ADJUSTING ENTRIES

FUNDAMENTALS OF ACCOUNTANCY, BUSINESS AND MANAGEMENT-1

TYPES OF ADJUSTING ENTRIES

• Entries prepared at the end of the accounting period to

update some common accounts and ensure their accuracy
before preparing the financial statements.
• All adjusting entries affect at least one income statement
and one balance sheet account. An adjusting entry will
always involve a revenue or an expense account and an
asset or a liability account.
ADJUSTING ENTRIES

• Depreciation
• Bad Debts
• Prepaid Expenses
• Accrued Expense
• Unearned Revenue
• Accrued Revenue
DEPRECIATION

• Is applied to components of property, plant and

equipment
• The process of allocating the depreciable cost of a fixed
asset over its estimated useful life.
• The accumulated amount of depreciation expense from
the year of recognition to the latest balance sheet date is
referred to as accumulated depreciation
DEPRECIATION

The pro-forma adjusting entry to take up depreciation of fixed asset follows:

Depreciation Expense (name of asset) xxx
Accumulated Depreciation expense (name of asset) xxx

The amount debited to Depreciation Expense is that potion of fixed asset

cost that is charged to expense. Accumulated Depreciation is a contra-
asset. The credit is not made directly to the fixed asset account to preserve
the original cost of the fixed asset.
DEPRECIATION

Illustration:
On January 2, 2010, DEF Company bought an equipment for a total cost
of P500,000. Its estimated useful life is 10 years and estimated residual
value is P50,000. The company is using the straight-line method of
computing depreciation.
To record the purchase of equipment on January2, the enry will be made as
follows:
2010
Jan 2 Equipment --------------------500,000
Cash -------------------------------500,000
DEPRECIATION

To take up the depreciation expense on December 31, 2010, the adjusting

entry follows:
Under straight-line method, Depreciation is computed as follows:
Cost of fixed asset (equipment) ---------------------P 500,000
Less: estimated residual value ----------------------- 50,000
Depreciable cost -------------------------------------- P 450,000
Divided by the estimated useful life---------------- 10 years
Annual Depreciation --------------------------------P 45,000
FACTORS TO BE CONSIDERED IN COMPUTING DEPRECIATION
(USING THE STRAIGHT-LINE METHOD)

1. Asset Cost – This includes its purchase price plus other direct
costs incurred in acquiring and bringing the asset to its
intended use. Examples of these other costs include freight
and installation cost.
2. Estimated Residual Value - This is the estimated amount of
fixed asset can be sold at the end of its useful life. Other
terms used are salvage value, scrap value, or trade in value.
3. Estimated Useful Life – This may be expressed in years or
number of units, or hours that the asset can be used.
SEVERAL METHODS OF COMPUTING DEPRECIATION

1. Straight-line method
2. Sum-of-the years digit
method
3. Declining balance method
4. Units of production method
ADJUSTING ENTRIES TO TAKE UP PROVISION FOR
UNCOLLECTIBLE ACCOUNTS (BAD DEBTS)

Uncollectible Accounts or Bad Debts relates to the company’s receivables

which might not be collected. Extending credit or rendering services on
account is normal in business operations. To comply with matching
principles, companies prepare adjusting entry to recognize the anticipated
loss that the business might incur arising from these uncollectible accounts.
The pro-forma adjusting entry to take up the provision for uncollectible
accounts follows:

Uncollectible Accounts Expense or Bad Debts Expense xxx

Allowance for Uncollectible Accounts xxx
ADJUSTING ENTRIES TO TAKE UP PROVISION FOR
UNCOLLECTIBLE ACCOUNTS (BAD DEBTS)

Let us assume that on December 31, 2010, the end of company’s annual
accounting period, the company has outstanding Accounts Receivable of
P400,000. The company estimates that 4% of these receivables might not be
collected.
The adjusting entry will be prepared by the company on December
31,2010 is:

Uncollectible Accounts Expense-----------------------16,000

Allowance for Uncollectible Accounts---------------------16,000
ADJUSTING ENTRIES TO TAKE UP PROVISION FOR
UNCOLLECTIBLE ACCOUNTS (BAD DEBTS)

Alternatively, Doubtful Accounts Expense may also be used

instead of Uncollectible Accounts expense or Bad Debt Expense.
Further, the allowance account should also depend on the expense
account used to record doubtful accounts. Alternative allowance
accounts may be Allowance for Doubtful Accounts and Allowance
for Bad Debts. Consistency as to the use of accounts must be
applied.
In case there is an existing allowance account balance, it has to
be considered in determining the amount for adjustment
ADJUSTING ENTRIES TO TAKE UP PROVISION FOR
UNCOLLECTIBLE ACCOUNTS (BAD DEBTS)

Let us consider the following examples and adjustments:

1. The allowance for Uncollectible Accounts has a credit balance
of P10,000.

Uncollectible Account Expense 6,000

Allowance for Uncollectible Account 6,000
P400,000 x 4% = P16,000 – 10,000=P6,000
ADJUSTING ENTRIES FOR PREPAID EXPENSES OR DEFERRED
EXPENSES

Prepaid Expenses – are expenses paid in advance. Since the benefits will
be received in the future, prepaid expenses are treated as asset. They are
expected to become expenses through the passage of time or through use and
consumption. Prepaid expense is the exact opposite of accrued expense.
Examples include Supplies, Prepaid rent, Prepaid insurance, Prepaid Interest.

The adjusting entries for prepaid expenses depend upon the method used to
record the prepayment. The two methods of recording prepaid expenses are
the Asset Method and the Expense Method.
ADJUSTING ENTRIES FOR PREPAID EXPENSES OR DEFERRED
EXPENSES

1. Asset Method – under this method, the account debited

upon payment is an asset account. Upon adjustment, an
expense account is debited with a corresponding credit
to an asset account.
2. Expense Method – under this method, the account
debited upon payment is an expense account. Upon
adjustment, an asset account is debited and an expense
account is credited.
ADJUSTING ENTRIES FOR PREPAID EXPENSES OR DEFERRED
EXPENSES

Illustrations:
1. Eastern Union Money Transfer, started business on January 2,
2010. On January 3, the company purchased office supplies
amounting to P8,000. The entry to record the purchase of the
office supplies under the asset and expense methods are:

Asset Method Expense Method

Jan 3 Office Supplies------8,000 Jan 3 Office Supplies Expense 8,000
Cash -------------------8,000 Cash -------------8,000
ADJUSTING ENTRIES FOR PREPAID EXPENSES OR DEFERRED
EXPENSES

For convenience, companies do not record the daily usage of

office supplies. To determine the amount of supplies consumed
during an accounting period, the common practice is to
determine the value of the remaining unused supplies. The
difference between the amount of supplies available for use and
the remaining unused supplies is the amount of supplies
consumed or supplies expense.
ADJUSTING ENTRIES FOR PREPAID EXPENSES OR DEFERRED
EXPENSES

If on January 31, 2010, the remaining unused office supplies

amounts to P2,000, it means that the amount of office supplies
used during the month of January amounts to P6,000.
Assuming the company adjusts and closes its book every
month, adjusting entry must be prepared, so that the balance
sheet prepared at January 31 would show Office Supplies (the
unused portion) amounting to P2,000. The income statement
for the month of January would show Offcie Supplies Expense
of P6,000 (the used portion.
ADJUSTING ENTRIES FOR PREPAID EXPENSES OR DEFERRED
EXPENSES

The adjusting entries to be prepared on January 31, 2010, the end of the company’s
accounting period are:

Asset Method
Office Supplies Expense ------------------6,000
Office Supplies ----------------------------6,000

At the end of the accounting period, the account Offie Supplies will show unadjusted
balance of P8,000 which is a Mixed Account. It is a mixed account because it
consists of the used portion which is P6,000, and unused portion which is P2,000.
The adjusting entry will split this mixed account. The used portion will be charged to
Expense and the unused portion as Asset.
ADJUSTING ENTRIES FOR PREPAID EXPENSES OR DEFERRED
EXPENSES

Failure to prepare the above adjusting entry will result to the overstatement of the account of Office
Supplies, and the understatement of the account Office Supplies Expense thereby overstating total
assets and capital. Understatement in total expenses will cause net income to be overstated thus capital
will also be overstated.

The adjusting entry under Expense Method follows:

Office Supplies --------------------------------2,000
Office Supplies Expense -------------------------2,000

If the above adjusting entry is not prepared there will be reversed effects on the elements of financial
statements.
Office Supplies Expense will be overstated, resulting to understatement of Net Income. On the other
hand, Office Supplies will be understated, thus the total assets will be understated. Because of the
understatement in net income and total assets, capital will likewise be understated.
ADJUSTING ENTRIES FOR PREPAID EXPENSES OR DEFERRED
EXPENSES

Shown below are the T-accounts of Office Supplies and Office Supplies Expense after posting the
adjusting entries.
Asset Method Expense Method

Office Supplies Office Supplies Expense

Jan 1 8,000 Jan 31 6,000 Jan 1 8,000 Jan 31 2,000
----------------------------------- -------- ---------------------------------------------
Adj. Bal 2,000 Adj. balance 6,000

Office Supplies Expense Office Supplies

--------------------------------------- --------------------------------
Jan 31 6,000 Jan 31 2,000
ADJUSTING ENTRIES FOR PREPAID EXPENSES OR DEFERRED
EXPENSES

After posting the adjusting entry, the account office Supplies will show adjusted balance of P2,000
under both methods of recording prepaid expenses. It is the same with the account Office Supplies
Expense which shows adjusted balance of P6,000 under both methods.

Whichever method the company adopts (asset method or expense method) the amount of office
supplies (asset), and the amount of Office Supplies Expense that will be reported in its January
financial statements are the same.