ADJUSTING ENTRIES

Financial transactions affect the revenues and expenses of more than one accounting period

ADJUSTING JOURNAL ENTRIES – entries required at the end of the period to update the accounts before financial statements are prepared

Purposes To record any revenue earned or expense incurred that

have not been recorded prior to the end of the period To apportion revenues and expenses properly between

accounting periods affected

Characteristics Adjusting entries are based on the concepts of accrual

accounting - states that revenue should be recognized when earned, regardless when cash is received and expenses be recognized when incurred, regardless when cash is paid

Every adjusting entry involves the recognition of either revenues or expenses and a corresponding change in either assets or liabilities

Adjusting Entries and Generally Accepted Accounting Principles

Revenue Realization principle – states that revenue should be recognized at the time goods are sold or services are rendered

Matching Principle – states that revenue earned during an accounting period is matched with the expenses incurred in generating this revenue

Year-End Adjustments1. Accrued Expense2. Accrued Income3. Prepaid Expense4. Unearned Income5. Depreciation6. Doubtful Accounts

ADJUSTING ENTRIES

1. Accrued expense – expenses incurred but not yet paid.

Purpose To record unrecognized expense

Adjustment required Recognizes expense incurred but not yet paid Records liability account

AJE: Expense xxxLiability xxx

to record accrued expense

TYPE OF ADJUSTME

NT

REASON FOR ADJUSTMEN

T

ACCOUNTS BEFORE

ADJUSTMENT

ADJUSTING ENTRY

Accrued Expense

Expenses have been incurred but not yet paid in cash or not yet recorded

Expenses UnderstatedLiabilities Understated

Dr. Expense Cr. Liability

Ex. The company failed to pay October-December rent, P12,000.

Adjusting EntryRent expense 12,000 Rent Payable 12,000To record accrued rent expense

2. Accrued income – income already earned but not yet collected.

Purpose To record unrecognized revenue

Adjustment required Recognizes revenue earned but not yet recorded Records asset account

AJE: Asset (Receivable) xxxRevenue xxx

to record accrued income

TYPE OF ADJUSTME

NT

REASON FOR ADJUSTMENT

ACCOUNTS BEFORE

ADJUSTMENT

ADJUSTING ENTRY

Accrued Income

revenue already earned but not yet collected or not yet recorded

Asset UnderstatedRevenue Understated

Dr. Asset Cr. REvenue

Ex. Services rendered was not yet recorded and paid amount to P20,000.

Adjusting EntryAccounts receivable 20,000 Service income 20,000To record accrued income

3. PREPAID EXPENSES – expenses already paid but not yet incurred or expenses paid in advance.

Ex. Paid rent for 1 year, P60,000. The place was occupied on August 1, 2011. Prepare adjustment as of December 31, 2011.Asset MethodAdjusting EntryRent expense 25,000 Prepaid Rent 25,000To record rent expense

Expense Method

Adjusting EntryPrepaid Rent 35,000 Rent expense 35,000To record rent expense

4. UNEARNED REVENUE – cash already received (collected) but services are not yet rendered.

Ex. Collected rent for 1 year, P60,000. The place was occupied on October 1, 2011. Prepare adjustment as of December 31, 2011.

Revenue MethodAdjusting EntryRent revenue 15,000 Unearned Rent revenue 15,000To record unearned rent.

Liability Method

Adjusting Entry

Unearned Rent revenue

45,000

Rent revenue 45,000To record rent income

5. DEPRECIATION – gradual decrease in value of fixed assets due to use, inadequacy (decrease in value caused by a business expansion such that the asset although in good condition can no longer fulfill the needs of the business) and obsolescence (decrease in value caused by introduction of new models or inventions)

Depreciation Expense – assigned portion of the cost of fixed asset to the period during which it is used.

Accumulated Depreciation – total accumulated amount of depreciation that has been recorded for the fixed asset

Straight-Line Method – depreciation method wherein an equal portion of the asset’s cost is allocated to depreciation expense in every period of the asset’s estimated useful life

Scrap Value / Salvage Value / Residual Value – estimated amount at which the asset can be sold or exchanged at the end of its serviceable life; an estimate of the asset’s value at the end of its benefit period Depreciable Cost – difference between the cost of the fixed asset and the scrap value; amount subject to depreciation

Estimated Useful Life – estimated serviceable life of a fixed asset

Carrying Value – difference between the cost of the fixed asset and the accumulated depreciation

Computation of Depreciation

Cost P 100,000Less: Scrap Value 5,000Depreciable Cost P 95,000Divided by Useful Life 10

yearsAnnual depreciation P 9,500

Adjusting Entry Depreciation expense 9,500 Accumulated depreciation

9,500

To record depreciation.

Note : if the equipment was purchased on September 1, 2011. The adjusting entry would have been:

Adjusting Entry Depreciation expense 3,167 Accumulated depreciation

3,167

To record depreciation.

Annual depreciation P9,500If acquired 9/12 x 4/12Depreciation P3,167 =====

Notes to Financial Statement Presentation

Asset P xxxLess: Accumulated Depreciation

xxx

Carrying value P xxx =======

6. BAD DEBTS/DOUBTFUL ACCOUNTS/ UNCOLLECTIBE ACCOUNTS – loss due to worthless or bad accounts caused by unforeseen events or errors in granting credit

Methods of Accounting for Doubtful Accounts1. Allowance method – recognizes estimated losses in the

period in which the credit sales are made regardless of when the specific accounts are determined to be uncollectible

2. Direct write-off method – recognizes a loss only when specific accounts are determined to be uncollectible

Adjustment required

AJE: Bad Debts Expense xxxAllowance for Bad Debts xxx

to record bad debts

Doubtful Accounts Expense – amount of receivables estimated to be doubtful of collection

Allowance for Doubtful Accounts – a valuation account which is deducted from the Accounts Receivable

Net Realizable Value – difference between the Accounts Receivable and the Allowance for Doubtful Accounts

Method of estimating probable loss from Doubtful Accounts

a. Balance Sheet Approach1. Allowance for Bad Debts is based on percentage of

Accounts Receivable Bad debts estimate: Accounts Receivable x percent doubtful xxx

less: Allowance for Doubtful Accounts, beginning xx Adjustment xx

2. Aging of Accounts Receivable – thorough analysis of every Accounts Receivable account to determine past due accounts and establish estimates for uncollectible accounts Bad debts estimate

Amount based on Aging Analysis xxx less: Allowance for Doubtful Accounts, beginning xx

Adjustment xx

Notes to Financial Statement Presentation

Accounts Receivable

P Xxx

Less: Allowance for Bad Debts

Xxx

Net realizable value P Xxx

Writing-Off Worthless Accounts – occurs when an account is definitely known to be uncollectible

JE: Allowance for Bad Debts

xxx

Accounts Receivable

xxx

write-off

Recovery of Worthless Accounts – occurs when an account previously written-off as uncollectible is later paid by the customer

JE: Accounts Receivable xxxAllowance for Bad Debts

xxx

Recovery

Cash

xxx

Accounts Receivable

xxx

Collection

Examples:

1. The allowance for doubtful accounts before adjustment on December 31, 2011, had a debit balance of P4,026. It is estimated that 3% of the accounts receivable of P245,300 was doubtful of collection.

Required allowance ( P245,300 x 3%) P 7,359

Add: Debit balance in allowance 4,026

Adjustment P11,385

======Adjusting Entry Doubtful Account expense

11,385

Allowance for Doubtful Account

11,385

To record doubtful account.

2. Uncollectible account is estimated 2.5% of the accounts receivable balance. Before adjustment, the accounts receivable had a balance of P230,000 and P1,500 for allowance for uncollectible accounts.

Required allowance ( P230,000 x 2.5%) P 5,750

Less: Credit balance in allowance 1,500

Adjustment P4,250

=====Adjusting Entry Doubtful Account expense

4,250

Allowance for Doubtful Account

4,250

To record doubtful account.