Adjusting Entries

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<p>Introductiony Principle Involved: Periodicity- entity s life can be</p> <p>subdivided into equal time periods for reporting purposes. y Problems: 1. Users need timely information to serve as a basis on making decisions about future activities. 2. The business is expected to continue its operation for an indefinite period of time. 3. It is not cost-efficient to wait until a business has ceased its operations before we can measure the entity s performance.</p> <p>The Need for Adjustmentsy The trial balance does not show all the information</p> <p>needed in the preparation of financial statements (some elements are not fairly or completely stated). y Distinction Between ACCRUAL and CASH Bases of Accounting:a. ACCRUAL- recognizes income as it is earned regardless of when it is received; expense as it is incurred regardless of when paid. b. CASH BASIS- Revenues and expenses are recognized only when they are received or paid, respectively.</p> <p>Basic End-of-Period AdjustmentsNature Description</p> <p>Accrued Expenses</p> <p>To take up expenses incurred in one period but remain unrecorded and unpaid as of the end of the period.</p> <p>Accrued evenue To take up income earned in one period but remain unrecorded and not received as of the end of the period. Prepaid Expense nearned evenue Depreciation To allocate expenses to two or more accounting periods. To allocate income to two or more accounting periods.</p> <p>To recognize the amount of used economic benefits of a fixed asset. To recognize the possible uncollectible amounts due from customers as of the end of the period</p> <p>Bad Debts</p> <p>Accrued ExpensesSituation Principles Involved Elements Affected Entry Reason for Recognition Examples Expense incurred but not yet paid; because it was not yet paid, it was not recorded in the books Expense Recognition Liability Recognition Accrual Basis Assumption Expenses (Increase)l, Liabilities (Increase) A liability is created because the unpaid expense constitutes an obligation of the company which will be paid in the future. Expense Liability xx xx</p> <p>Expenses (understated), Income (overstated) Liabilities (understated), Capital (overstated) Salaries Expense-, Rent Expense, Interest Expense on Notes Payable</p> <p>Example 1-Salaries Expensey Mark Anthony Lee Company pays its employee on a</p> <p>weekly basis (every Friday) at the uniform rate of P600 per day. Suppose December 31, 2008, the company s year-end, falls on a Tuesday. No entry was made to record salaries expense because payment is still on Friday, January 3, 2009.</p> <p>Entry: Salaries Expense Salaries Payable</p> <p>1,200 1,200</p> <p>Example 1- Salaries ExpenseEntry: Salaries Expense Salaries Payable 1,200 1,200</p> <p>y Note: In this case, the employees have already</p> <p>rendered services for two days, so an obligation already exists for those services already rendered but not yet paid and not yet recorded.</p> <p>Example 2- Interest Expense on Notes Payabley Mark Anthony Bello Company issued a P100,000, 90-day,</p> <p>18% note. The note matures on January 30, 2009 at which date, the principal and the interest due on the note will be paid.</p> <p>y Entry: Interest Expense Interest Payable(100,000 x 18% x 60/360 = 3,000)</p> <p>3,000 3,000</p> <p>Example 2- Interest Expense on Notes PayableEntry: Interest Expense Interest Payable 3,000 3,000</p> <p>Note: The company has an accrued interest covering the months of November and December. The said interest has not been taken up because it will be paid only on the maturity date. Since the expense will not be paid until January 30, 2009, its recognition should give rise to a liability.</p> <p>Accrued IncomeSit ati Pri ciples I v lve I c e alrea y ear e , t t yet c llecte i cas . ei c llecte , it as t rec r e . I c e Rec iti Pri ciple iti Pri ciple Asset Rec Accr al asis ass pti I c e (i crease), Assets (I crease) Asset is create eca se c llecte i c e c stit tes a ic e efit ic ill e receive i t e f t re. f t re ec Asset I c xx e xx e, I terest I c e N tes Receiva le</p> <p>Ele e ts Affecte</p> <p>E try Exa ples</p> <p>U rec r e fees i c</p> <p>Example 1 Unrecorded Fees Incomey On December 31, 2008, MAT Sanchez Company, a</p> <p>management consultancy firm has completed providing consultancy services to Mark Tan who had agreed to pay P250,000. y As of the same date (December 31), MAT Sanchez Company has not received any payment from the client, nor has issued the bill to the client. y ENTRY: Accounts Receivable 250,000 Service Fees Revenue 250,000</p> <p>Example 1 Unrecorded Fees Incomey ENTRY:</p> <p>Accounts Receivable Service Fees Revenue</p> <p>250,000 250,000</p> <p>y Since the income is already earned, income should be</p> <p>recognized during 2008, although it is not yet received.</p> <p>Example 2- Interest Incomey On December 1, 2008, Mark Anthony Santos Company</p> <p>received a P90,000, 60-day, 12% note from MAT De Veas Company, a customer. The note matures on January 30, 2009, at which date, the principal and the interest due on the note will be collected.</p> <p>Entry: Interest Receivable Interest Income(90,000 x 12% x 30/360 = 900)</p> <p>900 900</p> <p>Example 2- Interest IncomeEntry: Interest Receivable Interest Income 900 900</p> <p>y On December 31, 2008, Mark Anthony Santos</p> <p>Company has earned interest income for 30 days or P900, which amount should be taken up in the accounts .</p> <p>Prepaid ExpensesSituation Principles Involved Elements Affected Cash was already paid, but the expense was not yet incurred, or only a portion of the amount paid was used up as expense Expense recognition principle Asset recognition principle Accrual basis assumption Assets, Expenses Assets- unexpired portion which represents future economic benefits Expenses- expired portion of the amount paid Asset Method: Advanced payment was entirely debited to an Asset Expense xx Asset xx Expense Method: Advance payment was entirely debited to an expense Asset xx Expense xx Rent, Insurance, advertising, supplies</p> <p>Entry</p> <p>Examples</p> <p>Prepaid Expense- Asset Methody When the advance payment was received, it was</p> <p>entirely debited to an asset account y Entry Made: Prepaid Expense xx Cash xx y At the end of the period, the asset account will contain both the expired and the unexpired portions in its balance. y If remained unadjusted, the asset will be overstated, and the related expense, understated</p> <p>Example 1- Asset Methody On Nov. 1, 2008, JONO COCJIN COMPANY paid a</p> <p>premium of P24,000 for a one-year fire insurance coverage beginning on that date. The company s accounting period ends on December 31. Nov. 1 Prepaid Insurance Cash 24,000 24,000</p> <p>Example 1 Asset Methody As of December 31, only two months worth of</p> <p>insurance protection has been used up (P24,000/12 months= P2,000 x 2 months= P4,000) y Thus, the P24,000 prepaid insurance account contains both the expired portion of P4,000 and unexpired portion of P20,000. To adjust: Dec. 31 Insurance Expense 4,000 Prepaid Insurance 4,000</p> <p>Prepaid Expense- Expense Methody The advance payment was entirely debited to an</p> <p>expense account. y Entry Made: Expense xx Cash xx y At the end of the period, the expense account will contain both the expired and the unexpired components of its balance. y If remained unadjusted, the expense will be overstated, and the asset, understated.</p> <p>Example 2- Expense Methody On Nov. 1, 2008, JONO COCJIN COMPANY paid a</p> <p>premium of P24,000 for a one-year fire insurance coverage beginning on that date. The company s accounting period ends on December 31. Nov. 1 Insurance Expense Cash 24,000 24,000</p> <p>Example 2 Expense Methody As of December 31, only two months worth of</p> <p>insurance protection has been used up. (P24,000/12 months= P2,000 x 2 months= P4,000) y Thus, the P24,000 insurance expense account contains both the expired portion of P4,000 and unexpired portion of P20,000. To adjust: Dec. 31 Prepaid Insurance 20,000 Insurance Expense 20,000</p> <p>Unearned IncomeSituation Cash was received in advance, but the services was not yet performed, or goods not yet delivered, or only a portion of the amount paid was earned as income. In effect, since customer has already paid even before the performance, this creates an obligation on the part of the company to fulfill the obligation Income recognition principle Liability recognition principle Accrual basis assumption Liabilities, Income Income- earned portion Liabilities- unearned portion of the amount received Liability Method: Cash received is credited to a liability account Liability xx Income xx Income Method: Cash received in advanced is entirely credited to Income Income xx Liability xx Rent income</p> <p>Principles Involved Elements Affected Entry</p> <p>Examples</p> <p>Unearned Income- Liability Methody When the cash was received in advance, it was credited</p> <p>to a liability account. y Entry made: Cash</p> <p>xx</p> <p>Unearned Income xx y At the end of the period, the liability account will contain both the earned and the unearned portions of its balance. y If remained unadjusted, the liability will be overstated and the related income, understated.</p> <p>Example 1 Liability Methody On Oct. 1, 2009, AYIE SANCHEZ COMPANY received</p> <p>from Marky Sanches, a tenant, advance rental of P300,000 for one year effective on that date. The lease contract requires rental payments of P25,000 per month. The company s accounting period ends December 31. Oct. 1 Cash 300,000 Unearned Rent Income</p> <p>300,000</p> <p>Example 1 Liability Methody As of December 31, three (3) months worth of rent income</p> <p>has been earned. (P25,000/month x 3 months= P75,000) y Thus, the P300,000 unearned rent income account contains both the earned portion of P75,000 and the unearned portion of P225,000. To adjust Dec. 31 Unearned Rent Income Rent Income 75,000 75,000</p> <p>Unearned Income- Income Methody When the cash was received in advance, it was credited</p> <p>to an income account. y Entry made: Cash</p> <p>xx</p> <p>Income xx y At the end of the period, the income account will contain both the earned and the unearned portions of its balance. y If remained unadjusted, the income will be overstated and the liability, understated.</p> <p>Example 2- Income Methody On Oct. 1, 2009, AYIE SANCHEZ COMPANY received</p> <p>from Marky Sanchez, a tenant, advance rental of P300,000 for one year effective on that date. The lease contract requires rental payments of P25,000 per month. The company s accounting period ends December 31. Oct. 1 Cash 300,000 Rent Income 300,000</p> <p>Example 2- Income Methody As of December 31, only three (3) months worth of rent</p> <p>income has been earned. (P25,000/month x 3 months= P75,000) y Thus, the P300,000 rent income account contains both the earned portion of P75,000 and the unearned portion of P225,000. To adjust Dec. 31 Rent Income 225,000 Unearned Rent Income</p> <p>225,000</p> <p>Accruals and Deferralsy Accruals- incurred but not yet paid or earned but not</p> <p>yet received. It increases a balance sheet account and an income statement account. y Deferrals- postponements of recognition of expense (for prepayments) or income (for unearned income)</p> <p>Depreciationy Definition: a systematic allocation of the cost of the</p> <p>fixed asset over its useful life y Factors involved: 1. Cost of the asset; 2. Residual value, or the estimated amount that the asset can be sold for at the end of its life; 3. Useful life, years of productivity, or number of hours or units</p> <p>Depreciationy Most common method: y Straight line method- equal periodic charges for depreciationAnnual Depreciation= Cost- Residual value estimated useful life -recorded through the use of contra account called Accumulated Depreciation. - The use of contra account allows the disclosure of the original cost of the asset.</p> <p>End of Adjusting Entries</p>

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