Accounting Cycle for Service-Type

Businesses: Adjusting

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Did you know that not all
revenues and expenses of a
business come from cash
transactions?

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A company may recognize
revenue even if its client did
not pay in cash, and may also
recognize an expense even if
the business has not paid it
yet.

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Recognizing revenue and
expenses in the proper
accounting period will
assist the business in
understanding its
financial situation.

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To do this, businesses use the
accrual method of accounting
and prepare adjusting entries.

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PREPARING ADJUSTING ENTRIES
Cath is an accountant of Daniel Consulting, and she is tasked to prepare
the company’s financial statements for the year 20x2. She has journalized
the transactions, posted them to the ledger and prepared an unadjusted
trial balance. She is currently analyzing the company’s accounts that
require adjusting entries.

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PREPARING ADJUSTING ENTRIES
She discovered that on November 2, the former accountant recorded a
debit of ₱54,000 to the administrative expenses account for availing
auditing services from AM Accounting Office from November 20x2 to
April 20x3.

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QUESTIONS TO PONDER

1. What is the journal entry made by the former accountant to recognize

the administrative expense worth ₱54,000 on November 2?
2. What adjusting entry should Cath record to update the administrative
expense account at the end of the year?

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QUESTIONS TO PONDER

3. Assuming that no other adjustments are made to the administrative

expense account, how much should the Prepaid Expense and
Administrative Expense be in the Balance Sheet and Income Statement?

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Why should small businesses use the accrual
accounting method to record revenue and
expenses?

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ADJUSTING ENTRIES

● used to update a business’s account balances

● some accounts affect more than one accounting period
● no overstatement or understatement of balance sheet and
income statement accounts

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ADJUSTING ENTRIES

● involves recognizing an income or expense with a

corresponding asset or liability account
● affects both Statement of Financial Position and Statement
of Comprehensive Income accounts

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 BASIS FOR ADJUSTING ENTRIES

REVENUE RECOGNITION MATCHING PRINCIPLE

PRINCIPLE

recognize revenue when expenses should match its

earned, regardless of when revenues in the same
cash is received accounting period

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TYPES OF ADJUSTING ENTRIES

Adjusting Entries

Non- Cash
Expenses Accruals Deferrals

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TYPES OF ADJUSTING ENTRIES

● expenses incurred by the company without paying cash

● example: Depreciation Expenses
○ depreciation expenses are recognized at the end of the
accounting period because of the revenue generated
when the fixed assets are used.

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 NON-CASH EXPENSES

DEPRECIATION EXPENSE OTHER TERMS RELATED TO

DEPRECIATION EXPENSE:

Accumulated Depreciation
decreases the value of a Book Value
fixed asset Depreciable Cost

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 OTHER TERMS RELATED TO DEPRECIATION
EXPENSE
ACCUMULATED BOOK VALUE
DEPRECIATION

contra-asset account used Cost less Accumulated

to depreciate a fixed asset Depreciation

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 OTHER TERMS RELATED TO DEPRECIATION
EXPENSE

DEPRECIABLE COST Cost less Salvage Value

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 How much is it worth now?

Lara bought a laptop worth ₱50,000 for the business during the
current year. In the future, the worth of the laptop will be less
than what Lara paid for because time has passed and Lara
already used the laptop.

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FORMULA WHERE:

● Cost = the price of the

asset plus direct costs.
● Salvage Value = the price
of the asset at the end of
its life
● Estimated Useful Life =
number of years the
asset will use by the
business. 20
 NON-CASH EXPENSES

DEPRECIATION EXPENSE RECORDED AS:

● debit to Depreciation
increases expense
Expense account

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 NON-CASH EXPENSES

ACCUMULATED RECORDED AS:

DEPRECIATION

● credit to Accumulated
decreases asset
Depreciation account

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 KBMS’ Annual Depreciation

Liza is an accountant of Kirie Business Management Services

(KBMS). She is tasked to prepare the adjusting entries at the end of
the calendar year.

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KBMS’ Annual Depreciation

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 KBMS’ Annual Depreciation

A copy of the unadjusted trial balance of the business was given to

Liza. Liza determined that the equipment is estimated to have a
useful life of ten years without any salvage value. Liza is asked to
compute the annual depreciation & book value and to give the
adjusting entry at year-end.

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 KBMS’ Annual Depreciation

Given:
Cost = ₱290,000
Salvage Value = ₱0
Estimated Useful Life = 10 years

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 KBMS’ Annual Depreciation

Annual Depreciation = (Cost - Salvage Value)/Estimated Useful Life

Annual Depreciation = (₱290,000 - ₱0)/10
Annual Depreciation = ₱29,000
The adjusting entry would be:

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KBMS’ Annual Depreciation

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 KBMS’ Annual Depreciation

After calculating the depreciation for accounting period, Liza can

compute the book value of the equipment. The solution would be:
Book Value = Cost - Accumulated Depreciation
Book Value = ₱290,000 - ₱29,000
Book Value = ₱261,000

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 KBMS’ Annual Depreciation

The depreciation worth ₱29,000 increased the expense, decreasing

the owner’s equity, and decreased the asset of the business.
Therefore, the adjusting entry will require a debit to Depreciation
Expense to recognize the increase in expense; and a credit to
Accumulated Depreciation to recognize the decrease in Assets.

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 MARIE COMPANY PURCHASED AN OFFICE EQUIPMENT ON

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JULY 1, 20X2, FOR ₱250,000. IT HAS AN ESTIMATED LIFE OF 8
YEARS WITH A SALVAGE VALUE WORTH ₱20,000. WHAT IS
THE ADJUSTING ENTRY ON DECEMBER 31, 20X2?
Answer area

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 ACCRUALS

refers to revenue earned but TYPES:

the company did not receive ● ACCRUED
cash or expenses incurred REVENUE
but the company did not pay ● ACCRUED
cash EXPENSES

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 ACCRUALS

ACCRUED REVENUE EXAMPLES:

unrecorded revenues that ● accrual of interest from

the company has earned notes receivable
but remain uncollected ● accrual of revenue

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 ACCRUALS

ACCRUED REVENUE RECORDED AS:

● debit to a receivable
increases the company's
account; and
assets and increases the
income ● credit to an income
account

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 KBMS’ Accrued Revenue

Kirie Business Management Services (KBMS) entered into a contract

with Enrique Cafe to perform consulting services worth ₱4,000 per
quarter, to be paid 60 days after KBMS files its quarterly VAT
reports. KBMS filed its 3rd Quarter VAT reports on December 28. The
adjusting entry would be as follows:

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KBMS’ Accrued Revenue

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 KBMS’ Accrued Revenue

The accrued revenue worth ₱4,000 increased the asset and income,
increasing the owner’s equity of the business. Therefore, the
adjusting entry will include a debit to Accounts Receivable to
recognize the increase in asset; and a credit to Consulting Fees to
recognize the increase in income.

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 ACCRUALS

ACCRUED EXPENSES EXAMPLES:

● accrual of interest from

notes payables,
are expenses that have
● accrual of wages, rent;
been incurred by the
and
business but are yet to be
● other expenses to be
recorded and yet to be paid
paid in the next
accounting period
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 ACCRUALS

ACCRUED EXPENSES RECORDED AS:

increase the company’s ● debit to an expense

expense, decreasing the account
owner’s equity and increase ● credit to a liability
liability account

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 KBMS’ Accrued Interest

KBMS borrowed ₱40,000 in notes payable from Honest Bank on

April 1 of the current year, with an interest rate of 5% and it is
payable after three years. The interest is paid every March 31, until
the loan’s maturity date. Liza is asked to compute the interest and
give the adjusting entry at year-end.

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 KBMS’ Accrued Interest

Given:
Principal = ₱40,000
Rate = 5%
Time= 9/12

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 KBMS’ Accrued Interest

Interest = Principal x Rate x Time

Interest = ₱40,000 x 0.05 x 9/12
Interest = ₱1,500
The adjusting entry would be:

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KBMS’ Accrued Interest

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 KBMS’ Accrued Interest

The accrued interest worth ₱1,500 increased the expense,

decreasing the owner’s equity, and increased the liability of the
business. Therefore, the adjusting entry will require a debit to
Interest Expense to recognize the increase in expense; and a credit
to Interest Payable to recognize the increase in liability.

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 PASSION PHARMACEUTICAL COMPANY PROVIDES RT-PCR
TESTS THAT COST ₱3,000 PER TEST. AT YEAR END, THE
2 COMPANY DISCOVERED THAT FIVE PEOPLE WERE GIVEN RT-
PCR TESTS BUT THEY REMAINED UNBILLED. WHAT IS THE
ADJUSTING ENTRY AT YEAR-END?
Answer area

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 DEFERRALS

involve advance payments

made by the company for TYPES:
future expenses or advance
● PREPAYMENTS
● UNEARNED
payments of a company’s
REVENUE
client for future services

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 DEFERRALS

● BALANCE SHEET
There are two ways to record METHOD
deferrals:
● INCOME
STATEMENT
METHOD

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 DEFERRALS

PREPAYMENTS EXAMPLES:

● expenses paid in
advance ● insurance,
● also called, Deferred ● administrative; and
Expenses or Prepaid ● rent payments
Expenses

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 Prepaid Load

Prepaid Load is an example of a prepayment. Lara paid for prepaid

phone credits worth ₱300. As long as Lara hasn’t called or texted
anyone, the phone credits worth ₱300 are considered a
prepayment, an asset. But, once Lara consumes part of her phone
credits, the worth of consumption will be considered an expense.

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 DEFERRALS

PREPAYMENTS RECORDED AS:

● recorded as a debit to an
increases expenses,
expense account
decreasing the owner’s
● recorded as a credit to a
equity and decreases its
prepaid expense
related asset account
account

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 KBMS’ Prepaid Expense - Balance Sheet Method

On June 1, Kirie Business Management Services (KBMS) acquired 16

months worth of prepaid insurance during the year for ₱20,000.
Liza, KBMS’ accountant, recorded the transaction as follows:

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KBMS’ Prepaid Expense - Balance Sheet Method

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 KBMS’ Prepaid Expense - Balance Sheet Method

At the end of the accounting period, Liza should prepare an

adjusting entry to record the cost of insurance that expired during
the year. The expired portion of the prepayment will be recorded as
an expense. Assuming that the expired insurance is ₱8,750, the
adjusting entry would be as follows:

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KBMS’ Prepaid Expense - Balance Sheet Method

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 KBMS’ Prepaid Expense - Balance Sheet Method

The expired portion of the insurance worth ₱8,750 increased the

expense, decreasing the owner’s equity, and decreased the asset of
the business. Therefore, the adjusting entry will require a debit to
Insurance Expense to recognize the increase in expense; and a
credit to Prepaid Insurance to recognize the decrease in asset.

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 KBMS’ Prepaid Expense - Balance Sheet Method

The expired portion of the insurance worth ₱8,750 increased the

expense, decreasing the owner’s equity, and decreased the asset of
the business. Therefore, the adjusting entry will require a debit to
Insurance Expense to recognize the increase in expense; and a
credit to Prepaid Insurance to recognize the decrease in asset.

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 KBMS’ Prepaid Expense - Balance Sheet Method

₱20,000/16 x 7 = 8,750. The cost of prepaid insurance, ₱20,000, was

divided into 16 months to get the cost of insurance per month. The
quotient is then multiplied to 7 because there are seven months
from June 1 to December 31.

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 DEFERRALS

UNEARNED REVENUE EXAMPLES:

● income collected in
● consulting fees received
advance
in advance;
● also called, Deferred
● rent received in advance
Revenue

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 KBMS’ Unearned Revenue - Balance Sheet Method

Kirie Business Management Services (KBMS) entered into a contract

worth ₱92,500 to prepare financial statements for its clients for the
period October 1 20x2 to September 30, 20x3. The contract also
states that KBMS’ client should put down a 40% down payment for
the services. KBMS would record the transaction as follows:

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KBMS’ Unearned Revenue - Balance Sheet Method

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 KBMS’ Unearned Revenue - Balance Sheet Method

Receiving cash for a contract worth ₱37,000 to render services will

increase the asset and increase the liability of the business.
Therefore, the entry will require a debit to Cash to recognize the
increase in asset; and a credit to Unearned Consulting Fees to
recognize the increase in liability.

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 KBMS’ Unearned Revenue - Balance Sheet Method

At the end of the accounting period, Liza found out that Kirie
Business Management Services (KBMS) performed consulting fees
worth ₱30,000.
Liza would record the transaction as follows:

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KBMS’ Unearned Revenue - Balance Sheet Method

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 KBMS’ Unearned Revenue - Balance Sheet Method

The rendered portion of the unearned consulting fees worth

₱30,000 decreased the liability and increased the revenue,
increasing the owner’s equity of the business.

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 KBMS’ Unearned Revenue - Balance Sheet Method

Therefore, the adjusting entry will require a debit to Unearned

Consulting Fees to recognize the decrease in liability; and a credit to
Consulting Fees to recognize the increase in revenue.

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 ON OCTOBER 1, 20X2, YLA ACCOUNTING OFFICE RECEIVED
3 ONE YEAR WORTH OF ACCOUNTING FEES FOR ₱180,000.
WHAT IS THE ADJUSTING ENTRY ON DECEMBER 31, 20X2.

Answer area

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 INCOME STATEMENT METHOD OF RECORDING DEFERRALS

PREPAYMENTS UNEARNED REVENUE

transactions are initially transactions are initially

recorded as expenses recorded as income rather
rather than prepaid than as liabilities.
expenses.

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ALTERNATIVE METHOD OF RECORDING
DEFERRALS
● Both Balance Sheet Method and Income Statement
Method are acceptable in recording the transactions.
● Both methods leads to the same ending balances of the
accounts.

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 KBMS’ Prepaid Insurance - Income Statement Method

The previous accountant of Kirie Business Management Services

(KBMS) used the Income Statement method to record the advance
payment of insurance for 16 months worth ₱20,000 on June 1. The
entry would be as follows:

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KBMS’ Prepaid Insurance - Income Statement Method

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 KBMS’ Prepaid Insurance - Income Statement Method

The adjusting entry to reflect the amount of the remaining Prepaid

Insurance of KBMS would be as follows:

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 KBMS’ Prepaid Insurance - Income Statement Method

₱20,000-₱8,750= 11,250. To compute the amount of the remaining

Prepaid Insurance, we get the cost of insurance prior to adjustment
(₱20,000) and deduct the expired portion of the insurance ( ₱8,750).

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 KBMS’ Prepaid Insurance - Income Statement Method

₱20,00016 7 = ₱8,750. To compute the expired portion of prepaid

insurance, the cost of prepaid insurance (₱20,000) was divided into
16 months to get the cost of insurance per month. The quotient is
then multiplied to 7 because there are seven months from June 1 to
December 31.

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 KBMS’ Prepaid Insurance - Income Statement Method

The remaining portion of the Prepaid Insurance worth ₱11,250

increased the asset, and decreased the expense, increasing the
owner’s equity. Therefore, the adjusting entry will require a debit to
Prepaid Insurance to recognize the increase in asset; and a credit to
Insurance Expense to recognize the decrease in expense.

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 KBMS’ Supplies - Income Statement Method

The supplies expense account of Kirie Business Management

Services showed a balance of ₱6,400. Prior to adjustments, Liza
found out that the supplies was reduced to ₱2,000 at the end of the
accounting period. Liza made the following adjusting entry to match
the ending balance of the Supplies account:

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KBMS’ Supplies - Income Statement Method

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 KBMS’ Supplies - Income Statement Method

The ending balance of supplies worth ₱2,000 increased the asset

and increased the expense, decreasing owner’s equity. Therefore,
the adjusting entry will require a debit to Supplies to recognize the
increase in asset and a credit to Supplies Expense to recognize the
increase in expense.

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 KBMS’ Unearned Revenue - Income Statement Method

Kirie Business Management Services (KBMS) entered into a contract

worth ₱92,500 to prepare financial statements for its clients for the
period October 1 20x2 to September 30, 20x3. The contract also
states that KBMS’ client should put down a 40% down payment for
the services

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 KBMS’ Unearned Revenue - Income Statement Method

Let us assume that KBMS records the transaction initially at the

income statement method. KBMS would record the transactions as
follows:

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KBMS’ Unearned Revenue - Income Statement Method

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 KBMS’ Unearned Revenue - Income Statement Method

Receiving cash for a contract worth ₱37,000 to render services will

increase the asset and increase the revenue of the business.
Therefore, the entry will require a debit to Cash to recognize the
increase in asset; and a credit to Consulting Fees to recognize the
increase in the revenue.

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 KBMS’ Unearned Revenue - Income Statement Method

At the end of the accounting period, Liza found out that Kirie
Business Management Services (KBMS) performed consulting fees
worth ₱30,000.
KBMS would record the transaction as follows:

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KBMS’ Unearned Revenue - Income Statement Method

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 KBMS’ Unearned Revenue - Income Statement Method

₱37,000-₱30,000 = ₱7,000. To compute the remaining amount of

unearned revenue at the end of the accounting period, we get the
difference of the unearned revenue (₱37,000) and the earned
revenue (₱7,000).

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 KBMS’ Unearned Revenue - Income Statement Method

The remaining unearned revenue worth ₱7,000 decreased the

revenue, decreasing owner’s equity, and increased the liability.
Therefore, the adjusting entry will require a debit to Consulting Fees
to recognize the decrease in the revenue and credit the Unearned
Consulting Fees to recognize the remaining liability of the company.

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 PREPARING AN ADJUSTED TRIAL BALANCE

ADJUSTED TRIAL BALANCE

● prepared after adjusting entries

● lists accounts with updated general ledger balances
following adjustments made
● where financial statements are based from

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 ADJUSTED TRIAL BALANCE

● errors were made if the totals do not equal

● however, equal balance does not automatically mean that
there were no errors made.
● From the adjusted trial balance, accountants can prepare
financial statements.

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 The Fraud Scandal of the Waste Management Inc.

Founded in 1894, Waste Management Incorporation is an

environmental services company that manages waste. It is a
public company, i.e., anyone can purchase its shares, and it has
an approximate revenue of $80 million.

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 The Fraud Scandal of the Waste Management Inc.

When Waste Management, Inc. acquired Service Corporation of

America in the 1980s, it became the leading waste
management service in the country. However, between 1992
and 1997, the company was involved in fraudulent accounting
schemes.

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 The Fraud Scandal of the Waste Management Inc.

These schemes involved increasing its salvage value and

prolonging the estimated useful life of the company's long-
term assets. Moreover, due to the decrease in the value of its
company, it purposefully deferred recording its expenses.

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 The Fraud Scandal of the Waste Management Inc.

It also recognized its assets as expenses to further defer the

amount of expense. In doing these schemes, the company
recorded higher net income, and as a result, it attracted many
investors. A company with high profits is more attractive to
investors because it reflects profitability.

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 The Fraud Scandal of the Waste Management Inc.

However, in the case of Waste Management Inc., the company

is not profitable because it declared false profits. Because of its
fraudulent schemes, the company reduced its operating
expenses to roughly $490.

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 The Fraud Scandal of the Waste Management Inc.

When its irregular accounting schemes were made known to

the public, the stock price decreased by 33%, and its
shareholders lost about $6 billion in market value. The auditor
of Waste Management Inc. was fined $7 million, and the
company was made liable to pay $457 million.

93
 The Fraud Scandal of the Waste Management Inc.

When its irregular accounting schemes were made known to

the public, the stock price decreased by 33%, and its
shareholders lost about $6 billion in market value.

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 The Fraud Scandal of the Waste Management Inc.

The auditor of Waste Management Inc. was fined $7 million,

and the company was made liable to pay $457 million.
Adjusting entries makes the business reflect its proper
financial condition, but accountants should not prepare it to
defraud others.

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 The Fraud Scandal of the Waste Management Inc.

Businesses maintain integrity in their financial statements

because many users rely on it, such as suppliers, lenders, and
even the company's stakeholders. The actual condition of the
business will help all parties to make their decisions to achieve
their goals and objectives.

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● Recognition of revenue and income in the period in which they are
earned and incurred through the preparation of adjusting entries
reflect the actual financial condition of the business. Adjusting
entries does not involve Cash.
● Generally adjusting entries are classified as: non-cash expenses,
accruals, and deferrals.

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● There are two examples of accruals: accrued expenses and accrued
revenue. Accrued Expenses are expenses already incurred but not
yet paid; while Accrued Revenues are income already earned but not
yet received.

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● There are two examples of deferrals: Prepayments (Deferred
Expenses) and Deferred Revenue. Deferrals can be recorded using
the Balance Sheet or the Income Statement method. Prepayments
are expenses already paid but not yet used; while Deferred Revenue
are income already received but not yet earned.

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● After preparing the adjusting entries, the accountant can prepare the
adjusted trial balance and from there, prepare the financial
staements.

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101
Table 2. Comparison of accruals and deferrals

Incurred/Earned? Paid/Received?

Accrued Expenses Incurred Not Paid

Accrued Revenue Earned Not Received

Prepayments Not Incurred Paid

Deferred Revenue Not Earned Received

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Identify the adjusting entry described in the statement.

Accrued Revenue

Accrued Expense

1. Advance payment of rent Prepaid Expense

Unearned Revenue

Depreciation Expense

103
Identify the adjusting entry described in the statement.

Accrued Revenue

Accrued Expense

2. Unpaid wages Prepaid Expense

Unearned Revenue

Depreciation Expense

104
Identify the adjusting entry described in the statement.

Accrued Revenue

Accrued Expense

3. Depreciation of machinery Prepaid Expense

Unearned Revenue

Depreciation Expense

105
Identify the adjusting entry described in the statement.

Accrued Revenue

Accrued Expense
4. Rendered services without an
invoice Prepaid Expense

Unearned Revenue

Depreciation Expense

106
Identify the adjusting entry described in the statement.

Accrued Revenue

Accrued Expense
5. Cash received in advance from
clients Prepaid Expense

Unearned Revenue

Depreciation Expense

107
Carla A.V. Dental Clinic prepares adjusting entries every December 31
under the balance sheet method. Prepare the necessary adjusting
entries for the following transactions.

108
1. On January 1 of the current year, Carla purchased dental
equipment at a price of ₱100,000. It has an estimated life of five
years and a salvage value of ₱10,000.
2. It signed a ₱40,000, 8%, two year-year notes payable on October 1
of the current year. Interest is payable annually every September
30 until the maturity date.

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3. On December 1, the company received ₱20,000 from one of its
loyal customers in full payment for the services provided in
December and January.
4. Dental supplies at the beginning of the year amounted to ₱8,500.
On December 31, it amounted to ₱1,800.
5. The company is giving a dental service to Tomy Rod at an agreed
rate of ₱2,000 per check-up. On December 31, 6 days of unbilled
dental services were provided.

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Answer area

111
Examine the given document and perform the following tasks.

KB Accounting Office offers various bookkeeping, accounting,

and auditing services to its client, Pretty Accounting Office. Rit,
an intern of KB Accounting Office, was tasked to record the
adjusting entries to the general journal and create an adjusted
trial balance for its client. Below are the unadjusted trial
balance and the related adjustments of Pretty Accounting
Office.

Unadjusted Trial Balance of KB Accounting Office

112
Perform the following task.

1. Give the adjusting entry with explanation and write it in the

general journal.

General Journal Template

2. Prepare an adjusted trial balance. You may use this

template.

Adjusted Trial Balance Template

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