CH4: ADJUSTING THE ACCOUNTS

Principles of Accounting ACCO 014 (Lecture)

● There may be financial data not

THE ACCOUNTING PERIOD
previously recognized that needed to be
● Enterprise’s activities division recorded to make the books of accounts
● Divided into specific periods up to date, like:
○ Monthly, quarterly, semester, & ○ Expenses already incurred but no
yearly payment until sometime in the
● Usually spans for 12 months subsequent period
● It may be a calendar year or fiscal year ○ Revenues already earned but no
○ Calendar Year: normal year; cash is collected yet
starts in Jan 1 & ends in Dec 31
○ Fiscal Year: 12 consecutive
ITEMS THAT NEED ADJUSTMENTS
months that may or may not
coincide with the calendar year
■ Doesn’t start with Jan 1 Prepaid Expenses
but anytime of the year ● Expenditures paid for goods that are not
and ends after 12 months yet consumed
○ Ex: Insurance and Rent

ACCRUAL VS CASH ACCOUNTING

Accrued Expenses
● These are items already recorded as
ACCRUAL ACCOUNTING expenses but not yet paid
● Has an obligation to make payments in
● Requires that all revenue earned the future
whether payment is received or not, ● Similar to debt or loan
should be recognized in the period the
goods are delivered or rendered Accrued Revenue
● Moreover, all related costs to deliver the ● Revenues already earned but no
goods or to render the service, whether payment is received yet
paid or not should be recognized as ● Someone has loaned from you
expense to match the revenue
Deferred Revenue or Unearned Revenues
CASH BASIS ACCOUNTING ● Exact opposite of accrued revenues
● In this case, payment is received in
● Requires that all revenue is recognized
advance prior to delivery of services or
only when cash is received
goods
● Expenses are recognized only when
○ Creating a liability for the amount
cash is paid
collected in advanced
● However, as the company renders the
IMPORTANCE OF ADJUSTING ENTRIES service, the unearned revenue becomes
● Adjusting entries are made at the end of earned revenue
the period ● Accounts payable
○ To assign revenues to the period
in which they are earned Uncollectible Amount Expense or Doubtful
○ And expenses to the period in Accounts
which they are incurred ● Accounts of customers who don’t pay
● Many accounts need adjustments to what they have promised to pay
reflect the current conditions as of time ● Enterprise should provide allowance for
of reporting in order for the statements to uncollectible accounts and recognize an
be meaningful expense or loss from these accounts
 ● Hindi nagbabayad mga pinautang mo, a. On Oct 1, 2013, a company paid
tinakbuhan P12,000 as insurance premium
● Contra asset accounts for one year.
The entry to record the payment
Depreciation under the asset method is:
● The systematic means of allocating the
Prepaid Insurance 12,000
cost of long lived asset over its estimated
economic life Cash 12,000
● Assets that are used over a long period
of time (3-5 years) b. With the passage of time, the
○ Ex. Building prepaid insurance gradually
■ Doesn’t immediately expires, that’s why on Dec. 31, an
recognizing it as an adjusting entry is required to
expense but rather as recognize the expired portion of
depreciation, allocating its the insurance premium as
value over its period of expense
use
■ Divide the price of building Expense 3,000
over its lifespan (50 years) Prepaid Insurance 3,000

METHODS OF RECORDING 3. Rent

PREPAYMENTS
a. On Dec. 1, the company paid
P18,000 as rent for one year
ASSET METHOD The entry:

● Asset - Credit; Expense - Debit Prepaid Rent 18,000

● Recording the used portion
Cash 18,000

Examples:
b. On Dec. 31, the entry will be
1. Supplies (18,000/12 mons.) x 1 mon. =
1,500
a. Purchase supplies worth P5,000 Rent Expense 1,500
is recorded as
Prepaid Rent 1,500
Supplies 5,000

Cash 5,000
EXPENSE METHOD
b. At the end of a period, the
● This method requires an entry debiting
physical count of unused supplies
an expense account upon payment
showed a total of P3,500. This
● Recording the unused portion
shows that if P3,500 is unused,
● Expense-Credit, Asset-Debit
then P1,500 worth of supplies is
used or consumed
Examples:
Supplies Expense 1,500
1. Supplies
Supplies 1,500
a. Previous example; if the supplies
2. Insurance purchased were recorded. Entry:
Supplies Expense 5,000
 a. On June 15, when the company
Cash 5,000
pays the salaries of employees,
b. The adjusting entry required to the payment will be recorded as:
reflect the unused portion:
Salaries Expense PXXX
Supplies 3,500
Cash PXXX
Supplies Expense 3,500

b. No accrual for salary payment on

2. Insurance June 15 because this date is
a. Based on prev ex. The entry regular working day
made upon payment is: The salary for he 2nd half of the
Insurance Expense 12,000 month which is June 30 will not
be paid on that day because it is
Cash 12,000 a non-working day
So, the salary will be paid the ff.
b. The adjusting entry on Dec. 31, day Mon, July 2
would be: Expense will be recognized as:
Prepaid Insurance 9,000 Salaries Expense PXXX

Insurance Expense 9,000 Accrued Salaries or

Salaries Payable PXXX

3. Rent
a. Based on prev ex., if the expense
2. Accrued Interest on Notes Receivable
method is used, the entry is:
a. A company issued a 90-day 10%
Rent Expense 18,000 note on Dec 1 for P100,000
The notes payable is due 90 days
Cash 18,000
from date of issue inclu. interest
earned for 90 days
b. The adjusting entry on Dec. 31 If financial statements are
would be: prepared on Dec 31, the
Prepaid Rent 16,500 company must record the interest
for 30 days as:
Rent Expense 16,500
Interest Expense 833.33

Accrued Interest 833.33

ACCRUED EXPENSES Amount x interest rate x days/360
(accounting period)
● Items already recorded as expenses but
100,000 x 0.10 (10%) x 30/360
not yet paid, thus creating obligations to
make payments in the future
● Examples: ACCRUED REVENUE
○ Salaries of employees Example:
○ Utilities expenses; bill from
Meralco and Manila Water These are revenues already earned but no
payments received yet
Recording examples:
Interest Receivable PXXX
1. Salaries Expense Interest Revenue PXXX
 ○ Certain percentage of accounts
DEFERRED REVENUE OR UNEARNED
REVENUES receivable, or certain percentage
of sales income
○ Aging of accounts receivable and
1. Revenue Method arbitrary amounts which is
a. On Aug 1, a tenant paid its rent declared by business based on
for 1 year in advance in the studies
amount of P24,000
At the time cash’s received, entry: Example:
Cash 24,000
1. Percentage of Sales on Account or
Rent Revenue 24,000 Service Revenue on Account
a. The company estimates that 2%
b. When financial statement is of sales on account are proven to
prepared on Dec 31, an be uncollectible. The entry:
adjustment is necessary to reflect
Uncollectible Account Expense
the unearned portion of the rent PXXX
that corresponds to the period
Jan 1 - July 31, adjusting entry: Allowance of Uncollectible
Account PXXX
Rent Revenue 14,000

Unearned Rent 14,000 ● The allowance for doubtful accounts is a

Rent revenue (7/12 x 24,000) = contra account which is deducted from
14,000 the accounts receivable in the balance
sheet to arrive at its net realizable value
2. Liability Method
a. Used to record the receipt of 2. Accounts Receivable Balance
P24,000, the entry upon receipt: a. The ff balances are from the
records of Manila Premier Hotel
Cash 24,000 at Dec 21
Unearned Rent 24,000 Accounts Receivable, 12/31
P800,000
b. On Dec 31, the amount earned Allowance for Uncollectible
must be recognized as revenue Accounts, 1/1 P12,000 Cr.
through an adjusting entry
Service Revenue on account
Unearned Rent 10,000 P2,500,000
Rent Revenue 10,000
(Aug - Dec: 5x2 = 10,000) The company’s estimate for
uncollectible accounts is 2% of
accounts receivable
UNCOLLECTIBLE ACCOUNT EXPENSE
OR DOUBTFUL ACCOUNTS b. Adjusting entry to reflect expense
● The enterprise should provide allowance
Uncollectible account expense
for uncollectible accounts and recognize 4,000
and expense or loss from these accs
● Other terms for uncollectible accounts Allowance for uncollectible
are Bad Debts and Doubtful Accounts accounts 4,000
● The Two Ways to Measure Allowance of (800,000 x 2% - 12,000) = 4,000
Bad Debts are:
 DEPRECIATION Accumulated Depreciation -
Dep. Ex. 55,000
● Depreciation does not necessarily
measure the decline in the value of an
asset but it shows the only portion of the ● Accumulated Depreciation is a contra
cost of the asset that has expired due to account, which is reported as a
using up the asset deduction from the related asset account
● The assets that are subject to
depreciation are called depreciable A. The presentation of the asset and its
assets related accumulated depreciation on the
● Formula: balance follows:
Delivery Equipment P600,000

Less: Accumulated 55,000

Depreciation

● Cost of Asset Book Value P545,000

○ The amount of company paid to
purchase the asset ● Book Value is the part of the cost of the
○ Includes the invoice price plus asset that is not yet allocated to an
transportation charges and expense account
installation fees
● Scrap Value
○ The amount expected to be
recovered at the end of an
asset’s life
○ Also called as Residual Value or
Salvage Value
● Estimated Economic Life
○ The same as the estimated useful
life of an asset
● Depreciation Cost or Value is the
difference between the cost of an asset
and its scrap value

Example:

1. Depreciation Cost or Value

a. A delivery equipment was
purchased on Jan 3 for P600,000
It’s estimated that the vehicle’s
salvage value at the end of 10 yrs
is P50,000

formula:
Dep. Expense = 600,00 - 50,000 /
10 yrs. = 55,000/yr

b. Adjusting entry on Dec 31:

Depreciation Expense 55,000