Adjusting Entries – journal entries prepared at the end of accounting period of
one year following the preparation of Trial Balance for the following reasons:
1. To bring records or balances of accounts updated
2. To match revenues against expenses during the period.
Matching Principle – a GAAP that requires recognition of revenue when earned
and expenses when incurred during the same period as revenue is earned.
Note: An adjusting entry must always have a balance sheet account and an
income statement account
Items requiring adjusting entries:
I. ACCRUALS (note: no original entries made)
Accrued income – income already earned but not
received (Receivable)
ENTRY: DEBIT > ACCRUED REVENUE(RECEIVABLE ACCOUNT)
CREDIT> REVENUE ACCOUNT
Accrued expense – expense already incurred but not
paid (Payable)
ENTRY: DEBIT > EXPENSE ACCOUNT
CREDIT> ACCRUED EXPENSE(Lliability account)
Illustration 1:
A building owned by Metro Davao Hotel was partly rented by PNB for P50,000 per
month payable every 5th day of the following month. The rental for the month of
Dec 31, 20A will be paid on Jan 5, 20B.
Metro Davao Hotel:
Accrued Rent (Rent Receivable) 50,000
Rental income
To record rent income earned
50,000
PNB:
Rent expense
50,000
Accrued rent expense
50,000
To record rent expense incurred:
Illustration 2:
Assume that the entity pays its employees every Saturday for a seven day work
week and that the daily salary is ₱ 10,000. The last Saturday of the year fell on
December 28 and a week’s salary of ₱70,000 was paid to employees.
December 31 Salaries Expense
30,000
Salaries payable
to record 3-day
salary fr Dec.29-31
30,000
Illustration 3:
Assume that the business entity received a promissory note from a customer on
October 1. The note is for ₱100,000 with interest of 12% due after one year.
December 31 Interest receivable
3,000
Interest revenue
To record interest
from Oct 1-Dec 31
Principal
Interest rate
Period
Interest earned
3,000
₱ 100,000
12%
3/12
₱ 3,000
At the end of an accounting period, some accounts may have mixed - that is partly
temporary and partly permanent - components. Before financial statements can
be prepared, mixed accounts must be segregated into their permanent (asset or
liability) and temporary (income or expense) components. Splitting the
components of mixed accounts is accomplished by preparing adjusting entries at
the end of the period.
II. DEFERRALS – advances
A) Unearned income(revenue) – income already collected
but not yet earned.
Assume that the business owns a building for rent. It was rented on
November 1 to a tenant who immediately paid ₱300,000 corresponding to
three months’ rent up to January 31.
1. Liability Method – liability account is credited in the original entry
Original entry:
Nov 1 Cash
300,000
Unearned rent
300,000
Adjusting entry:
Dec 31
Unearned Rent
Rent Income
(300,000x2/3)
200,000
200,000
2. Income Method – income or revenue account is credited in the original entry
Original entry:
Nov 1 Cash
300,000
Rent Income
Adjusting entry:
300,000
Dec 31
Rent Income
Unearned Rent
(300,000x1/3)
100,000
100,000
B) Prepaid expenses – expenses already paid but not yet
incurred
1.Asset Method – asset account is debited in the original entry
Illustration 1:
Assume that on December 1, a business entity paid ₱12,000 for a one-year
insurance premium.
Original Entry:
December 1- Prepaid Insurance 12,000
Cash
12,000
Adjusting Entry:
December 31 – Insurance Expense
1,000
Prepaid Insurance
1,000
(12,000/12)
Illustration2:
Assume that on December 1, ₱5,000 worth of office supplies were
purchased. At the end of the year, the physical count shows that ₱2,000 of
office supplies are still on hand.
Original Entry:
December 1 Office Supplies
Cash
Adjusting Entry:
5,000
5,000
Dec 31
Supplies Expense 3,000
Office Supplies
3,000
2. Expense Method – expense account is debited in the original
entry
i.
Assume that on December 1, the business entity paid ₱60,000 to cover the
rent for a three-month period starting December 1.
Original Entry:
December 1 Rent Expense
Cash
Adjusting Entry:
Dec 31
60,000
Prepaid Rent
Rent Expense
(60,000x2/3))
60,000
40,000
40,000
(CLUE FOR DEFERRALS’ ADJUSTING JOURNAL ENTRIES: THE AMOUNT TO
BE USED SHALL BE THAT OF THE CORRECT ENTRY OR WITH NORMAL
BALANCE)
III. PROVISION FOR DEPRECIATION – straight line method
Depreciation expense – is a systematic and rational allocation of portions of
property and equipment over the number of years. Depreciation expense is the
expense that will be matched against the revenues earned.
Straight line method:
1. Acquisition cost – purchase price and other incidental expenses of its
acquisition.
2.
3.
Scrap Value – estimated value of the asset at the end of its economic or
useful life. Also called salvage or residual value.
Estimated Useful or Economic Life – estimated length of time stated in
years that the asset is usable.
Formula:
Cost of the Asset – Salvage Value
Estimated life in years
Asset Cost
Less estimated salvage value
Depreciable cost
Divide by estimated useful life
Annual depreciation
Divide by no . of months in a yr
Monthly depreciation
xx
xx
xx
xx
xx
12
xx
Illustration:
On Sep 1, 20A, Adi machine Shop acquired a brand new machine at a cost of
P100,000. The estimated life of the machine is 5 years and with a residual value
of P10,000.
Cost of the Asset
Less Salvage Value
Net
Divide by
Annual dep
Divide by
Monthly depreciation
100,000
10,000
90,000
5 yrs
18,000
12 mos
1,500
To record monthly depreciation:
Depreciation Expense
Accumulated Depreciation
1,500
1,500
Note: The difference between the cost and accumulated depreciation is called
net book value or carrying value.
IV. PROVISION FOR ESTIMATED COLLECTIBLE ACCOUNTS (BAD DEBTS)
Assume that Gabby Company has an outstanding accounts receivable of P60,000.
Based on past experience, it is estimated that 2% is doubtful of collection at the
end of the accounting period on Dec 31, 20A.
To record provision for uncollectible accounts:
Uncollectible Account Expense
1,200
Estimated Uncollectible Account
1,200
Note: Estimated Uncollectible Account is a reduction from Accounts receivable to
arrive at Estimated Realizable Value.
Assume that later P300 of the 1,200 estimated uncollectible accounts could no
longer be collected:
Estimated Uncollectible Account
Accounts receivable
300
300
MORE EXERCISES
Exercise 1:
On Oct. 1, 2018, SATS Company acquired a 3-year insurance policy for P36,000
paid in advance. Make adjusting entries assuming SATS recorded this transaction
initially as an A) ASSET and B) EXPENSE
A) As an asset:
Orig entry: Prepaid Insurance exp
Cash
AJE:
36,000
36,000
Insurance Expense
3,000
Prepaid insurance exp
(36,000/36 X 3)
B) As an expense:
Orig entry: Insurance Expense
Cash
AJE:
Prepaid insurance
Insurance exp
(36,000/36 x 33)
3,000
36,000
36,000
33,000
33,000
EXERCISE 2:
On July 1, 2018, Happy Company received a P48,000 check for 2 years’ rent paid
in advance. Make adjusting entries at the end of the year assuming SATS
recorded this transaction initially as a A) LIABILITY and a B) REVENUE.
A) As a Liability:
Orig entry: Cash
AJE:
48,000
Unearned rent income
Unearned rent income
Rent Income
(48,000/24 x 6)
B) As a revenue:
Orig entry:
Cash
12,000
12,000
48,000
Rent income
AJE:
48,000
48,000
Rent income
36,000
Unearned rent income
36,000
(48,000/24 x 18)
EXERCISE 3:
On July 1, 2018, JW Manpower Services owned by Jo Wick borrowed P100,000 by
signing an 18-month note at 16% interest per annum. The principal and interest
are to be repaid when the note matures on Dec. 31, 2019. What is the adjusting
entry on Dec 31, 2018?
AJE: Interest Expense
8,000
Accrued interest expense
(100,000 x 16% x6/12)
8,000
Exercise 4:
Trial Balance
Jan 31, 20A
Cash
Accounts Receivable
Prepaid Insurance
Prepaid Rent
Shop Supplies Inventory
Shop Equipment
Accounts Payable
Unearned Service Income
A.Suelan, Capital
A.Suelan, Drawings
Service Income
Salaries expense
Taxes and Licenses
P176,600
61,000
13,800
12,000
25,000
120,000
2,000
5,000
300,000
10,000
142,000
25,000
5,600
ADDITIONAL DATA :
1.
Physical counting of shop supplies inventory revealed that P10,000 remain
unused.
2.
Insurance premium was paid for one year period starting Jan 1, 20A.
3.
Rental was paid in advance for one year period starting Jan 1, 20A
4.
Property and equipment was acquired on Jan 1, 20A. It has estimated life
of 5 years without scrap value.
5.
It is estimated that 3% of the outstanding Accounts Receivable of P61,000 is
doubtful of collection.
6.
Unpaid light and water expenses for the month of Jan 20A, P850.
Required: Prepare Adjusting Entries as of Dec 31, 20A
Answers:
1. Shop Supplies Expense
15,000
Shop supplies inventory
15,000
2. Insurance Expense
13,800
Prepaid insurance
13,800
3. Rent expense
12,000
Prepaid rent
12,000
4. Depreciation expense
24,000
Accumulated depreciation-shop equip
24,000
(120,000/5)
5. Uncollectible accounts expense
1,830
Estimated uncollectible accounts
1,830
(61,000 x 3%)
6. Utilities Expense
850
Accrued utilities expense
850
ACCRUED INCOME
On December 31, 2017, Gray Electronic Repair Services rendered P3000 worth of
services to a client. However, the amount has not yet been collected. It was
agreed that the customer will pay the amount on January 15, 2018. The
transaction was not recorded in the books of the company as of 2017.
In this case, we should make an adjusting entry in 2017 to recognize the income
since it has already been earned. The adjusting entry would be:
Dec
31
Accounts Receivable
3000.00
Service Revenue
3000.00
Here are some more illustrations.
Example 1: Company ABC leases its building space to a tenant. The tenant agreed
to pay monthly rental fees of P2,000 covering a period from the 1st to the 30th or
31st of every month. On December 31, 2017, ABC Company did not receive the
rental fee for December yet and no record was made in the journal.
Under the accrual basis, the rent income above should already be recognized
because it has already been earned even if it has not yet been collected. The
adjusting journal entry would be:
Dec
31
Rent Receivable 2,000.00
Rent Income
2,000.00
Example 2: ABC Company lent P9,000 at 10% interest on December 1, 2017. The
amount will be collected after 1 year. At the end of December, no entry was
entered in the journal to take up the interest income.
Interest is earned through the passage of time. In the case above, the P9,000
principal plus a P900 interest will be collected by the company after 1 year. The
P900 interest pertains to 1 year.
However, 1 month has already passed. The company is already entitled to 1/12 of
the interest, as prorated. Therefore the adjusting entry would be to recognize P75
(i.e. P900 x 1/12 ) as interest income:
Dec
31
Interest Receivable
Interest Income
75.00
75.00
ACCRUED EXPENSES
For the month of December 2017, Gray Electronic Repair Services used a total of
P1,800 worth of electricity and water. The company received the bills on January
10, 2018. When should the expense be recorded, December 2017 or January
2018?
Answer – in December 2017. According to the accrual concept of accounting,
expenses are recognized when incurred regardless of when paid. The amount
above pertains to utilities used in December. Therefore, if no entry was made for
it in December then an adjusting entry is necessary.
Dec
31
Utilities Expense 1,800.00
Utilities Payable
1,800.00
In the adjusting entry above, Utilities Expense is debited to recognize the expense
and Utilities Payable to record a liability since the amount is yet to be paid.
Here are some more examples.
More Examples: Adjusting Entries for Accrued Expense
Example 1: VIRON Company entered into a rental agreement to use the premises
of DON's building. The agreement states that VIRON will pay monthly rentals of
P1,500. The lease started on December 1, 2017. On December 31 of the same
year, the rent for the month has not yet been paid and no record for rent expense
was made.
In this case, VIRON Company already incurred (consumed/used) the expense.
Even if it has not yet been paid, it should be recorded as an expense. The
necessary adjusting entry would be:
Dec
31
Rent Expense
1,500.00
Rent Payable
1,500.00
Example 2: VIRON Company borrowed P6,000 at 12% interest on August 1, 2017.
The amount will be paid after 1 year. At the end of December, the end of the
accounting period, no entry was entered in the journal to take up the interest.
Let's analyze the above transaction.
VIRON will be paying P6,000 principal plus P720 interest after a year. The P720
interest covers 1 year. At the end of December, a part of that is already incurred,
i.e. P720 x 5/12 or $300. That pertains to interest for 5 months, from August 1 to
December 31. The adjusting entry would be:
Dec
31
Interest Expense 300.00
Interest Payable
300.00
Expenses are recognized when incurred regardless of when paid. What you need
to remember here is this: when it has been consumed or used and no entry was
made to record the expense, then there is a need for an adjusting entry.