Adjusting Entries

Adjusting Entries

Definition

• Journal entries prepared to update the balances of certain accounts and subsequently record unrecognized accounts

• Prepared to split the real and nominal components of a particular account

• Prepared in compliance with the Time-Period

Concept and the Matching Principle

• Real Component

– The portion of the account balance that should be reported to the Balance Sheet

• Nominal Component

– The portion of the account balance that should be presented to the Income Statement

• Time-Period Concept

– The life of an entity can be divided into various periods, usually in years.

• Matching Principle

– Expenses incurred should be matched with revenues generated in a particular period.

– Only those revenues generated and expenses incurred for a particular period should be presented in the income statement.

Types of Adjustments

• Adjustments for

– Accruals

• Accruals of income

• Accruals of expense

– Deferrals

• Prepayment of expense

• Precollection of income

– Depreciation

– Uncollectible Accounts

Accruals

• As a concept of accrual basis in accounting, income should be recorded when earned and expenses should be recorded when incurred, regardless of whether cash is received or paid.

Accruals

• Accrued Income

– Income already earned but not yet collected

– An asset account which has a similar nature with

Accounts Receivable

• Accrued Expense

– Expense already incurred but not yet paid

– A liability account which has a similar nature with

Accounts Payable

Accruals

• Accrued Income Illustration #1

– On December 31, 2011, service income that is unbilled amounts to 15,000

– As of year-end, unrecorded rent revenue amounts to 10,000

Accruals


– On June 1, 2011, the business entered into a contract where it will render services for 12 months from June 2011 to May 2012 for a contract price of 60,000. The payment will be received on May 2012. What is the adjusting entry on December 31, 2011?

Accruals


– On September 30, 2011, the business loaned money in the amount of 100,000. it carries a 6% interest and due on March 31, 2012. Payment of principal and interest will be on March 31, 2012.

What will be the adjusting entry on December 31,

2011?

Accruals

• Accrued Expense Illustration #1

– As of year-end, unpaid salaries amount to 6,000.

Prepare the necessary adjusting entry.

– As of December 31, 2011, unpaid electricity bill amounts to 8,000. prepare the required adjusting entry.

Accruals

• Accrued Expense Illustration #2

– The company pays its 50 employees 2500 each per week for a 5-day work week from Monday to

Friday. Salary is paid every Friday. December 31 falls on a Tuesday. What is the adjusting entry to be made?

Accruals

• Accrued Expense illustration #3

– The business borrowed 250,000 from a bank on

July 31, 2011. the loan carries an 8% interest.

Principal and interest is payable on July 31, 2012.

Prepare the adjusting entry on December 31,

2011.

Deferrals

• In accounting parlance, these pertains to advance payments or collections of cash. In relation to adjusting entries, it may pertain to prepaid expenses or precollected income.

Deferrals

• Prepaid Expense

– This pertain to items already paid for but not yet used. As a concept, it is generally acceptable for an entity to recognize such as an asset. However some businesses record it initially as an expense.

Therefore, a business may account for such under the:

• Asset method, or the

• Expense Method

Deferrals

• Prepaid Expense Illustration #1

– The company entered into a 3 year insurance contract on May 31, 2011 and paid the contract price of 36,000. Prepare the entries on May 31 and December 31 using the:

• Asset method

• Expense method

Deferrals


– The company leased an office space on

September 30, 2011 and paid 6 months advance rent in the amount of 60,000. Prepare the entries on September 30 and December 31 using:

• Asset method

• Expense method

Deferrals


– The company bought supplies amounting to

15,000 on March 15, 2011. On December 31,

2011, supplies remaining amount to P6,000.

Prepare the journal entries on March 15 and

December 31 using:

• Asset method

• Expense method

Deferrals

• Precollected Income

– These pertains to cash already received from customers for services to be rendered in the future. Such is generally accounted for by recognizing a liability. However, some firms record this by recognizing a revenue immediately. A business therefore accounts for such under:

• Liability method, or

• Revenue Method

Deferrals

• Precollected Income Illustration #1

– Flavio, a blacksmith, received 5,000 from Lizardo on June 1, 2011 for him to create 5 swords. On

December 31, 2011, he was able to finish 3 swords. Prepare the journal entries on June 1 and

December 31 using the:

• Liability method

• Revenue method

Deferrals

• Precollected Income Illustration #2

– On August 1, 2011, Ator Nee, a lawyer, received

50,000 from a client for legal services to be rendered from September 1, 2011 to January 31,

2012. Prepare the entries for August 1 and

December 31 under the:

• Liability method

• Revenue method

Depreciation

• It is the reduction in the value of an asset due to usage and passage of time.

• Applicable to all property, plant and equipment except for Land.

• The most common method used in computing for depreciation is the straight line method

Depreciation

• Under the straight line method, annual depreciation is computed using this formula

• 𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

=

𝐶𝑜𝑠𝑡−𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑜𝑟 𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑉𝑎𝑙𝑢𝑒

𝑈𝑠𝑒𝑓𝑢𝑙 𝐿𝑖𝑓𝑒

Depreciation

• Depreciation Illustration #1

– The company purchased equipment amounting to

50,000 on May 31, 2011. useful life is 9 years and residual value is 5,000.

• How much is the depreciation expense on 2011?


• How much is the accumulated depreciation on 2012?

• What is the book/carrying value of the equipment on

2012?

Depreciation


– The company purchased building amounting to

5,000,000 on January 31, 2011. useful life is 20 years and residual value is 500,000.




• What is the book/carrying value of the building on

2012?

Depreciation



5,000,000 on January 31, 2011. useful life is 20 years and residual value is 0.





2012?

Depreciation



5,000,000 on May 15, 2011. useful life is 20 years and residual value is 10%.





2017?

Uncollectible Accounts

• Pertains to the portion of receivables that are doubtful as to collection.

• May be computed using the:

– Percentage of Revenue Method

– Percentage of Receivables Method

– Aging of Receivables


• Percentage of Revenue Method

– Using this method, the amount computed will be the required expense to be recognized during the period.

• Percentage of Receivables Method

– Using this method, the amount computed will be the required allowance to be recognized during the period.


• Illustration #1

– The revenue of the company is 600,000 and the accounts receivable amounts to 150,000. The beginning balance of the Allowance for

Uncollectible Accounts is 1,000.

• How much is the Uncollectible Accounts Expense if the company used percentage of Revenue at 5%?

• How much is the Uncollectible Accounts Expense if the company uses Percentage of Receivables at 10%?


• Illustration #2


Uncollectible Accounts is 2,000.

• How much is the Allowance of Uncollectible Accounts if the company used percentage of Revenue at 3%?

• How much is the Allowance for Uncollectible Accounts if the company uses Percentage of Receivables at 12%?

• How much is the net realizable value of the receivables under both methods?


• Illustration #3


Uncollectible Accounts is 2,000 (DEBIT).

• How much is the Allowance of Uncollectible Accounts if the company used percentage of Revenue at 3%?

• How much is the Allowance for Uncollectible Accounts if the company uses Percentage of Receivables at 12%?

• How much is the net realizable value of the receivables under both methods?

Adjusting Entries

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