Adjusting Entries

Introduction
Principle Involved: Periodicity- entity’s life can be
subdivided into equal time periods for reporting purposes.
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.
The Need for Adjustments
The trial balance does not show all the information
needed in the preparation of financial statements
(some elements are not fairly or completely stated).
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.
Basic End-of-Period Adjustments
Nature Description

Accrued To take up expenses incurred in one period but remain

Expenses unrecorded and unpaid as of the end of the period.

Accrued Revenue To take up income earned in one period but remain

unrecorded and not received as of the end of the period.

Prepaid Expense To allocate expenses to two or more accounting periods.

Unearned To allocate income to two or more accounting periods.

Revenue

Depreciation To recognize the amount of used economic benefits of a

fixed asset.

Bad Debts To recognize the possible uncollectible amounts due from

customers as of the end of the period
Accrued Expenses
Situation Expense incurred but not yet paid; because it was not yet paid, it
was not recorded in the books
Principles Expense Recognition
Involved Liability Recognition
Accrual Basis Assumption
Elements Expenses (Increase)l, Liabilities (Increase)
Affected A liability is created because the unpaid expense constitutes an
obligation of the company which will be paid in the future.
Entry Expense xx
Liability xx
Reason for Expenses (understated), Income (overstated)
Recognition Liabilities (understated), Capital (overstated)
Examples Salaries Expense-, Rent Expense, Interest Expense on Notes
Payable
Example 1-Salaries Expense
Mark Anthony Lee Company pays its employee on a
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.

Entry:
Salaries Expense 1,200
Salaries Payable 1,200
Example 1- Salaries Expense
Entry:
Salaries Expense 1,200
Salaries Payable 1,200

Note: In this case, the employees have already

rendered services for two days, so an obligation already
exists for those services already rendered but not yet
paid and not yet recorded.
Example 2- Interest Expense on Notes
Payable
Mark Anthony Bello Company issued a P100,000, 90-
day, 18% note. The note matures on January 30, 2009 at
which date, the principal and the interest due on the
note will be paid.
Entry:
Interest Expense 3,000
Interest Payable 3,000

(100,000 x 18% x 60/360 = 3,000)

Example 2- Interest Expense on Notes
Payable
Entry:
Interest Expense 3,000
Interest Payable 3,000

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.
Accrued Income
Situation Income already earned, but not yet collected in cash. Being
uncollected, it was not recorded.

Principles Income Recognition Principle

Involved Asset Recognition Principle
Accrual Basis assumption

Elements Income (increase), Assets (Increase)

Affected Asset is created because uncollected income constitutes a
future economic benefit which will be received in the future.

Entry Asset xx
Income xx

Examples Unrecorded fees income, Interest Income on Notes Receivable

Example 1 – Unrecorded Fees
Income
On December 31, 2008, MAT Sanchez Company, a
management consultancy firm has completed
providing consultancy services to Mark Tan who had
agreed to pay P250,000.
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.
ENTRY:
Accounts Receivable 250,000
Service Fees Revenue 250,000
Example 1 – Unrecorded Fees Income
ENTRY:
Accounts Receivable 250,000
Service Fees Revenue 250,000

Since the income is already earned, income should be

recognized during 2008, although it is not yet
received.
Example 2- Interest Income
On December 1, 2008, Mark Anthony Santos Company
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.

Entry:
Interest Receivable 900
Interest Income 900

(90,000 x 12% x 30/360 = 900)

Example 2- Interest Income
Entry:
Interest Receivable 900
Interest Income 900
On December 31, 2008, Mark Anthony Santos
Company has earned interest income for 30 days or
P900, which amount should be taken up in the
accounts .
Prepaid Expenses
Situation Cash was already paid, but the expense was not yet incurred, or only
a portion of the amount paid was used up as expense
Principles Expense recognition principle
Involved Asset recognition principle
Accrual basis assumption
Elements Assets, Expenses
Affected Assets- unexpired portion which represents future economic
benefits
Expenses- expired portion of the amount paid
Entry 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
Examples Rent, Insurance, advertising, supplies
Prepaid Expense- Asset Method
When the advance payment was received, it was
entirely debited to an asset account
Entry Made: Prepaid Expense xx
Cash xx
At the end of the period, the asset account will contain
both the expired and the unexpired portions in its
balance.
If remained unadjusted, the asset will be overstated,
and the related expense, understated
Example 1- Asset Method
On Nov. 1, 2008, JONO COCJIN COMPANY paid a
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 24,000

Cash 24,000
Example 1 – Asset Method
As of December 31, only two months’ worth of
insurance protection has been used up
(P24,000/12 months= P2,000 x 2 months= P4,000)
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
Prepaid Expense- Expense Method
The advance payment was entirely debited to an
expense account.
Entry Made: Expense xx
Cash xx
At the end of the period, the expense account will
contain both the expired and the unexpired
components of its balance.
If remained unadjusted, the expense will be
overstated, and the asset, understated.
Example 2- Expense Method
On Nov. 1, 2008, JONO COCJIN COMPANY paid a
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 24,000

Cash 24,000
Example 2 – Expense Method
As of December 31, only two months’ worth of
insurance protection has been used up.
(P24,000/12 months= P2,000 x 2 months= P4,000)
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
 Unearned Income
Situation 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
Principles Income recognition principle
Involved Liability recognition principle
Accrual basis assumption
Elements Liabilities, Income
Affected Income- earned portion
Liabilities- unearned portion of the amount received
Entry 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
Examples Rent income
Unearned Income- Liability Method
When the cash was received in advance, it was
credited to a liability account.
Entry made: Cash xx
Unearned Income xx
At the end of the period, the liability account will
contain both the earned and the unearned portions of
its balance.
If remained unadjusted, the liability will be overstated
and the related income, understated.
Example 1 – Liability Method
On Oct. 1, 2009, AYIE SANCHEZ COMPANY received
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 300,000
Example 1 – Liability Method
As of December 31, three (3) months’ worth of rent
income has been earned.
(P25,000/month x 3 months= P75,000)
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 75,000
Rent Income 75,000
Unearned Income- Income Method
When the cash was received in advance, it was
credited to an income account.
Entry made: Cash xx
Income xx
At the end of the period, the income account will
contain both the earned and the unearned portions of
its balance.
If remained unadjusted, the income will be overstated
and the liability, understated.
Example 2- Income Method
On Oct. 1, 2009, AYIE SANCHEZ COMPANY received
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
Example 2- Income Method
As of December 31, only three (3) months’ worth of rent
income has been earned.
(P25,000/month x 3 months= P75,000)
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 225,000
Accruals and Deferrals
Accruals- incurred but not yet paid or earned but not
yet received. It increases a balance sheet account and
an income statement account.
Deferrals- postponements of recognition of expense
(for prepayments) or income (for unearned income)
Depreciation
Definition: a systematic allocation of the cost of the
fixed asset over its useful life
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
Depreciation
Most common method:
Straight line method- equal periodic charges for
depreciation

Annual 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.
End of Adjusting Entries