MEASURING
BUSINESS
INCOME:
RECORDING
ADJUSTMENTS
2
Hello!
3
WHY?
Purpose of adjustment:
1. To reflect the proper amount of income
realized and expenses incurred during the
accounting period. (Calendar year- ends Dec
31; Fiscal year- period of 12 months but ends
on a date other than Dec 31)
2. To show a fairly measure of the assets,
liabilities and owner’s equity.
Adjusting process is made in order to comply with
the generally accepted accounting principles
regarding revenue recognition and matching
principles.
4
The two accounting methods
commonly used in practice to
measure business income and
expenses are (1) accrual basis
and (2) cash basis.
Accrual basis accounting recognizes transactions
as they occur. Income is recognized when earned
and expenses are recognized when incurred.
Cash basis accounting recognizes income only
when cash related to income is collected and
expenses are recognized only when paid.
5
“The great difference between
those who achieve and those
who fail is concentration.”
-Atty. Rigoberto Gallardo, CPA
6
Accounts that need to be
adjusted:
⊸
Adjustment for the expiration of prepaid expenses. (Prepayments)
⊸
Adjustment for the realization of income collected in
advance. (Pre-collections)
⊸
Adjustment for the accrued expenses or expenses
incurred but not yet paid. (Accruals)
⊸
⊸
Adjustment for the accrued income. (Accruals)
⊸
Provision for bad debts. (Estimated uncollectible
accounts)
⊸
Ending inventory (applicable to merchandising and
manufacturing businesses)
⊸
Bank account reconciliation.
Provision for depreciation. (Depreciation &
Amortization)
7
Prepayments
Adjustment for Prepaid Expenses
8
Prepayments are advanced payments of
business expenses or supplies to be used
in a business operation.
Prepaid expense is expenses paid in
advance but this said expense is not yet
incurred at the time of payment. The
account is an asset and as it expires it
becomes an expense.
ASSET METHOD
EXPENSE METHOD
The original entry made
is charged to an asset
account.
The original entry made
is charged to an
expense account.
9
Example:
On October 31, 20XX, Joe Marts
Enterprise paid in advance an
insurance premium for ₱12,000
covering a period of one year.
On December 31, 20XX, the
financial statements are about to be
prepared and adjusting entry
should be made.
10
Asset Method:
Initial Journal Entry
Prepaid Insurance 12,000
Cash
12,000
Adjusting Journal Entry
Insurance expense 2,000
Prepaid insurance
2,000
11
Analysis:
Required prepaid insurance (₱12,000 x 10/12)
Recorded prepaid insurance
₱10,000
(12,000)
Decrease in prepaid insurance
(₱2,000)
In using asset method, the intention of the adjustment is to
know the expired portion of the prepayments done.
12
Expense Method:
Initial Journal Entry
Insurance expense 12,000
Cash
12,000
Adjusting Journal Entry
Prepaid insurance 10,000
Insurance expense
10,000
13
Analysis:
Required insurance expense (₱12,000 x 2/12)
Recorded insurance expense
₱2,000
(12,000)
Decrease in insurance expense
(₱10,000)
In expense method, the intention of the adjustment is to know
the unexpired portion of the prepayments done.
14
Precollections
Adjustment for the realization of income collected
in advance or Deferred (unearned) Income
15
Pre-collections (also known as deferred
revenue) are advance collections of
business from customers.
Common types of pre-collected income
are rent collected in advance, interest
received in advance, miscellaneous
income received in advance.
INCOME METHOD
LIABILITY METHOD
The original entry made
is charged to an income
account.
The original entry made
is charged to a liability
account.
16
Example:
On October 1, 20XX, Kings Court
Pension House received in advance
a rent income of ₱60,000
covering a period of one year.
On December 31, 20XX, the
financial statements are about to be
prepared and adjusting entry
should be made.
17
Income Method:
Initial Journal Entry
Cash
Rent Income
60,000
60,000
Adjusting Journal Entry
Rent Income
Unearned rent
45,000
45,000
18
Analysis:
Required rent income (₱60,000 x 3/12)
Recorded rent income
₱15,000
(60,000)
Decrease in rent income
(₱45,000)
In using income method, the intention of the adjustment is to
know the unearned portion of the deferred income received.
19
Liability Method:
Initial Journal Entry
Cash
Unearned rent
60,000
60,000
Adjusting Journal Entry
Unearned rent
Rent income
15,000
15,000
20
Analysis:
Required unearned rent (₱60,000 x 9/12)
Recorded unearned rent
₱45,000
(60,000)
Decrease in unearned rent
(₱15,000)
In liability method, the intention of the adjustment is to know
the earned portion of the deferred income received.
21
Accruals
Adjustment for Accrued Income and Expense
Adjustment for Accrued Interest
22
The term “accrual” as used in accounting,
means to recognize (to accrue) revenue
earned regardless of when it was
collected, and to record expenses incurred
whether paid or not.
Accrued income arises when goods have
been decreased or services have been
rendered but no payment have been
collected or if there is payment, such
collection is not yet recorded.
Accrued expenses are items of expense
which have been incurred and not yet due
for payment at the end of the period.
23
IIllustration
Accrued Income:
Oliveros Company rendered service on
account, ₱4,500.
Journal Entry:
Accounts Receivable
Service Income
₱4,500
₱4,500
24
25
IIllustration
Accrued Expense:
Company employees are paid every week.
On December 31, 20XX, four days salary
of an office employee for ₱382/day have
accrued.
Journal Entry:
Salaries & Wages
₱1,528
Accrued Salaries & Wages
₱1,528
26
27
Adjustment for Accrued Interest
Normally, notes issued to supplier bear an
interest which is payable either quarterly,
monthly or yearly. When the payment of
interest arrived and no actual payment is
done, then accrued interest is arising.
Basic formula: P x R x T
whereas:
P- principal amount
R- interest rate
T- time (normally in years, months (12) or
days (360)
28
Example:
Regina Estillero issued promissory
notes to the supplier, ₱10,000,
10% payable every January
31, dated October 1, 20XX.
29
IIllustration
Accrued Interest:
₱10,000 x 10% x 3/12 = ₱250.00
Journal Entry:
Interest expense
Interest payable
₱250
₱250
30
Depreciation
Provision for Depreciation
31
Depreciation is the allocation of the cost
(depreciate cost) of tangible assets used in
business over its estimated useful life in
years in accordance with the systematic
and rational allocation expense principle
of accounting.
Examples include buildings, equipment,
furniture and automobiles.
Formula:
Annual depreciation expense (SL) =
acquisition cost – salvage value/ estimated
useful life in years
32
Acquisition cost is the historical cost. It
usually includes the purchase price and
other incidental cost to acquire and prepare
the fixed asset for its intended use.
Salvage value refers to the scrap or residual
value of the fixed asset at the end of its
useful life.
Estimated useful life is the estimated
economic life of the fixed asset.
33
Example:
On January 1, 20XX, Computromix
acquired a computer with an
invoice price of ₱47,000, and
transportation cost and installation
cost of ₱1,000 and ₱2,000,
respectively. The computer is
intended for office use. It was
estimated to have a useful life of
five years and a salvage value of
₱5,000.
34
Depreciation:
Initial Journal Entry
Office equipment
Cash
50,000
50,000
Adjusting Journal Entry
Depreciation expense
9,000
Accum. depreciation- office equipment 9,000
35
Estimated
Uncollectible
Accounts
Provision for Bad Debts or Estimated Doubtful
Account
36
When accounts receivables are already long overdue,
some portion will be adjusted as “uncollectible
accounts,” “bad debts”, or “doubtful accounts.”
Determining uncollectible account expenses
depends on the intention for which the financial
statement prepared is submitted. If the financial
statement is for BIR purposes, the only allowed
method is the direct method. But if the FS is for
general-purpose reporting, the allowance method
shall be used.
DIRECT METHOD
ALLOWANCE METHOD
Recording uncollectible accounts
records bad debts expense only
when a specific accounts receivable
is ascertained to be worthless. This
method is also known as “actual
write-off method” because the
worthless accounts receivable is
removed from the books of accounts
by writing it off.
Records bad debts expense even if the
uncollectible is only estimated. This
method does not remove the amount of
deemed uncollectible account, but only
provides for allowance to reduce it at the
end of the period.
37
Example:
The following transactions of the
Highland Enterprises:
1. Total sales on account, ₱50,000.
2. Amount estimated to be
uncollectible, ₱6,000.
3. Actual amount ascertained to be
worthless and was eventually
written-off, ₱2,000.
38
1. To record sales on account.
2. To record estimated amount
uncollectible.
3. To record actual amount ascertained to
be worthless.
39
Thanks!
Any questions?