Lesson 2 : Adjusting the Entries

Accounting Cycle consists of successive steps starting with the recording of transactions in the
books of accounts and ending with a post-closing trial balance.
1. Journalizing
2. Posting
3. Preparation of the Trial Balance
4. Adjusting the entries
5. Preparation of the worksheet
6. Preparation of the financial statements
7. Closing the entries
8. Reversing the entries

Adjusting entries

Adjusting entries ( also known as end-of-period adjustments ) are journal entries that are made at
the end of an accounting period to adjust the accounts to accurately reflect the revenues and
expenses of the current period.
Purposes of adjusting the entries :

1. To reflect the proper amounts of revenue realized and expenses incurred during a period.
2. To show a fairly measure of the assets, liabilities and owner’s equity.
When are adjusting entries made ?

Adjusting entries are usually made at the end of an accounting period. They can, however, be made
at the end of a quarter, a month, or even at the end of a day, depending on the accounting
procedures and the nature of business carried on by the company.

Two Types of Accounting Method

1. Cash Method

2. Accrual Method

Cash method - income is recorded only when the cash is received and expenses are recorded only
when cash are paid.
Accrual method - recognizes revenue when earned or when goods are delivered or services are
rendered to customer and the recognizes expenses when incurred.
The accrual method is commonly used method because it gives precise results when used in the
normal operation of the business.

Examples of Adjusting Entries

1. Adjustment for Prepaid Expenses
Prepaid Expenses or Deferred Expenses are expenses paid in advance before receiving the
product or service.
Examples are :
1. Prepaid rent
2. Prepaid insurance
3. Prepaid salaries / wages
4. Prepaid subscription
5. Prepaid interest
At the time of payment, the account is an asset and as it is used it becomes an expense.
There are two methods to be used : the asset method and the expense method.
1. Asset Method. Under this method, the original entry made is charged to an asset account.
Example
On November 1 of the current year, C. Santos paid P3,000 for a three month rental of the office
space.
Original Entry Adjusting Entry
Nov. 1 - Prepaid Rent P3,000 Dec. 31 - Rent Expense P2,000
Cash P3,000 Prepaid Rent P2,000
Analysis
The P3,000 which was paid in November 1 is for a three month rental of the space, November,
December and January. As of December 31, the end of the accounting period, only P2,000 have
already been incurred, so that portion is an expenses and the remaining P1,000 is still prepaid until
January 31 of the following accounting period.

2. Expense Method. Under this method, expense account is charged when payment is made.
Using the same example, the following are the entries made :
Original Entry Adjusting Entry
Nov. 1 - Rent Expense P3,000 Dec. 31 - Prepaid Rent P2,000
Cash P3,000 Rent Expense P2,000

Analysis
The rental payment of P3,000 is paid for the months of November, December and January. As of
December 31, only P2,000 or for two months rental have been incurred. The remaining P1,000 is still
prepaid until January 31 of the next accounting period.
2. Adjustment for Unearned Income / Unearned Revenue / Deferred Revenue
Unearned Income are income received in advance and to be earned the next accounting period.
Unearned income arises when payment is received before goods are delivered or before services
are rendered.
There are two methods to be used : the income method and the liability method.

1. Income Method. Under this method, income account is credited when cash is received.
Example
On November 1 of the current year, the business received P3,000 cash from the tenant of the
vacant space of the store.
Original Entry Adjusting Entry
Nov. 1- Cash P3,000 Dec. 31 - Rent Income P2,000
Rent Income P3,000 Unearned Rent P2,000
Analysis
The business received from a tenant a P3,000 cash advance rentals for the months of
November, December and January. As of December 31, only two months rental or P2,000 are
already earned. The remaining P1,000 is still unearned until January 31 of the following accounting
period.

2. Liability Method. Under this method, a liability account is credited upon receipt of cash.
Example
Original Entry Adjusting Entry
Nov. 1 - Cash P3,000 Dec. 31 - Unearned Rent P2,000
Unearned Rent P3,000 Rent Income P2,000

3. Accrual of Expenses
Accrued Expenses are those expenses that are incurred during a period but no cash payment is
made for them during that period.
Accrued Expenses are expenses incurred before payment is made.
Such expenses are recorded by making an adjusting entry at the end of the accounting period. It is
known as accruing unpaid expenses.

Primary examples of accrued expenses are :

1. salaries payable
2. interest payable
Salaries payable are wages earned by employees in one
accounting period but not paid until the next.
Interest payable is interest expense that has been
incurred but not yet paid.

At the end of the accounting period, the income statement should reflect such expense and the
balance sheet should reflect a liability account. The adjusting entry to record accrual of expenses is
debit the expense account and credit the liability account.
Example
Office employees are paid every two weeks. On December 31, five days’ salaries of an
employee for P400 per day have accrued.
Adjusting Entry:

Date Account Titles and Explanation Debit Credit

Dec. 31 Salaries Expense P2,000
Accrued Salaries Expense P2,000
Five-days accrued salaries of an employee for P400 per day.

4. Accrual of Income
Uncollected Revenue or Accrued Revenue or Accrued Income is revenue that is earned during
the period but not collected during that period.
Accrued Revenue is revenue earned before cash is received.
Such revenues are recorded by making an adjusting entry at the end of the accounting period. It is
known as accruing the uncollected revenue.
Accrued Revenues are recorded as receivables on the balance sheet to reflect the amount of money
that customers owe the business for the goods or services they purchased.

The entry to adjust accrual of income is to debit the asset account and credit the income account.
Example
A tenant, who occupies the right side of the shop space, is two months in arrears as of the
balance sheet date. His monthly rental is P5,000 per month.
Adjusting Entry:

Date Account Titles and Explanation Debit Credit

Dec. 31 Accrued Rent Income P10,000
Rent Income P10,000
Two months arrears of the tenant for P5,000 per month.

5. Provision for Bad Debts

Usually, most business firms extend credits to attract more customers and to sell more goods.
However, not all credits extended are good or collectible. For a reason or another, a certain
percentage of these collectibles are not collected. For this reason, the business should provide for
such losses for non-collection of credits. This loss from uncollectible accounts is called bad debts.
Bad debts is nominal account which must be shown in the income statement at the end of the
accounting period.

The entry to adjust bad debts is as follows:

Bad Debts Expense P500

Allowance for Bad Debts P500

Bad debts or Loss from Bad Debts is debited to show a decrease in proprietorship account due to
estimated loss.

Estimated Uncollectible Account or Allowance for Bad Debts is deducted from Accounts
Receivable to show the net book value or the net realizable value of the accounts receivable.

Illustration
Accounts Receivable P7,000
Less: Allowance for Bad Debts 500
Net Realizable Value or Net Book Value P6,500

Illustration
Accounts Receivable P7,000
Less: Allowance for Bad Debts 500
Net Realizable Value or Net Book Value P6,500
There are several methods of estimating the probable losses from bad debts:
1. Increasing the accumulated allowance for bad debts by a certain percentage of the accounts
receivable.
2. Increasing the accumulated allowance for bad debts to a certain percentage of the accounts
receivable
Illustration

The following accounts are shown in the pre-adjusted trial balance of Mr. Rodriguez as of
December 31, 19_
Debit Credit
Accounts Receivable P7,000
Allowance for Bad Debts P500

1. Allowance for Bad Debts by a Certain Percentage of Accounts Receivable

Computation:
Bad Debt estimate =P7,000 x .10 = P700
Adjusting Entry
Bad Debts Expense P700
Allowance for Bad Debts P700
To increase the allowance for bad
debts by 10% of the accounts receivable
Balance Sheet Presentation
Accounts Receivable P7,000
Less: Allowance for Bad Debts 1,200 P5,800
2. Allowance for Bad Debts to a Certain Percentage of Accounts Receivable
Computation:
Bad Debt estimate = P7,000 x .10 = P700
P 700 – P500 = P200
Adjusting Entry
Bad Debts Expense P200
Allowance for Bad Debts P200
To increase the allowance for bad
debts to 10% of the accounts receivable
Balance Sheet Presentation
Accounts Receivable P7,000
Less: Allowance for Bad Debts 700 P6,300

6. Provision for Depreciation

Asset which are relatively permanent in nature are fixed assets. They are used by the business in its
operation and not intended for sale. The value of these assets, except land decreases as time passes
by due to the following reasons:
1. wear and tear from operations
2. inadequacy and obsolescence

An asset is said to be inadequate for the business if there is business expansion and the asset can
no longer fulfil the needs of the business.
If it said to be obsolete in the introduction of new models or inventions and the business desires to
replace the old asset with a new one.
The cost of the fixed asset is allocated to the number of its useful life. Depreciation is the
portion of the cost of the asset which is already used or consumed.
There are several methods of depreciating assets such as the straight-line method of
depreciation. The following formula is used to compute depreciation:
D=C–S
n
Where: D - is the depreciation
C - is the original cost which includes the invoice price less discount plus other cost
incurred before the use of the asset such as freight and installation.
S - is the salvage value or scrap value. This is the amount wherein the asset can be sold after its
useful life.
n - is the number of estimated useful life
Example:
A delivery truck was purchased for P25,000. It is estimated to last 10 years after which it shall have
a value of P5,000. Compute for the depreciation.
D=C–S
n
= P25,000 - P5,000
10 years
= P20,000
10
= P2,000 / year
Adjusting Entry:
Depreciation Expense -delivery truck P2,000
Accumulated depreciation -delivery tuck P2,000
Adjusting Entry:
Depreciation Expense -delivery truck P2,000
Accumulated depreciation -delivery tuck P2,000

Balance Sheet Presentation :

Delivery Truck P25,000

Less: Accumulated Depreciation 2,000 P23,000

Illustration
Transactions
1998
Sept. 1 - G. Alajar, opened a television repair shop he called “ Sure Repair Shop “.
He began business by investing P2,500 in cash and the following assets:
repair tools, P1,200; repair supplies, P1,500 and a service truck, P20,000.
2 - Paid P250 for newspaper advertising announcing the opening of his shop.
3 - Purchased office tables and chairs and filing cabinets from Cruz Furniture
on credit, P6,500.
5 - Completed repair work for R. Gil on credit, P1,200.
9 - Completed repair work for M. Soriano, P2,200. Accepted P1,000 in cash
and a promised to pay the balance after five days.
15 - Paid the salaries of the shop helper, P450.
18 - Paid one-half of the account due to Cruz Furniture and issued a
promissory note for the other-half.
20 - R. Gil paid his account.
25 - Withdrew cash for P750 for personal use.
28 - Received P2,500 from S. Serna for repair service rendered.
30 - Paid the monthly utility bills, P150.
30 - Paid the month’s rent of the shop, P1,000.
30 - Paid the salaries of the shop helper, P450.

Sure Repair Shop

Trial Balance
September 30, 1998
Accounts Debit Credit
Cash P900
Accounts Receivable - M. Soriano 1,200
Repair Supplies 1,500
Repair Tools 1,200
Furniture and Fixtures 6,500
Service Truck 20,000
Notes Payable- Cruz Furniture P3,250
G. Alajar, Capital 25,200
G. Alajar, Drawing 750
Service Income 5,900
Advertising Expense 250
Salaries Expense 900
Utility Expense 150
Rent Expense 1,000
Total 34,350 34,350
Adjustments
On December 31, the end of the accounting period, the following data were taken:

1. An actual count of repair supplies showed a balance of P850.

2. Repair tools were depreciated at 10% per annum.
3. Furniture and fixtures are estimated to have a useful life of 5 years while service truck has a useful
life of 10 years.
4. A 10% interest has accrued on the notes payable.
5. Of the income received, P900 is applicable to the next accounting period.
6. Accrual of expenses: salaries P250 and rent P500.
7. The balance of the advertising expense account represents payment for five months.

Adjusting Journal Entries:

1. Repair Supplies Used or Repair Supplies Expense P650
Repair Supplies P650
( P1,500 – P850 = P650 )
2. Depreciation Expense – Repair Tools P120
Accumulated Depreciation – Repair Tools P120
( P1,200 x .10 = P120 / year)
3. a. Depreciation Expense – Furniture and Fixtures P433
Accumulated Depreciation – Furniture and Fixtures P433
( P6,500 / 5 years = P1,300 / year )
(P1,300 / 12 months = P108. 33 / month x 4 months = P433 )
b. Depreciation Expense – Service Truck P667
Accumulated Depreciation – Service Truck P667
( P20,000 / 10 years = P2,000 / year )
( P2,000 / year / 12 months = P 166.67 / month x 4 months = P667)
4. Interest Expense P325
Accrued Interest Expense P325
( P3,250 x .10 = P325 )
5. Service Income P900
Unearned Service Income P900

6. a. Salaries Expense P250

Accrued Salaries Expense P250
b. Rent Expense P500
Accrued Rent Expense P500
7. Prepaid Advertising P50
Advertising Expense P50
( P250 / 5 month = P50 / month )
( P50 / month x 4 months from Sept. to Dec. = P200 )
( P250 – P200 = P50 )
ACTIVITY 1
Sassy Mo Beauty Salon
Trial Balance
January 31, 2012
Accounts Debit Credit
Cash P15,430
Accounts Receivable 5,900
Office Supplies 22,800
Prepaid Rent 48,000
Equipment 80,000
Accounts Payable P5,200
Notes Payable 20,000
Accrued Utilities Expense 15,964
Mo, Capital 100,000
Mo, Drawing 5,000
Service Income 86,600
Salaries Expense 38,200
Advertising Expense 5,000
Utilities Expense 3,964
Miscellaneous Expense 3,470 ________
P 227,764 P 227,764
Adjustments
The following are relevant information of Sassy Mo Beauty Salon:

1. Office Supplies of P4,320 were still unused till the end of the period.
2. Prepaid rent of P48,000 was paid for the months of January to April.
3. The equipment costing P80,000 has a useful life of 5 years and its estimated salvage value is
P14,000.
4. A 9% interest has accrued on the notes payable.

XYZ Company
Trial Balance
December 31, 2012

Accounts Debit Credit

Cash P245,000
Accounts Receivable 65,900
Allowance for bad debt P324
Interest Receivable 200
Prepaid Insurance 36,000
Prepaid Rent 28,000
Supplies on Hand 25,000
Building 1,000,600
Furniture and Fixtures 765,700
Machinery and Equipment 143,000
Accounts Payable P21,500
Notes Payable 28,800
Delos Santos, Capital 1,943,871
Delos Santos, Drawing P15,000
Rent Income 378,950
Interest Income 400
Utilities Expense 20,800
Repair and Maintenance Expense 10,765
Representation Expense 5,800
Supplies Expense 12,080 __________
Total P2,373,845 P2,373,845

Sure Repair Shop

Trial Balance
September 30, 1998