ACCOUNTING FUNDAMENTALS

CHAPTER 5
Adjusting the Accounts

ACCRUAL BASIS
The financial statements, except for the cash flow statement, are prepared on
the accrual basis of accounting in order to meet their objectives. Under the
accrual basis, the effects of transactions and other events are recognized when
they occur and not as cash (or its equivalent) is received or paid. This means
that the accountant records revenues as they are earned and expenses as they
are incurred. The timing of cash flows is relatively immaterial for determining
when to recognize revenues and expenses.
Financial statements prepared on the accrual basis inform users not only of
past transactions involving the payment and receipt of cash, but also of
obligations to pay cash in the future, and of resources that represent cash to
be received in the future.
Generally accepted accounting principles require that a business use the
accrual basis.
In cash basis accounting, however, the accountant does not record a
transaction until cash is received or paid. Generally, cash receipts are treated
as revenues and cash payments as expenses. Cash basis income is the
difference between operating cash receipts and disbursements. These cash
flows necessarily exclude investments by and distributions to the owner in the
computation of income.

PERIODICITY CONCEPT
The only way to know how successfully a business has operated is to close its
doors, sell all its assets, pay the liabilities and return any excess cash to the
owners. This process of going out of business is called liquidation. This,
however, is not a practical way of measuring business performance.
Accounting information is valued when it is communicated early enough to be
used for economic decision-making. To provide timely information, accountants
have divided the economic life of a business into artificial time periods. This
assumption is referred to as the periodicity concept.
Accounting periods are generally a month, a quarter or a year. The most basic
accounting period is one year. Entities differ in their choice of the accounting
year - fiscal, calendar or natural. A fiscal year is a period of any twelve
consecutive months. A calendar year is an annual period ending on December
31. A natural business year is a twelve-month period that ends when business

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ACCOUNTING FUNDAMENTALS

activities are at their lowest level of the annual cycle. A period of less than a
year is an interim period. Some even adopt an annual reporting period of 52
weeks.
Businesses need periodic reports to assess their financial condition and
performance. The periodicity concept ensures that accounting information is
reported at regular intervals. It interacts with the revenue recognition and
expense recognition principles to underlie the use of accruals. To measure
profit in a fair manner, entities update the income and expense accounts
immediately before the end of the period.

RECOGNITION AND DERECOGNITION

Per 2018 Conceptual Framework, recognition is the process of capturing for
inclusion in the statement of financial position or the statement(s) of financial
performance an item that meets the definition of an asset, a liability, equity,
income or expenses. The amount at which an asset, a liability or equity is
recognized in the statement of financial position is referred to as its “carrying
amount”.
The statement of financial position and statement(s) of financial performance
depict an entity’s recognized assets, liabilities, equity, income and expenses in
structured summaries that are designed to make financial information
comparable and understandable.
Recognition links the elements, the statement of financial position and the
statement(s) of financial performance. The statements are linked because the
recognition of one item (or a change in its carrying amount) requires the
recognition or derecognition of one or more other items (or changes in the
carrying amount of one or more other items). For example:

(a) the recognition of income occurs at the same time as:

(i) the initial recognition of an asset, or an increase in the carrying
amount of an asset; or
(ii) the derecognition of a liability, or a decrease in the carrying amount of
a liability.

(b) the recognition of expenses occurs at the same time as:

(i) the initial recognition of a liability, or an increase in the carrying
amount of a liability; or

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ACCOUNTING FUNDAMENTALS

(ii) the derecognition of an asset, or a decrease in the carrying amount of

an asset.

The initial recognition of assets or liabilities arising from transactions or other

events may result in the simultaneous recognition of both income and related
expenses. For example, the sale of goods for cash results in the recognition of
both income (from the recognition of one asset - the cash) and an expense
(from the derecognition of another asset - the goods sold). The simultaneous
recognition of income and related expenses is sometimes referred to as the
matching of costs with income.
Recognition is appropriate if it results in both relevant information about
assets, liabilities, equity, income and expenses and a faithful representation
of those items, because the aim is to provide information that is useful to
investors, lenders and other creditors.

Derecognition is the removal of all or part of a recognized asset or liability

from an entity’s statement of financial position. Derecognition normally occurs
when that item no longer meets the definition of an asset or of a liability:
(a) for an asset, derecognition normally occurs when the entity loses control
of all or part of the recognized asset; and
(b) for a liability, derecognition normally occurs when the entity no longer
has a present obligation for all or part of the recognized liability.

THE NEED FOR ADJUSTMENTS

Accountants make adjusting entries to reflect in the accounts information on

economic activities that have occurred but not yet been recorded. Adjusting
entries assign revenues to the period in which they are earned, and expenses to
the period in which they are incurred. These entries are needed to measure
properly the profit for the period, and to bring related asset and liability
accounts to correct balances for the financial statements.

In short, adjustments are needed to ensure that the revenue recognition and
expense recognition principles are followed thus resulting to financial
statements reporting the effects of all transactions at the end of the period.

Adjusting entries involve changing account balances at the end of the period
from what is the current balance of the account to what is the correct balance
for proper financial reporting. Without adjusting entries, financial statements

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ACCOUNTING FUNDAMENTALS

may not fairly show the solvency of the entity in the balance sheet and the
profitability in the income statement.

DEFERRALS AND ACCRUALS

Accountants use adjusting entries to apply accrual accounting to transactions
that cover more than one accounting period. There are two general types of
adjustments made at the end of the accounting period - deferrals and accruals.
Each adjusting entry affects a balance sheet account (an asset or a liability
account) and an income statement account (income or expense account).

Deferral is the postponement of the recognition of ”an expense already paid but
not yet incurred,” or of ”a revenue already collected but not yet earned”. This
adjustment deals with an amount already recorded in a balance sheet account;
the entry, in effect, decreases the balance sheet account and increases an
income statement account. Deferrals would be needed in two cases:

1. Allocating assets to expense to reflect expenses incurred during the

accounting period (e.g. prepaid insurance, supplies and depreciation).
2. Allocating revenues received in advance to revenue to reflect revenues
earned during the accounting period (e.g. subscriptions).

Accrual is the recognition of “an expense already incurred but unpaid”, or

“revenue earned but uncollected”. This adjustment deals with an amount
unrecorded in any account; the entry, in effect, increases both a balance
sheet and an income statement account. Accruals would be required in two
cases:

1. Accruing expenses to reflect expenses incurred during the accounting period

that are unpaid and unrecorded.
2. Accruing revenues to reflect revenues earned during the accounting period
that are uncollected and unrecorded.

The Del Mundo Landscape Specialist case is continued to illustrate the

adjustment process. The letters A, L, OE, OE:l and OE:E are still used to
ensure a better understanding of the nature of the accounts affected.

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ACCOUNTING FUNDAMENTALS

ADJUSTMENTS FOR DEFERRALS (Step 5)

Allocating Assets to Expenses

Entities often make expenditures that benefit more than one period. These
expenditures are generally debited to an asset account. At the end of each
accounting period, the estimated amount that has expired during the period or
that has benefited the period is transferred from the asset account to an
expense account. Two of the more important kinds of adjustments are prepaid
expenses, and depreciation of property and equipment.

Prepaid Expenses
Some expenses are customarily paid in advance. These expenditures (e.g.
supplies, rent and insurance) are called prepaid expenses. Prepaid expenses
are assets, not expenses. At the end of an accounting period, a portion or all of
these prepayments may have expired. The portion of an asset that has expired
becomes an expense. Prepaid expenses expire either with the passage of time
or through use and consumption.

If adjustments for prepaid expenses are not made at the end of the period, both
the balance sheet and the income statement will be misstated. First, the assets
of the entity will be overstated; second, the expenses of the entity will be
understated. For this reason, owner's equity in the balance sheet and profit in
the income statement will both be overstated. Besides prepaid rent, Del Mundo
Landscape Specialist has prepaid expenses for supplies and insurance, both
accounts need adjusting entries.

Prepaid Rent (Adjustment a). Del Mundo makes adjusting entry to record the
expiration of one month of the three months’ advance rent paid on Nov. 1.

Entry: Dr. Cr.

Rent Expense (OE:E) 7,000
Prepaid Rent (A) 7,000

After adjustments, the prepaid rent account has a balance of P14,000

(prepayment of P21,000 less the P7,000 expired portion); the rent expense
account reflects the P7,000 (P21,000/3 months) expense for the month.

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ACCOUNTING FUNDAMENTALS

Prepaid Insurance (Adjustment b). Del Mundo records the expiration of one-
twelfth of the entity’s one-year insurance policy taken last Nov. 5.

Entry: Dr. Cr.

Insurance Expense (OE:E) 2,000
Prepaid Insurance (A) 2,000

The prepaid insurance account has a balance of P22,000 (P24,000 prepayment

less P2,000) and insurance expense reflects the expired cost of P2,000
(P24,000/12 months) for the month.

Supplies (Adjustment c). Del Mundo discovers that he used P500 worth of
supplies during November. He makes the necessary adjusting entry.

Entry: Dr. Cr.

Supplies Expense (OE:E) 500
Supplies (A) 500

The asset account Supplies now reflect the adjusted amount of P500 (Nov. 8
supplies purchase of P1,000 less P500). In addition, the amount of supplies
expensed during the accounting period is reflected as P500.

Depreciation of Property and Equipment

When an entity acquires long-lived assets such as buildings, service vehicles,
computers or office furniture, it is basically buying or prepaying for the
usefulness of that asset. These assets help generate profit for the entity.
Therefore, a portion of the cost of the assets should be reported as expense in
each accounting period. Proper accounting requires the allocation of the cost of
the asset over its estimated useful life. The estimated amount allocated to any
one accounting period is called depreciation or depreciation expense. Three
factors are involved in computing depreciation expense:

1. Asset cost is the amount an entity paid to acquire the depreciable asset.
2. Estimated salvage value is the amount that the asset can probably be sold
for at the end of its estimated useful life.

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ACCOUNTING FUNDAMENTALS

3. Estimated useful life is the estimated number of periods that an entity can
make use of the asset. Useful life is an estimate, not an exact measurement.
Accountants estimate periodic depreciation. They have developed a number of
methods for estimating depreciation. The simplest procedure is called the
straight-line method. The formula for determining the amount of depreciation
expense for each period using this method is:

Asset cost xx
Less: Estimated salvage value xx
Depreciable cost xx
Divided by: Estimated useful life xx
Depreciation Expense for each time period xx

When recording depreciation expense, the asset account is not directly

reduced. Instead, the reduction is recorded in a contra account called
accumulated depreciation. A contra account is used to record reductions in a
related account and its normal balance is opposite that of the related account.
Use of the contra account - accumulated depreciation - allows the disclosure of
the original cost of the related asset in the balance sheet. The balance of the
contra account is deducted from the cost to obtain the book value of the
property and equipment.

Vehicle and Equipment (Adjustments d and e). Del Mundo bought a truck
and lawn mowers last Nov. 2 and 3, respectively. Del Mundo allocates a full
month’s depreciation for property and equipment bought on or before the 15th
day of the month; otherwise, it is haIf-month’s depreciation. It is estimated that
the truck will have a useful life of five years and a salvage value of P30,000,
while the lawn mowers, four-and-a-half years usefuI life without salvage value.
Del Mundo then computes the depreciation expenses for the truck as P4,5OO a
month [(P300,000 - P30,000) / 60 months] and for the lawnmowers, P1,000
(54,000/54 months).

Entry: Dr. Cr.

Depreciation Expense-Vehicles (OE:E) 4,500

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ACCOUNTING FUNDAMENTALS

Accumulated Depreciation-Vehicles (A) 4,500

Depreciation Expense-Equipment (OE:E) 1,000

Accumulated Depreciation-Equipment (A) 1,000

After adjustments, the property and equipment section of the balance sheet for
Del Mundo Landscape Specialist will be:

Del Mundo Landscape Specialist

Partial Balance Sheet
Nov . 30, 2019

Property and Equipment (Net):

Service Vehicle 300,000
Less: Accumulated Depreciation 4,500 295,500

Office Equipment 54,000

Less: Accumulated Depreciation 1,000 53,000
348,500

Allocating Revenues Received in Advance to Revenues

There are times when an entity receives cash for services or goods even before
service is rendered or goods are delivered. When such is received in advance,
the entity has an obligation to perform services or deliver goods. The liability
referred to is unearned revenue.
For example, publishing entities usually receive payments for magazine
subscriptions in advance. These payments must be recorded in a liability
account. If the entity fails to deliver the magazines for the subscription period,

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ACCOUNTING FUNDAMENTALS

subscribers are entitled to a refund. As the entity delivers each issue of the
magazine, it earns a part of the advance payments. This earned portion must
be transferred from the unearned subscription revenues account to the
subscription revenues account.

Unearned Referral Revenues (Adj. f). On Nov. 20, Del Mundo received a
P13,500 prepayment for six future visits. Since Del Mundo completed one of
these visits in November, he makes an adjusting entry to reflect this.

Entry: Dr. Cr.

Unearned Revenues (L) 2,250
Lawn Cutting Revenues (OE:I) 2,250

The liability account unearned revenues reflects the lawn cutting revenues still
to be earned, P11,250. The revenues account reflects the amount of lawn
cutting already completed and considered as revenues during the month,
P2,250 (P13,500/6 visits).

ADJUSTMENTS FOR ACCRUALS (Step 5)

Accrued Expenses

An entity often incurs expenses before paying for them. Cash payments are
usually made at regular intervals of time such as weekly, monthly, quarterly or
annually. If the accounting period ends on a date that does not coincide with
the scheduled cash payment date, an adjusting entry is needed to reflect the
expense incurred since the last payment. This adjustment helps the entity
avoid the impractical preparation of hourly or daily journal entries just to
accrue expenses. Salaries, interest, utilities (e.g., electricity,
telecommunications and water) and taxes are examples of expenses that are
incurred before payment is made.

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ACCOUNTING FUNDAMENTALS

Accrued Salaries (Adj. g). Del Mundo records an expense for the salaries of his
part-time employee who earned P1,600 during the last four days of November
but will not be paid until Dec. 10.

Entry: Dr. Cr.

Salaries Expense (OE:E) 1,600
Salaries Payable (L) 1,600

The liability of P1,600 (P400 daily rate x 4 days) is now correctly reflected in the
salaries payable account. The actual expense incurred for salaries during the
month is P5,600 (Nov. 26 salaries payment of P4,000 + P1,600).

Interest is a charge for the use of money over time. Interest expense is matched
to a particular period during which the benefit - the use of borrowed money - is
received. The interest is a fixed obligation and accrues regardless of the results
of the entity's operations. Interest rates are expressed at annual rates, so if
interest is being calculated for less than a year, the calculation must express
time as a portion of a year. Interest calculations usually exclude the day that
loans occur and include the day that loans are paid off.

Accrued Interest (Adj. h). Del Mundo’s P100,000 note payable, which he
signed on Nov. 2, carries an 18% interest rate. Del Mundo uses the formula (for
simple interest) below to calculate how much interest expense accrued during
the final twenty-eight days or November.

Interest = Principal x Interest Rate x Length of Time

= P100,000 x 18% per year x 28/360 of a year
= P1,400

Entry: Dr. Cr.

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ACCOUNTING FUNDAMENTALS

Interest Expense (OE:E) 1,400

Interest Payable (L) 1,400

At the end of November, Del Mundo owed the bank P1,400 for interest in
addition to the P100,000 loan.

Accrued Revenues
An entity may provide services during the period that are neither paid for by
clients nor billed at the end of the period. The value of these services
represents revenue earned by the entity. Any revenue that has been earned but
not recorded during the accounting period calls for an adjusting entry that
debits an asset account and credits an income account.

Accrued Lawn Cutting Revenues (Adj. i). During the afternoon of Nov. 30,
Del Mundo cuts one lawn, and he agrees to mail the customer a bill for P2,500
which he does on Dec. 2. Del Mundo makes an adjusting entry in accordance
with the revenue recognition principle.

Entry: Dr. Cr.

Accounts Receivable (A) 2,500
Lawn Cutting Revenues (OE:I) 2,500

A total of P42,250 (P37,500 + P2,250 + P2,500) in consulting revenues was

earned by the entity during the month.

ACCRUAL FOR UNCOLLECTIBLE ACCOUNTS

Entities often allow clients to purchase goods or avail of services on credit.
Some of these accounts will never be collected; hence, there is a need to reflect
these as charges against income. In practice, an expense is recognized for the
estimated uncollectible accounts in the current period, rather than when
specific accounts actually become uncollectible. This practice produces a better

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ACCOUNTING FUNDAMENTALS

matching of income and expenses. Estimates of uncollectible accounts may be

based on credit sales for the period or on the accounts receivable balance.

Assume that an entity made credit sales of P1,100,000 in 2019 and prior
experience indicates an expected 1% average uncollectible accounts rate based
on credit sales. The contra account - Allowance for Uncollectible Accounts has
a normal credit balance and is shown in the balance sheet as a deduction from
Accounts Receivable. The allowance account need to be increased by P11,000
(P1,100,000 x 1%) because accounts receivable in that amount is doubtful of
collection. The adjustment will be:

Entry: Dr. Cr.

Uncollectible Accounts Expense (OE:E) 11,000
Allowance for Uncollectible Accounts (A) 11,000

Throughout the accounting period, when there is positive evidence that a

specific account is definitely uncollectible, the appropriate amount is written off
against the contra account. For example, if a P1,500 receivable were considered
uncollectible, that amount would be written off as follows:

Entry: Dr. Cr.

Allowance for Uncollectible Accounts (A) 1,500
Accounts Receivable (A) 1,500

No entry is made to Uncollectible Accounts Expense, since the adjusting entry

has already provided for an estimated expense based on previous experience
for all receivables.

EFFECTS OF OMITTING ADJUSTMENTS

When an accountant failed to include the proper adjusting entries, the
resulting financial statements will not accurately reflect the financial position
and the performance of the entity. Inaccuracies in one accounting period can
cause further inaccuracies in the statements of subsequent periods.

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ACCOUNTING FUNDAMENTALS

Illustration. On July 1, 2018, Guagua Manpower Services owned by

Bienvenida Alvaro borrowed P100,000 by signing an 18-month note at 16%
interest pet annum. The principal and interest are to be repaid when the note
matures on Dec. 31, 2019. As at Dec. 31, 2018, the entity has incurred
interest expense of P8,000 (P100,000 x 16% x 6/12). The accountant did not
record the adjustment for the accrued interest. The entry should have been a
debit to Interest Expense and a credit to Interest Payable for P8,000. The
effects of the omission in the 2018 financial statements are as follows:

> In the 2018 income statement, interest expense is understated by P8,000

and. therefore, profit is overstated by P8,000.

> In the Dec. 31, 2018 balance sheet, owner’s equity is overstated by P8,000
because of the overstatement in profit. Total liabilities is understated because
of the omission of the P8,000 interest payable.

On Dec. 31, 2019, the maturity date, the note is paid together with interest.
Since there was no adjusting entry made to accrue interest in 2018, the entire
interest of P24,000 (P100,000 x 16% x 18/12) is erroneously charged against
2019 profit. The correct interest expense for 2019 should have been P16,000
(P100,000 x 16% x 12/12). The effects of the omissions in the 2019 financial
statements are as follows:

> In the 2019 income statement, interest expense is overstated by P8,000 and,
therefore, profit is understated by P8,000.

> The Dec. 31, 2019 balance sheet is correctly stated since the note along with
its interest has been settled by year-end. The effect of the omission has
counterbalanced by the end of the second accounting period.

In summary, the omission has produced two erroneous income statements and
one erroneous balance sheet. Assume further that the entity should have
reported a correct profit of P500,000 in the 2018 and 2019 income statements.

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ACCOUNTING FUNDAMENTALS

As a result of the omission, the proprietorship's profit in 2018 is P508,000 and

in 2019, P492,000.

ANALYSIS USING T-ACCOUNTS

To recapitulate, each adjusting entry affects a balance sheet account (an asset
or a liability account) and an income statement account (an income or an expense
account). Almost every revenue or expense account on the income statement
has one or more related accounts on the statement of financial position. For
instance, rent expense is related to prepaid rent, supplies expense to supplies,
service revenues to unearned service revenues and salaries expense to salaries
payable.

Having been apprised of these relationships, transactions affecting particular

accounts can now be analyzed using T-accounts. This learning will be of use in
reconstructing accounts to derive details like cash inflows, cash outflows,
revenues recognized for the period or expenses charged for the period.

To illustrate, Eco-Tours, established by Joseph Guintu at the start of the

month, reported at month-end the following related accounts and account
balances: Supplies, P36,600 and Supplies Expense, P15,400.

Looking at the foregoing, Guintu wants to know how much cash was paid out
to purchase supplies. Start by placing the relevant information in a T-account.
Input the beginning balance on the normal balance of the account. In this case,
Supplies is debit. There is no beginning balance since the entity just started
operations this month.

As a technique, the ending balance of an account, here, Supplies for P36,600,

is placed opposite its normal balance. In adjusting for supplies expense, the
entry made was debit Supplies Expense, P15,400 and credit Supplies, P15,400.
Total both debit and credit sides. The cash paid out for supplies can now be
derived; it’s P52, 000 (P52, 000 - zero), the plug figure. If there was a beginning
balance of P2, 000 then cash paid out would have been P50, 000 (P52, 000 -
P2,000).

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ACCOUNTING FUNDAMENTALS

Assume instead that the P36,000 ending balance for Supplies and the P52,000
cash paid for supplies were given, using the T-account, Supplies Expense
isP15,400 (P52,000 – P36,600):

To illustrate further, an entity reported at month-end the following related

accounts and account balances: Prepaid Insurance, End, P67,000; Insurance
Expense, P12,000 and Prepaid Insurance, Beginning, P48,000. How much cash
was used to pay for insurance this period? Answer: P31,000

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ACCOUNTING FUNDAMENTALS

To have an ending balance of P67,000, there must have been a P31,000 debit
to the Prepaid Insurance account. Since a debit to this account is normally
offset by a credit to Cash, the analysis confirms that cash outflows for
insurance was P31,000.

APPENDIX
ALTERNATIVE METHODS OF RECORDING DEFERRALS
In the discussions, all the transactions that required adjustments are initially
recorded in balance sheet accounts. A prepaid expense is initially recorded in a
prepaid asset account. Likewise, revenue received in advance is initially
recorded in a liability account – unearned revenues. In the case of a prepaid
expense, an adjusting entry is made at the end of the period to transfer the
portion of the expired asset to an expense account. Similarly, an adjusting
entry is made to transfer earned revenues from the liability account to an
income account.

Entities may initially account for deferrals using income and expense accounts.
The alternative approach is illustrated in this appendix.

Prepaid Expenses
On Oct. 1, 2019, Moises Dondoyano acquired a 3-year insurance policy for
P36,000 paid in advance. The entity may record this transaction depending on
which of the two accounting policies it follows. The P36,000 payment may
initially be recorded either as an asset or as an expense.

Initial entry is recorded as:

1. An asset
2019 Oct.10 Dr. Cr.
Prepaid Insurance (A) 36,000
Cash 36,000

2. An expense
2019 Oct. 10 Dr. Cr.
Insurance Expense(OE:E) 36,000
Cash 36,000

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ACCOUNTING FUNDAMENTALS

At the end of the year, an adjusting entry is needed to establish the proper
balances in the prepaid insurance and insurance expense accounts. On Dec.
31, 2019, three months' insurance has been consumed, or insurance expense
is equal to P3,000 (P36,000/36 months x 3 months). Prepaid insurance
equivalent to P33,000 (P36,000 - P3,000) remain. The appropriate adjustment
depends on how the initial transaction was recorded.

Adjusting entry required if initial entry is recorded as:

1. An asset
2019 Dec. 31 Dr. Cr.
Insurance Expense (OE:E) 3,000
Prepaid insurance (A) 3,000

2. An expense
2019 Dec. 31 Dr. Cr.
Prepaid Insurance (A) 33,000
Insurance Expense (OE:E) 33,000

The effect of the adjusting entries on the ledger accounts after posting is the
same regardless of the initial debits as shown below:

As an Asset As an Expense
Dec. 31 balances: Dec. 31 balances:
Prepaid insurance 33,000 debit Prepaid Insurance 33,000 debit

Insurance Expense 3,000 debit Insurance Expense 3,000 debit

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ACCOUNTING FUNDAMENTALS

Unearned Revenues
On July 1, 2019, Alfred Quinsay Realty received a P48,000 check for 2 years’
rent paid in advance. On this date, the entity may record a credit in that
amount either as unearned rental revenue or rental revenue, depending on its
accounting policy.

Initial entry is recorded as:

1. A liability
2019 July 1 Dr. Cr.
Cash 48,000
Unearned Rent Revenues (L) 48,000

2. A revenue
2019 July 1 Dr. Cr.
Cash 48,000
Rent Revenues (OE:I) 48,000

At the end of the year, an adjusting entry is needed to establish the proper
balances in the rent revenue and unearned rent revenue accounts. On Dec.
31, 2019, six months’ rent has been earned, or rent revenue is equal to
P12,000 (P48,000/24 months x 6 months). Unearned rent revenues
equivalent to P36,000 (P48,000 – P12,000) remain. The appropriate
adjustment depends on how the initial transaction was recorded.

Adjusting entry required if initial entry is recorded as:

1. A liability
2019 Dec. 31 Dr. Cr.
Unearned Rent Revenues (L) 12,000
Rent Revenues (OE:I) 12,000

2. A revenue
2019 Dec. 31 Dr. Cr.
Rent Revenues (OE:I) 36,000
Unearned Rent Revenues (L) 36,000

The effect of the adjusting entries on the ledger accounts after posting is the
same regardless of the initial credits as shown below:

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ACCOUNTING FUNDAMENTALS

As an Liability As an Income
Dec. 31 balances: Dec. 31 balances:
Unearned Rent Revenues 36,000 credit Unearned Rent Revenues 36,000 credit

Rent Revenues 12,000 credit Rent Revenues 12,000 credit

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