ADJUSTING

THE
ACCOUNTS
MS. CLAUDINE B. ESGUERRA
ACCRUAL BASIS
◦ Financial statements (except the cash flow statement) are
prepared on the accrual basis of accounting, where the
effects of transactions and other events are recorded when
they occur and not as cash (or its equivalent) is received or
paid.
◦ Revenues are recorded as they are earned
◦ Expenses are recorded as they are incurred
CASH BASIS
◦ Transactions are not recorded until cash is received or
paid.
◦ Cash receipts are treated as revenues
◦ Cash payments are treated as expenses
◦ Cash basis income is the difference between operating cash
receipts and disbursements.
Example:
A client paid the Sea REVENUE ACCRUAL CASH BASIS
ON BASIS 
Wind Resort in Boracay
APRIL 8
Island P7,000 on April 8,
2021 for a one-day super MAY 13
deluxe accommodation
on May 13, 2021.
PERIODICITY CONCEPT
Liquidation – process of going out of business; sell all
assets, pay all liabilities and return excess cash to owners;
not a practical way of measuring business performance.

Periodicity concept – dividing the economic life of a

business into artificial time periods (a month, a quarter, a
year) to provide timely information.
PERIODICITY CONCEPT
Businesses need periodic reports to assess their financial
condition and performance and the periodicity concept
ensures that accounting information is reported at regular
intervals.
To measure profit in a fair manner, entities need to update
the income and expense accounts immediately before the
end of the period.
PERIODICITY CONCEPT
◦ Fiscal year – any twelve consecutive months
◦ Calendar year -  an annual period ending on December 31
◦ Natural business year – a twelve-month period that ends
when business activities are at their lowest level of the
annual cycle
◦ Interim period – a period of less than a year
 RECOGNITION
The process of capturing an item that meets the definition of
an asset, a liability, equity, income or expenses, for inclusion in
the financial statements (balance sheet or income statement).
The amount at which an asset, a liability, equity, income or
expense is recognized in the statements is referred to as  its
"carrying amount."
 DERECOGNITION
The removal of all or part of a recognized asset or liability
from an entity's statement of financial position; normally
occurs when an item no longer meets the definition of an asset
or of a liability.
Assets – when the entity loses control of all or part of the
recognized asset.
Liabilities – when the entity no longer has a present
obligation for all or part of the recognized liability
 RECOGNITION
The recognition of income occurs at the same time as:
          the initial recognition of an asset, or an increase in the
carrying amount of an asset; or
         the derecognition of a liability, or a decrease in the
carrying amount of a liability.
 RECOGNITION
The recognition of expenses occurs at the same time as:
          the initial recognition of a liability, or an increase in the
carrying amount of a liability; or
         the derecognition of an asset, or a decrease in the
carrying amount of an asset.
 THE NEED FOR ADJUSTMENTS
• Adjusting entries are needed to measure properly the profit
for the period.
• Adjusting entries are journal entries made at the end of a
period to correct the account balances before the financial
statements are prepared. 
• Adjusting entries are used to apply accrual accounting to
transactions that cover more than one accounting period. 
• Each adjusting entry affects a balance sheet account (asset /
liability) and an income statement account (income or
expense)
 • Accruals
Types of
Adjustments • Deferrals
• Noncash adjustments
 Prepayments / Deferrals
◦  Cash payments are made prior to the actual consumption or sale of
goods and services. 
◦ When expenses are prepaid, a debit asset account is created
together with the cash payment. 
◦ The adjusting entry is made when the goods or services are actually
consumed, which recognizes the expense and the consumption of the
asset.

"Deferred Expense : an expense already Paid but Not yet incurred"

 Prepayments / Deferrals
Prepaid Insurance and Prepaid Rent are common examples of deferrals.
7/1 Prepaid Rent 72,000

          Cash 72,000

To record the rent for 8 months paid in advance

12/31 Rent Expense 54,000

       Prepaid Rent 54,000

To adjust prepaid rent

PREPAID RENT RENT EXPENSE CASH

7/1 Prepaid Rent 72,000

          Cash 72,000
To record the rent for 8 months paid in
advance

12/31 Rent Expense 54,000

       Prepaid Rent 54,000
To adjust prepaid rent
 Prepayments / Deferrals
◦ Cash collections are made prior to the actual delivery or provision of
goods and services. 
◦ When a collection for services that have yet to be rendered is made,
a credit liability account is created together with the cash collection. 
◦ The adjusting entry is made when the goods or services are delivered
or provided, which recognizes the revenue and the reduction of the
liability.

"Deferred Revenue: a revenue already Collected but Not yet earned"

Prepayments / Deferrals
◦ Unearned Revenue (L) will decrease once the firm renders the
service or delivers the good to the customer.
11/1 Cash 65,000

          Unearned Revenue 65,0000

To record the receipt of cash from a customer for 5

months' worth of services

12/31 Unearned Revenue 26,000

       Service Revenue 26,000

To adjust unearned revenue

 UNEARNED REVENUE SERVICE REVENUE CASH

11/1 Cash 65,000

          Unearned Revenue 65,0000
To record the receipt of cash from a customer for 5
months' worth of services

12/31 Unearned Revenue 26,000

       Service Revenue 26,000
To adjust unearned revenue
Accruals
◦ An accrued expense is the expense that has been incurred (goods
or services have been consumed) before the cash payment has
been made. 
◦ Examples include utility bills, salaries, and taxes, which are usually
charged in a later period after they have been incurred.
◦ When the cash is paid, an adjusting entry is made to remove the
account payable that was recorded together with the accrued
expense previously.
"Accrued Expense : an expense already Incurred but Unpaid" 
Accrued Expenses
11/30 Utilities Expense 25,000

          Utilities Payable 25,0000

To record receipt of electricity bill for the month of

November

12/15 Utilities Payable 25,000

       Cash 25,000

To record payment of utilities

 UTILITIES EXPENSE UTILITIES PAYABLE CASH

11/30 Utilities Expense 25,000

          Utilities Payable 25,0000
To record receipt of electricity bill for the month of
November

12/15 Utilities Payable 25,000

       Cash 25,000
To record payment of utilities
Accruals
◦ An accrued revenue is the revenue that has been earned (goods or
services have been delivered), while the cash has neither been
received nor recorded. A typical example is credit sales.
◦ The revenue is recognized through an accrued revenue account and
a receivable account.
◦ When the cash is received at a later time, an adjusting journal entry
is made to record the payment for the receivable account.

"Accrued Revenue : a revenue already Earned but Uncollected" 

Accrued Revenue
9/15 Accounts Receivable 150,000

          Service Revenue 150,0000

To record the services rendered on account

12/15 Cash 150,000

       Accounts Receivable 150,000

To record receipt of customer's payment

 UNEARNED REVENUE SERVICE REVENUE CASH

9/15 Accounts Receivable 150,000

          Service Revenue 150,0000
To record the services rendered on account

12/15 Cash 150,000

       Accounts Receivable 150,000
To record receipt of customer's payment
Noncash Adjustments
◦ When the exact value of an item cannot be easily identified,
accountants must make estimates, which are also reported as
adjusting journal entries. 
◦ A common example is depreciation expenses for property, plant and
equipment, which is estimated based on depreciation schedules
with assumptions on useful life and residual value.
◦ A depreciation expense is usually recognized at the end of each
month or at the end of the period.
Depreciation
12/31 Depreciation Expense - Building 500,000

          Accumulated Depreciation - Building 500,000

To record the depreciation for building during the year

12/31 Depreciation Expense - Equipment 180,000

          Accumulated Depreciation - Equipment 180,000

To record the depreciation for equipment during the

year
DEPRECIATION ACCUMULATED DEPRECIATION ACCUMULATED
EXPENSE DEPRECIATION - EXPENSE DEPRECIATION -
- BUILDING BUILDING - EQUIPMENT EQUIPMENT

12/31 Depreciation Expense - Building 500,000

          Accumulated Depreciation - Building 500,000
To record the depreciation for building during the year

12/31 Depreciation Expense - Equipment 180,000

          Accumulated Depreciation - Equipment 180,000
To record the depreciation for equipment during the
year
Allowance for Doubtful Accounts
◦ Identifies the part of receivables that the company does not expect
to be able to collect. It is a contra-asset account that reduces the
value of the receivables. When it is definite that a certain amount
cannot be collected, the previously recorded allowance for the
doubtful account is removed, and a bad debt expense is recognized.
12/31 Bad Debts Expense 10,000

        Allowance for Doubtful Accounts 10,000

To record doubtful accounts for the period
 ALLOWANCE
ACCOUNTS BAD DEBTS FOR DOUBTFUL
RECEIVABLE EXPENSE ACCOUNTS

12/31 Bad Debts Expense 10,000

        Allowance for Doubtful Accounts 10,000

To record doubtful accounts for the period
Straight-line Method
◦ This is the most commonly used method to calculate depreciation.
Under this method, an equal amount is charged for depreciation of
every fixed asset in each of the accounting periods. This uniform
amount is charged until the asset gets reduced to nil or its salvage
value at the end of its estimated useful life.
◦ The amount of depreciation is calculated by simply dividing the
difference of original cost or book value of the fixed asset and the
salvage value by useful life of the asset.
Straight-line Method
◦ The formula for annual depreciation under straight line method is
as follows:
◦ Annual Depreciation Expense = (Cost of an asset – Salvage
Value)/Useful life of an asset
◦ Where:
◦ Cost of the asset is purchase price or historical cost
◦ Salvage value is value of the asset remaining after its useful life
◦ Useful life of the asset is the number of years for which an asset is
expected to be used by the business
Example:
The company bought an
Equipment for P5,000,000.
Its estimated useful life is
10 years and a salvage
value of P100,000.
Declining Balance Method
◦ A fixed percentage of depreciation is charged in each accounting
period to the net balance of the fixed asset under this method. This
net balance is nothing but the value of asset that remains after
deducting accumulated depreciation.
◦ The depreciation rate is charged on the reducing balance of the
asset. This asset is the one reflected in the books of accounts at the
beginning of an accounting period. So, the book value of the asset
is written down so as to reduce it to its residual value.
Declining Balance Method

◦Depreciation Expense = Book value of

asset at beginning of the year x Rate of
Depreciation
Example:
The company
YEA PARTICULAR DEP. EXPENSE ACC. DEP'N CARRYING
bought an R AMOUNT

Equipment for 1
2
P500,000. Its
3
estimated useful 4
5
life is 5 years
and a salvage
value of P50,000.
Sum of Years’ Digits Method
 This method recognizes depreciation at an accelerated rate. The
depreciable amount of an asset is charged to a fraction over different
accounting periods under this method.
This fraction is the ratio between the remaining useful life of an asset in a
particular period and sum of the years’ digits. As an asset moves
towards the end of its useful life, the benefit gained out of such an asset
declines. That is to say, highest amount of depreciation is allocated in
the first year since no amount of capital has been recovered till then.
Accordingly, least amount of depreciation should be charged in the last
year as major portion of capital invested has been recovered.
Sum of Years’ Digits Method
Sum of Years’ Digits Depreciation Formula

Depreciation Expense = Depreciable Cost x (Remaining useful life

of the asset/Sum of Years’ Digits
where :
depreciable cost = Cost of asset – Salvage Value
Sum of years’ digits = [n(n +1)] /2 
n = useful life of an asset
Example:

The company
YEA PARTICULAR DEP. EXPENSE ACC. DEP'N CARRYING
bought R AMOUNT

a machine for 1
2
P430,000. Its
3
estimated useful 4

life is 4 years and

a salvage value
of P30,000.
 Unit of Production Method
Unit of production depreciation calculates depreciation based on
the unit of production and ignores the passage of time over the
useful life of an asset, in other words, unit of production
depreciation is directly proportional to production. It is mainly
used in the manufacturing sector.
The value of the same asset may be different due to its usage. For
example, one asset X produce 10 units, and another asset Y
produce 20 units, both are the same asset, but the depreciation
of Y will be higher as compared to X asset because of more unit
produced.
Unit of Production Method
Example:
The company bought an
Equipment for P5,000,000.
Its estimated useful life is
10 years and a salvage
value of P100,000. Its total
estimated output is
2,500,000 units. During the
1st year, they produced
232,150 units; 197,855 on
the 2nd year; and 274,330
units on the 3rd year.