired life of the asset. It increases
every time the life of the asset expires.
86

For example, if a business’


machinery has a depreciation
cost of ₱2,800,000 with
estimated life of 10 years:
Accumulated depreciation
Depreciable cost
Annual depreciation =
Estimated useful life
₱2,800,000
Annual depreciation =
10
Annual depreciation = ₱280,000
Book Value

This is the difference between the cost and


accumulated depreciation. The book value
decreases every time its useful life expires.
STRAIGHT LINE DEPRECIATION
Cost of the machinery ₱3,000,000
Less: Salvage value ₱200,000
Accumulated depreciation: ₱2,800,000
Year Annual depreciation Accumulated depreciation Book Value
2016
2017
2018
2019
STRAIGHT LINE DEPRECIATION
Cost of the machinery ₱3,000,000
Less: Salvage value ₱200,000
Accumulated depreciation: ₱2,800,000
Year Annual depreciation Accumulated depreciation Book Value
2016 280,000 280,000 2,720,000
2017 280,000 560,000 2,440,000
2018 280,000 840,000 2,160,000
2019 280,000 1,120,000 1,880,000
ESTIMATES
DOUBTFUL ACCOUNTS

These are customers’ accounts arising


from sales of goods and services on
credit, but become doubtful in
collectibility.
DOUBTFUL ACCOUNTS

Businesses, in order to generate more


revenues, usually extend credit to
customers.
DOUBTFUL ACCOUNTS
Reasons why credits are not totally collected:

1) Debtor loses capacity to pay


2) Customer is not willing to pay
3) Customer cannot be located anymore in the
designated address
4) Customer dies
Pro-forma Journal Entry

Doubtful accounts xxx


Allowance for doubtful accounts xxx
Pro-forma Journal Entry

Bad debts xxx


Allowance for doubtful accounts xxx
BASIS
FOR
ESTIMATING
DOUBTFUL
ACCOUNTS
BASIS FOR ESTIMATING DOUBTFUL ACCOUNTS

Doubtful accounts are computed based on the ff.:

1) As a percent of sales or service income


2) As a percent of accounts receivable
3) Based on aging of accounts receivable
Percent of Sales

The basic mathematical process appears as follows:

Total credit sales or revenue xxxx


Multiplied by percent of doubtful accounts xxxx
Doubtful accounts or Bad debts xxxx
Example
On December 31, 2016, Nicandro II Service Shop provided
the following information:
Service income ₱3,500,000
Accounts receivable 2,100,000
Allowance for doubtful accounts 50,000

Required: 1) Compute the doubtful account expense


2) Prepare the adjusting entry.
Answer 1

The doubtful accounts expense is computed as follows:

Service income ₱3,500,000


Multiplied by: Doubtful accounts rate 5%
Doubtful accounts expense ₱175,000
Answer 2
The adjusting entry appears as follows:

Doubtful accounts 175,000


Allowance for doubtful accounts 175,000
Percent of Accounts Receivable

The basic mathematical process appears as follows:

Outstanding accounts receivable xxxx


Multiplied by percent of doubtful accounts xxxx
Doubtful accounts or Bad debts xxxx
Example
On December 31, 2016, Nicandro II Service Shop provided
the following information:
Service income ₱3,500,000
Accounts receivable 2,100,000
Allowance for doubtful accounts 50,000

Required: 1) Compute the doubtful account expense


2) Prepare the adjusting entry.
Answer 1

The doubtful accounts expense is computed as follows:

Outstanding accounts receivable ₱2,100,000


Multiplied by: Doubtful accounts rate 5%
Required allowance of doubtful accounts ₱105,000
Answer 1

The doubtful accounts expense is computed as follows:

Required allowance of doubtful accounts ₱105,000


Less: Doubtful accounts rate 50,000
Doubtful accounts expense ₱55,000
Answer 2
The adjusting entry appears as follows:

Doubtful accounts 55,000


Allowance for doubtful accounts 55,000
NET REALIZABLE VALUE
Refers to the value of the receivable after deducting the
allowance for doubtful accounts from the outstanding
balance.

Accounts Receivable ₱2,100,000


Less: Allowance for doubtful expense - Ending 105,000
Net realizable value ₱1,995,000