ADJUSTING ENTRIES

Atty. Ronald A. Ricablanca, CPA

Juris Doctor
Doctor of Business Administration
Master of Business Administration
BS Accountancy

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Learning Objectives

1. To understand the need for the preparation of

adjusting entries.
2. To identify the accounts that need to be adjusted.
3. To determine the date adjusting entries are to be
prepared.
4. To explain the effects if an entity failed to prepare
the necessary adjusting entries.

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ADJUSTING ENTRIES

• These are journal entries that need to be prepared at the end of reporting
period in order to update the balance of some accounts.
• Effects if not prepared:
– Overstatement of assets resulting to understatement of expenses; or
– Overstatement of expenses resulting to understatement of assets; or
– Understatement of expenses resulting to understatement of liabilities; or
– Understatement of income/revenue resulting to understatement of
assets;
– Overstatement of liabilities, resulting to understatement of
income/revenue; or
– Overstatement of income/revenue, resulting to understatement of
liabilities.

• Adjusting entries include the following:

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 Prepaid Expenses

• Expenses already paid but not yet incurred,

used or utilized at the end of the reporting
period.
• Also known as Deferred expense.
• Portion of the assets like supplies and prepaid
rent actually used must be recognized as
expense, while portion unused must be shown
as an asset.

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 Unearned Revenue

• Revenue or income already received from the

customers but not yet earned.
• Also known as deferred revenue/income or
pre-collected revenue/income.
• Portion of cash received in advance is
recognized as income when earned while the
portion still unearned must be reported as a
liability.

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 Accrued Expense

• Expenses already incurred but not yet paid

as of the reporting date.
• GAAP requires the application of accrual
basis rather than cash basis.
• Examples: accrued salaries expense,
accrued interest expense, accrued utilities
expense, etc.

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 Accrued income

• Revenue or income already earned but not yet

received or collected.
• GAAP requires the application of accrual basis
rather than cash basis.
• Example: accrued interest income

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 Depreciation

• The process of allocating the cost depreciable

tangible assets used in the business over its
estimated useful life in years in accordance
with the systematic and rational allocation
principle of accounting.
• Includes items on property, plant and
equipment such as building, equipment,
furniture and fixtures etc.

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 Bad Debts

• Amount of accounts receivable that becomes

worthless or estimated to be uncollectible.
• Also known as doubtful accounts, uncollectible
accounts, or impairment loss.
• Accounts receivable must be reported at
amortized cost (Net Realizable Value).

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PREPAID EXPENSES

• Asset Method
• Expense Method

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 Asset Method

• The transaction will be recorded as a debit to an

asset account like “Supplies”, or “Prepaid Rent” and
credit to “Cash” or “Accounts Payable” as the case
may be.
• At the end of the reporting period, an adjusting entry
will be prepared to recognize the used or expired
portion of an asset as an expense, thereby debiting
an expense account and crediting an asset account
equal to the amount used or expired.

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 Illustration:

On October 1, 2019, Office Supplies amounting

to P80,000 were purchased for cash. At
December 31, 2019, the end of the reporting
period, the amount of supplies used was
P30,000.

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Journal Entry:

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Adjusting Entry:

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Adjusted balance

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Adjusted Balance

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 Expense Method

• The transaction will be recorded by debiting an

expense account and crediting “Cash” or
“Accounts Payable” as the case may be.
• At the end of the reporting period, adjusting
entry will be prepared to recognize the unused
or unexpired portion of the previously recorded
expense, thereby debiting an asset account
and crediting the expense account equal to the
amount of unused or unexpired.
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 Illustration

On October 1, 2019, Office Supplies amounting

to P80,000 were purchased for cash. At
December 31, 2019, the end of the reporting
period, the amount of supplies used was
P30,000.The journal entry to record this
transaction and the necessary adjusting journal
entry that should be made at December 31, 2019
would be:

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Journal Entry

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Adjusting Entry

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Adjusted Balance

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Adjusted Balance

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UNEARNED REVENUE

• Liability Method
• Revenue/Income Method

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 Liability Method

• Receipt of advanced payment from the

customer will be credited to a liability account.
• The transaction will be debited to “Cash” and a
credit to “Unearned Revenue” account.
• At the end of the reporting period, adjusting
entry will be prepared to recognize the earned
portion of an unearned revenue as an income
or revenue, thereby debiting an “unearned
revenue” account and crediting the “revenue”.
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 Illustration

• On October 1, 2019, received P120,000 from

customer as advanced payment for rent of an
office space for 12 months beginning October
1, 2019.

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Journal Entry

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Unadjusted Balance

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Adjusting Entry

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Adjusted Balance

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Adjusted Balance

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 Revenue or Income Method

• Receipt of advanced payment from the customer

will be credited to an income or revenue account.
• The transaction will be debited to “Cash” and a
credit to “Revenue” account.
• At the end of the reporting period, an adjusting
entry will be prepared to recognize the unearned
portion of the previously recorded revenue as a
liability, thereby debiting an “revenue” account
and crediting the “ unearned revenue” account.
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 Illustration

On October 1, 2019, received P120,000 from

customer as advanced payment for rent of an
office space for 12 months beginning October 1,
2019.

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Journal Entry

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Unadjusted Balance

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Adjusting Entry

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Adjusted Balance

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Adjusted Balance

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ACCRUED EXPENSES

• Expenses already incurred but not yet paid. This

means that there are assets or services which have
been already used or consumed by the business
entity during the reporting period but unpaid as of
the end of the reporting period.
• Following the accrual principle, expenses incurred
even though unpaid must be recognized in the
period of incurrence. Being unpaid a corresponding
liability must also be recognized.

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 Illustration

At the end of the reporting period, the following

items have been incurred during the year but not
yet paid:
 Salaries of the employees, P100,000
 MERALCO bill, P24,000
 PLDT bill, P6,000
 Interest on loans with the Bank of PI,
P12,000

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Adjusting Entries

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ACCRUED INCOME

• These are income already earned but not yet

received or collected.
• Income is earned when the services are already
rendered to the customer during the reporting
period but the corresponding payment for such
services has not yet been received at the end of
the reporting period.

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 Illustration

On August 1, 2019, RCBC Co. received a one-

year, 10%, P100,000 face value notes from
customer for services rendered.

The journal entry to record the receipt of the note

as well as the adjusting entry at the end of the
calendar year reporting period would be:

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Journal Entries

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DEPRECIATION

• The cost depreciable property, plant and equipment

must be periodically charged to expense through a
systematic and rational allocation method.
• Such periodic allocation is called depreciation
expense.
• Depreciation method: Straight-line method
• Formula:
– Annual Depreciation Expense = (Cost - Salvage Value)
÷ Estimated Useful Life in Years

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Pro-forma Entry

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 Illustration

On April 1, 2019, RCBC Company acquired a

brand new delivery truck with acquisition cash
price of P1,400,000. The truck has an estimated
useful life of 10 years after which it can be sold
for P200,000.

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Journal Entries

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DOUBTFUL ACCOUNTS

• Direct Write-off Method (Not GAAP)

• Allowance Method
 Percentage of Sales
 Percentage of Accounts Receivable
 Aging of Receivables

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 Direct Write-off Method

• Under the direct write-off method, doubtful

accounts expense is recognized when specific
accounts receivable have been ascertained to
be worthless. Such worthless accounts are
thereby removed from the books. However, this
method is not acceptable in financial
accounting though the only acceptable method
as far as the Bureau of Internal Revenue
regulations is concerned.
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 Allowance Method

• Under the allowance method, recognition of doubtful

accounts expense is by way of estimation. The accounts
receivable are not written-off or removed from the books,
instead, an allowance is set-up against the accounts
receivable. By setting up an allowance of doubtful accounts,
it signals the readers of the financial statements that portion
of the accounts receivable reported may not be collected.

• In estimating the amount of doubtful accounts, surrounding

circumstances like, past experiences, economic condition,
among others, must be considered.

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Comparison

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 Percentage of Accounts Receivable

• In the percentage of accounts receivable method, the

doubtful accounts expense is determined by computing first
the required balance of the allowance for doubtful accounts
to be reported in the statement of financial position. The
required balance of the allowance for doubtful accounts is
computed by multiplying a pre-determined rate to balance of
accounts receivable at the end of the period. The doubtful
accounts expense would now be computed by getting the
difference between the required balance of the allowance for
doubtful accounts and the balance of allowance for doubtful
accounts before adjustment. Because of this approach, this
method is also known as balance sheet approach.
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Illustration

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Questions

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Questions

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 Aging of Accounts Receivable

• Under the aging of accounts receivable method, doubtful accounts

expense is computed with due consideration of the age of the
receivable. The age of a receivable starts from the moment it is created,
meaning, from the time the contract of sale is perfected, and that is,
generally, when the goods are delivered by the seller to the buyer.
However, it does not necessarily follow that once a receivable is
created, it is already due because the seller may grant the buyer
certain period of time (usually in terms of days) to make payment, or
the so-called credit terms. It is only after the lapse of the credit term
without the receivable being collected it is considered as past due.
Logically, the longer the time the receivables remain uncollected or
outstanding, the higher the risk that these would not be collected. This
method of estimating doubtful accounts expense is more accurate and
reliable as compared to the other two previously discussed.

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