A slide presentation of various problems on adjusting entries.

1. ADJUSTING THE ACCOUNTS
Chapter 5

2. The Periodicity Concept

3. PERIODICITY CONCEPT
• The periodicity concept is applied when
accountants divide the life of a business entity
into artificial time periods (year, quarter, etc.)

4. PERIODICITY CONCEPT
• The most basic accounting period is one year.

5. Types of Accounting Periods

6. TYPES OF ACCOUNTING PERIODS
Fiscal year – any twelve consecutive months.
Example – March 1, 2012 to February 28, 2013

7. TYPES OF ACCOUNTING PERIODS
• Calendar year – an annual period ending
December 31.

8. TYPES OF ACCOUNTING PERIODS
• Natural business year – a twelve month
period that ends when business activities are
at their lowest level of the annual cycle.

9. TYPES OF ACCOUNTING PERIODS
Interim period – a period of less than one year.

10. Revenue Recognition Principle
When is revenue recognized?

11. REVENUE RECOGNITION PRINCIPLE
Revenue is recognized when it is probable that
economic benefits will flow to the enterprise and
these economic benefits can be measured reliably.

12. REVENUE RECOGNITION PRINCIPLE
In most cases, revenue is recognized in the
accounting period when the services are rendered
or the goods sold are delivered.

13. Expense recognition principle
When are expenses recognized?

14. EXPENSE RECOGNITION PRINCIPLE
Expenses are recognized in the income statement
when it is probable that a decrease in future
economic benefits related to a decrease in an
asset or an increase in a liability has arisen, and
that the decrease in economic benefits can be
measured reliably.

15. EXPENSE RECOGNITION PRINCIPLE
The expense recognition principle has three broad
applications namely:

16. EXPENSE RECOGNITION PRINCIPLE
1. Direct association between the costs incurred
and the earning of specific items of income.
Example: sales commissions expense

17. EXPENSE RECOGNITION PRINCIPLE
2. Systematic and rational allocation – This is used
when economic benefits are expected to arise
over several accounting periods. This is often
necessary in recognizing the expenses associated
with the using up of assets.
Example – insurance, rent, depreciation of
equipment

18. EXPENSE RECOGNITION PRINCIPLE
3. Immediate recognition – This is applied when an
expenditure produces no future benefits.
Example: salaries

19. The Need for Adjustments

20. THE NEED FOR ADJUSTMENTS
• Adjustments are necessary to reflect in the
accounts information on economic activities
that have occurred but have not yet been
recorded.

21. THE NEED FOR ADJUSTMENTS
• Adjustments ensure that the revenue
recognition principle and the expense
recognition principles are followed.

22. Types of Adjustments

23. TYPES OF ADJUSTMENTS
• There are two general types of adjustments:
adjustment for deferrals and adjustment for
accruals.

24. TYPES OF ADJUSTMENTS
• Deferral – is the postponement of the
recognition of an “expense already paid but
not yet incurred” or of “revenue already
collected but not yet earned.”

25. TYPES OF ADJUSTMENTS
• Accruals– is the recognition of an “expense
already incurred” but not yet paid or “revenue
earned but uncollected.”

26. Adjustment for Deferrals
Prepaid Expenses

27. ADJUSTMENT – PREPAID EXPENSES
Example 1: Prepaid Rent
On May 1, Weddings “R” Us paid P12,000 for
three months’ rent in advance. This resulted
to an asset consisting of the right to occupy
the office for two months. A portion of the
asset expires and becomes an expense each
day. By May 31, one-third of the asset had
expired, and should be treated as an expense.

28. ADJUSTMENT – PREPAID EXPENSES
Example 1: Prepaid Rent (continued)
This transaction may be initially recorded in an
asset account. This is called asset method. The
initial entry on May 1:

29. ADJUSTMENT – PREPAID EXPENSES
Example 1: Prepaid Rent (continued)
Date Description PR Debit Credit
1-MayPrepaid Rent 12,000
Cash 12,000

30. ADJUSTMENT – PREPAID EXPENSES
Example 1: Prepaid Rent (continued)
Come May 31, an adjusting entry for the expired
prepaid rent must be made. The adjusting
entry is:

31. ADJUSTMENT – PREPAID EXPENSES
Example 1: Prepaid Rent (continued)
Date Description PR Debit Credit
31-MayRent Expense 4,000
Prepaid Rent 4,000

32. ADJUSTMENT – PREPAID EXPENSES
Example 1: Prepaid Rent (continued)
Alternatively, the transaction may be initially
recorded in an expense account. Thus, the
initial entry on May 1 is:

33. ADJUSTMENT – PREPAID EXPENSES
Example 1: Prepaid Rent (continued)
Date Description PR Debit Credit
1-MayRent Expense 12,000
Cash 12,000

34. ADJUSTMENT – PREPAID EXPENSES
Example 1: Prepaid Rent (continued)
Come May 31, an adjusting entry for the
unexpired prepaid rent must be made. The
adjusting entry is:

35. ADJUSTMENT – PREPAID EXPENSES
Example 1: Prepaid Rent (continued)
Date Description PR Debit Credit
1-MayPrepaid Rent 8,000
Rent Expense 8,000

36. ADJUSTMENT – PREPAID EXPENSES
• Thus the following rules must be followed in
adjustment for prepaid expenses:

37. ADJUSTMENT – PREPAID EXPENSES
• When a prepaid expense was recognized in
the initial entry (asset method), the adjusting
entry will involve an amount that has already
expired (expense).

38. ADJUSTMENT – PREPAID EXPENSES
• When an expense was recognized in the initial
entry (expense method), the adjusting entry
will involve an amount that is not yet expired
(asset).

39. ADJUSTMENT – PREPAID EXPENSES
• The two methods will have the same effect, as
will be shown in the following analysis:

40. ADJUSTMENT – PREPAID EXPENSES
` ASSET METHOD EXPENSE METHOD
Initial Entry Prepaid Rent 12,000 Rent Expense 12,000
Cash 12,000 Cash 12,000
Adjusting Entry Rent Expense 4,000 Prepaid Rent 8,000
Prepaid Rent 4,000 Rent Expense 8,000
Prepaid Rent = 12,000 – 4,000 Prepaid Rent = 8,000
Prepaid Rent = 8,000
Rent Expense = 12,000 – 8,000
Rent Expense = 4,000 Rent Expense = 4,000

41. ADJUSTMENT – PREPAID EXPENSES
• TIP: All adjusting entries include a balance
sheet (real or permanent) account and an
income statement (nominal or temporary)
account.

42. ADJUSTMENT – PREPAID EXPENSES
Example 2: Supplies
On May 8, Weddings “R” Us purchased supplies,
P18,000. During the month, the entity used
supplies in the process of performing services for
clients. There is no need to account for these
supplies everyday since the financial statements
will not be prepared until the end of the month.
At the end of the accounting period, Gevera
makes a careful physical inventory of the
supplies. The inventory count showed that
supplies costing P15,000 are still on hand.

43. ADJUSTMENT – PREPAID EXPENSES
Example 2: Supplies (continued)
Again the transaction maybe recorded in two
ways: by debiting an asset or debiting an
expense. The initial entries and adjusting
entries for the two methods follow:

44. ADJUSTMENT – PREPAID EXPENSES
• Example 2: Supplies (continued)
` ASSET METHOD EXPENSE METHOD
Initial Entry Supplies 18,000 Supplies Expense 18,000
Cash 18,000 Cash 18,000
Adjusting Entry Supplies Expense 3,000 Supplies 15,000
Supplies 3,000 Supplies Expense 15,000
Supplies = 18,000 – 3,000 Supplies = 15,000
Supplies = 15,000
Supplies Expense = 18,000 – 15,000
Supplies Expense = 3,000 Supplies Expense = 3,000

45. Adjustment for deferrals
Depreciation

46. ADJUSTMENT – DEPRECIATION
When an entity acquires long-lived assets such
as buildings, vehicles, and equipment, it is
basically prepaying for the usefulness of that
asset. Because the usefulness of these assets
extends beyond one year, a portion of their
cost must be allocated as expense in each
accounting period. This allocation is called
depreciation.

47. ADJUSTMENT – DEPRECIATION
Three factors are involved in the computation of
depreciation, namely:

48. ADJUSTMENT – DEPRECIATION
1. Cost – the amount the entity paid to acquire
the depreciable asset.

49. ADJUSTMENT – DEPRECIATION
2. Estimated salvage value – the amount the
asset can probably be sold for at the end of its
useful life. It is also known as scrap value.

50. ADJUSTMENT – DEPRECIATION
3. Estimated useful life– the estimated
number of periods that an entity can make
use of the asset. It is an estimate, not an exact
measurement.

51. ADJUSTMENT – DEPRECIATION
Accountants estimate periodic depreciation
using different method. The simplest
procedure is called the straight-line method,
with the formula:

52. ADJUSTMENT – DEPRECIATION
Depreciation Expense =
Depreciable cost / Estimated useful life
Depreciable cost = Asset cost – Salvage value

53. ADJUSTMENT – DEPRECIATION
The asset account is not directly reduced when
recording depreciation expense. Instead, an
account with a balance directly deducted to
the balance of another account is used. We
call this a contra account.

54. ADJUSTMENT – DEPRECIATION
In adjustments for depreciation, the contra
account Accumulated Depreciation is used to
record reduction to the property, plant, and
equipment account.

55. ADJUSTMENT – DEPRECIATION
Example 3: Suppose that Weddings “R” Us
estimated that the service vehicle, which was
bought on May 4 for P420,000, will last for
seven years (84 months) and with a salvage
value of P84,000. As a matter of company
policy, the period May 4 to May 31 is
considered a whole month. The depreciation
adjustment and pertinent computations
follow:

56. ADJUSTMENT – DEPRECIATION
Depreciation Expense =
Depreciable cost / Estimated useful life
Depreciable cost = Asset cost – Salvage value
Depreciation Expense = (420,000-84,000) / 84 mo
Depreciation Expense = 4,000 per month

57. ADJUSTMENT – DEPRECIATION
Date Description PR Debit Credit
31-MayDepreciation Expense - Service Vehicle 4,000
Accumulated Depreciation - Service Vehicle 4,000
Service Vehicle P420,000
This account is presented in the statement of financial
Less: Accumulated Depreciation (4,000)
position as a direct deduction to the account “Service
Net Book Value P416,000
Vehicle.”

58. Adjustment for deferrals
Unearned Revenues

59. ADJUSTMENT – UNEARNED REVENUES
When an entity receives cash for services to be
rendered in the future, the amount received is
referred to as unearned revenue. Once service
has been rendered, an adjustment is required
to reflect the correct amount of revenue and
liability in the financial statements.

60. ADJUSTMENT – UNEARNED REVENUES
Example 4: Unearned Revenue
On May 15, Weddings “R” Us received P10,000
as an advance payment for referrals made.
Assume that by the end of the month, one of
the three couples referred has already taken
their marriage vows and as a result the
amount of P4,000 pertaining to the referred
event has been realized.

61. ADJUSTMENT – UNEARNED REVENUES
Example 4: Unearned Revenue (continued)
As with prepayments, cash received before the
rendering of services may be recorded in two
ways. The debit to cash may be accompanied
by a credit to a liability account (liability
method) or a credit to a revenue account
(revenue method).

62. ADJUSTMENT – UNEARNED REVENUES
Example 4: Unearned Revenue (continued)
The pertinent entries under the two methods
follow:

63. ADJUSTMENT – UNEARNED REVENUES
Example 4: Unearned Revenue (continued)
` LIABILITY METHOD REVENUE METHOD
Initial Entry Cash 10,000 Cash 10,000
Unearned Revenues 10,000 Referral revenues 10,000
Adjusting Entry Unearned Revenue 4,000 Referral Revenues 6,000
Referral Revenues 4,000 Unearned Revenues 6,000
UnearnedThe adjusting entry under the
Revenues = 10,000 – 4,000 Unearnedadjusting entry under the
The Revenues = 6,000
Unearnedliability method involves the
Revenues = 6,000 revenue method involves the
amount already earned. Referral Revenues unearned. 6,000
amount still = 10,000 –
Referral Revenues = 4,000 Referral Revenues = 4,000

64. Adjustment for accruals
Accrued Expenses

65. ADJUSTMENT FOR ACCRUED
EXPENSES
There are instances that an entity incurs
expenses before actual cash payment are
made. 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 happens often in
salaries, utilities, and interest.

66. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 5: Salaries
Wedding “R” Us has a 6-day workweek, and pays
salaries every two Saturdays. Assume that the
last pay day was on May 27. The next pay day will
be on June 10. At month-end the employees have
already worked for three days (29, 30, and 31)
since the last pay day. The salary for these days
are rightfully an expense of May, and the
liabilities should reflect that the entity owes the
employees salaries for these days.

67. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 5: Salaries (continued)
Each of the employee’s salary rate is P7,800 per
month or P300 per day (P7,800/26 days).
Assuming we are to adjust for the salaries for
the office assistant and the account executive,
the total accrued salaries will be:
2 employees x 3 days x P300 per day = P 1,800

68. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 5: Salaries (continued)
The adjusting entry will be:
Date Description PR Debit Credit
31-MaySalaries Expense 1,800
Salaries Payable 1,800
This reflects that the entity has already benefited
This reflects that the entity owes the employees
from the services rendered by the employees for
for the services rendered for May 29, 30, and 31,
May 29, 30, and 31, and thus an expense must be
and thus a liability must be recognized.
recognized.

69. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 6: Interest
On May 2, Gevera borrowed P210,000 from
Metrobank. She issued a promissory note that
carried a 20% interest per annum. Both the
interest and principal are payable in one year.
By the end of the month, Gevera owes the
bank interest amounting to P3,500 computed
as follows:

70. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 6: Interest (continued)
Interest = Principal x Interest rate x Time lapsed
Interest = P210,000 x 20% x 1 mo/12 mo
Interest = P 3,500

71. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 6: Interest (continued)
The adjusting entry will be:
Date Description PR Debit Credit
31-MayInterest Expense 3,500
Interest Payable 3,500

72. ADJUSTMENT FOR ACCRUED
EXPENSES
Uncollectible Accounts
Entities often allow clients to purchase goods or
services on credit. Some of these accounts will
never be collected; hence there is a need to
reflect these as charges against income.

73. ADJUSTMENT FOR ACCRUED
EXPENSES
Uncollectible Accounts (continued)
In practice, an expense is recognized for the
estimated uncollectible accounts in the
current period, rather than when specific
accounts actually become uncollectible, to
produce a better matching of income and
expenses.

74. ADJUSTMENT FOR ACCRUED
EXPENSES
Uncollectible Accounts (continued)
The estimated uncollectible accounts is recorded
by debiting an expense and crediting a contra-
asset account: Allowance for Uncollectible
Accounts which is shown as a direct deduction
to the Accounts Receivable account.

75. ADJUSTMENT FOR ACCRUED
EXPENSES
Uncollectible Accounts (continued)
Estimates of uncollectible accounts may be
based on credit sales for the period or on the
accounts receivable balance.
The difference between the two methods will be
demonstrated in the following section.

76. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 7: Uncollectible Accounts
Assume that an entity made credit sales of
P1,100,000 in 2011 and prior experience
indicates an expected 1% average
uncollectible accounts rate based on credit
sales.

77. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 7: Uncollectible Accounts (continued)
The Allowance for Uncollectible Accounts needs
to be increased by P11,000, which is 1% of
P1,100,000. The amount computed is the
amount of adjustment.

78. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 7: Uncollectible Accounts (continued)
The adjusting entry is:
Date Description PR Debit Credit
31-DecUncollectible Accounts Expense 11,000
Allowance for Uncollectible Accounts 11,000
This account is shown as a direct deduction to the
Accounts Receivable balance.

79. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 7: Uncollectible Accounts (continued)
The adjusting entry is:
Date Description PR Debit Credit
31-DecUncollectible Accounts Expense 11,000
Allowance for Uncollectible Accounts 11,000
Accounts Receivable (assumed amount) P150,000
Allowance for Uncollectible Accounts (11,000)
Accounts Receivable – net P139,000

80. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 8: Uncollectible Accounts
Assume that the Accounts Receivable balance as
of December 31, 2011 is P200,000. The
entity’s experience shows that 3% of the
outstanding accounts receivables will become
uncollectible. The Allowance for Uncollectible
Accounts has a credit balance of P4,000
before adjustment.

81. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 8: Uncollectible Accounts (continued)
Take note that the amount of uncollectible
accounts is based on the balance of accounts
receivable. If the rate of uncollectible
accounts is based on the balance of accounts
receivable, the amount computed will be the
required balance of the Allowance for
Uncollectible Accounts.

82. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 8: Uncollectible Accounts (continued)
An analysis of the Allowance account follows:
ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS
Date Description JR Debit Date Description JR Credit
1-JanBeginning balance 4,000
31-DecAdjustment ?
Ending Balance 6,000
The ending balance is computed by multiplying
the ending Accounts Receivable Balance by the
estimated rate of uncollectible accounts.

83. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 8: Uncollectible Accounts (continued)
An analysis of the Allowance account follows:
ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS
Date Description JR Debit Date Description JR Credit
1-JanBeginning balance 4,000
31-DecAdjustment ?
Ending Balance 6,000
P2,000,000 x 3% = P6,000

84. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 8: Uncollectible Accounts (continued)
An analysis of the Allowance account follows:
ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS
Date Description JR Debit Date Description JR Credit
1-JanBeginning balance 4,000
31-DecAdjustment ?
Ending Balance 6,000
The amount of adjustment will be computed as follows:
4,000 + n = 6,000
n = 6,000 – 4,000
n = 2,000

85. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 8: Uncollectible Accounts (continued)
An analysis of the Allowance account follows:
ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS
Date Description JR Debit Date Description JR Credit
1-JanBeginning balance 4,000
31-DecAdjustment 2,000
Ending Balance 6,000
The amount of adjustment will be computed as follows:
4,000 + n = 6,000
n = 6,000 – 4,000
n = 2,000

86. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 7: Uncollectible Accounts
The adjusting entry is:
Date Description PR Debit Credit
31-DecUncollectible Accounts Expense 2,000
Allowance for Uncollectible Accounts 2,000
Accounts Receivable P200,000
Allowance for Uncollectible Accounts (6,000)
Accounts Receivable – net P194,000
The balance of the Allowance Account is composed of:
Beginning Balance 4,000
Adjustment 2,000
Ending Balance 6,000

87. Adjustment for accruals
Accrued Revenues

88. ADJUSTMENT FOR 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. An adjusting entry
must be made to reflect the asset that the
entity acquired through the provision of
services.

89. ADJUSTMENT FOR ACCRUED
REVENUES
Example 8: Accrued Revenues
Suppose that Weddings “R” Us agreed to
arrange a rush but simple civil wedding for a
madly-in-love couple in the afternoon of May
31. The entity intended to charge fees of
P5,300 for the services, which is earned but
unbilled. An adjusting entry must be made as
shown below:

90. ADJUSTMENT FOR ACCRUED
EXPENSES
Example 5: Salaries (continued)
The adjusting entry will be:
Date Description PR Debit Credit
31-MayAccounts Receivable 5,300
Consulting Revenues 5,300
This reflects that the client owes the entity a
certain amount forthe entity has already earned
This reflects that services already rendered.
revenue because services has been rendered,
though the amount is still uncollected.