Types of Adjusting Entries

Generally, there are 4 types of adjusting entries. Adjusting entries are prepared for the
following:
1.

Accrued Income income earned but not yet received

2.

Accrued Expense expenses incurred but not yet paid

3.

Deferred Income income received but not yet earned

4.

Prepaid Expense expenses paid but not yet incurred

Also, adjusting entries are made for:

5.

Depreciation

6.

Doubtful Accounts or Bad Debts, and other allowances

Adjusting Entry for Accrued Expenses

Pro-Forma Entry
The pro-forma adjusting entry to record an accrued expense is:
mmm

dd

Expense account*

x,xxx.xx

Liability account**

x,xxx.xx

*Appropriate expense account (such as Utilities Expense, Rent Expense, Interest Expense, etc.)
**Appropriate liability account (Utilities Payable, Rent Payable, Interest Payable, Accounts Payable, etc.)

For Example
For the month of December 2014, Gray Electronic Repair Services used a total of $1,800
worth of electricity and water. The company received the bills on January 10, 2015. When
should the expense be recorded, December 2014 or January 2015?
Answer in December 2014. 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.

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 $1,500. The lease
started on December 1, 2014. On December 31, 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 $6,000 at 12% interest on August 1, 2014. 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.

Adjusting Entry for Unearned Revenue

Hence, they are also called "advances from customers".

Liability Method of Recording Unearned Revenue

Under the liability method, a liability account is recorded when the amount is collected. The
common accounts used are: Unearned Revenue, Deferred Income, Advances from
Customers, etc. For this illustration, let us use Unearned Revenue.
Suppose on January 10, 2015, ABC Company made $30,000 advanced collections from its
customers. If the liability method is used, the entry would be:
Jan

10

Cash
Unearned Revenue

30,000.00
30,000.00

Take note that the amount has not yet been earned, thus it is proper to record it as a liability.
Now, what if at the end of the month, 20% of the unearned revenue has been rendered? This
will require an adjusting entry.
The adjusting entry will include: (1) recognition of $6,000 income, i.e. 20% of $30,000, and
(2) decrease in liability (unearned revenue) since some of it has already been rendered. The
adjusting entry would be:
Jan

31

Unearned Revenue

6,000.00

Service Income

6,000.00

We are simply separating the earned part from the unearned portion. Of the $30,000
unearned revenue, $6,000 is recognized as income. In the entry above, we removed $6,000
from the $30,000 liability. The balance of unearned revenue is now at $24,000.

Income Method of Recording Unearned Revenue

Under the income method, the accountant records the entire collection under
an incomeaccount. Using the same transaction above, the initial entry for the collection
would be:
Jan

10

Cash

30,000.00

Service Income

30,000.00

If at the end of the year the company earned 20% of the entire $30,000, then the adjusting
entry would be:
Jan

31

Service Income
Unearned Income

24,000.00
24,000.00

By debiting Service Income for $24,000, we are decreasing the income initially recorded. The
balance of Service Income is now $6,000 ($30,000 - 24,000), which is actually the 20%
portion already earned. By crediting Unearned Income, we are recording a liability for
$24,000.
Notice that the resulting balances of the accounts under the two methods are the same
(Cash: $30,000; Service Income: $6,000; and Unearned Income: $24,000).

Another Example
On December 1, 2014, DRG Company collected from TRM Corp. a total of $60,000 as rental
fee for three months starting December 1.
Under the liability method, the initial entry would be:
Dec

Cash

60,000.00

Unearned Rent Income

60,000.00

Adjusting Entries for Prepaid Expense

Asset Method
Under the asset method, a prepaid expense account (an asset) is recorded when the amount
is paid. Prepaid expense accounts include: Office Supplies, Prepaid Rent, Prepaid Insurance,
and others.
In one of our previous illustrations (if you have been following our comprehensive illustration
for Gray Electronic Repair Services), we made this entry to record the purchase of service
supplies:
Dec

Service Supplies
Cash

1,500.00
1,500.00

Take note that the amount has not yet been incurred, thus it is proper to record it as an
asset.
Suppose at the end of the month, 60% of the supplies have been used. Thus, out of the
$1,500, $900 worth of supplies have been used and $600 remain unused. The $900 must
then be recognized as expense since it has already been used.

In preparing the adjusting entry, our goal is to transfer the used part from the asset initially
recorded into expense for us to arrive at the proper balances shown in the illustration
above.
The adjusting entry will include: (1) recognition of expense and (2) decrease in the asset
initially recorded (since some of it has already been used). The adjusting entry would be:
Dec

31

Service Supplies Expense

900.00

Service Supplies

900.00

The "Service Supplies Expense" is an expense account while "Service Supplies" is an asset.
After making the entry, the balance of the unused Service Supplies is now at $600 ($1,500
debit and $900 credit). Service Supplies Expense now has a balance of $900. Now, we've
achieved our goal.

Expense Method
Under the expense method, the accountant initially records the entire payment as expense.
If the expense method was used, the entry would have been:
Dec

Service Supplies Expense

Cash

1,500.00
1,500.00

Take note that the entire amount was initially expensed. If 60% was used, then the adjusting
entry at the end of the month would be:
Dec

31

Service Supplies

600.00

Service Supplies Expense

600.00

This time, Service Supplies is debited for $600 (the unused portion). And then, Service
Supplies Expense is credited thus decreasing its balance. Service Supplies Expense is now at
$900 ($1,500 debit and $600 credit).
Notice that the resulting balances of the accounts under the two methods are the same
(Cash paid: $1,500; Service Supplies Expense: $900; and Service Supplies: $600).

Another Example
GVG Company acquired a six-month insurance coverage for its properties on September 1,
2014 for a total of $6,000.
Under the asset method, the initial entry would be:
Sep

Prepaid Insurance

6,000.00

Cash

6,000.00

On December 31, 2014, the end of the accounting period, part of the prepaid insurance
already has expired (hence, expense is incurred). The expired part is the insurance from
September to December. Thus, we should make the following adjusting entry:
Dec

31

Insurance Expense
Prepaid Insurance

4,000.00
4,000.00

Of the total six-month insurance amounting to $6,000 ($1,000 per month), the insurance for
4 months has already expired. In the entry above, we are actually transferring $4,000 from
the asset to the expense account (i.e., from Prepaid Insurance to Insurance Expense).

If the company made use of the expense method, the initial entry would be:
Sep

Insurance Expense

6,000.00

Cash

6,000.00

In this case, we must decrease Insurance Expense by $2,000 because that part has not yet
been incurred (not used/not expired). Insurance Expense shall then have a balance of
$4,000. The amount removed from the expense shall be transferred to Prepaid Insurance.
The adjusting entry would be:
Dec

31

Prepaid Insurance

2,000.00

Insurance Expense

2,000.00

Conclusion
What we are actually doing here is making sure that the incurred (used/expired) portion is
included in expense and the unused part into asset. The adjusting entry will always depend
upon the method used when the initial entry was made.
If you are having a hard time understanding this topic, I suggest you go over and study the
lesson again. Sometimes, it really takes a while to get the concept. Preparing adjusting
entries is one of the challenging (but important) topics for beginners.

Adjusting Entry for Depreciation Expense

Understanding the Concept of Depreciation

There are several methods in depreciating fixed assets. The most common and simplest is
the straight-line depreciation method.
Under the straight line method, the cost of the fixed asset is distributed evenly over the life
of the asset.
For example, ABC Company acquired a delivery van for $40,000 at the beginning of 2012.
Assume that the van can be used for 5 years. The entire amount of $40,000 shall be
distributed over five years, hence a depreciation expense of $8,000 each year.

Straight-line depreciation expense is computed using this formula:

Depreciable Cost Residual Value
Estimated Useful Life
Depreciable Cost: Historical or un-depreciated cost of the fixed asset
Residual Value or Scrap Value: Estimated value of the fixed asset at the end of its useful life
Useful Life: Amount of time the fixed asset can be used (in months or years)
In the above example, there is no residual value. Depreciation expense is computed as:
= $40,000 $0
5 years
= $8,000 / year

With Residual Value

What if the delivery van has an estimated residual value of $10,000? The depreciation
expense then would be computed as:

= $40,000 $10,000
5 years
= $30,000
5 years
= $6,000 / year

How to Record Depreciation Expense

Depreciation is recorded by debiting Depreciation Expense and crediting Accumulated
Depreciation. This is recorded at the end of the period (usually, at the end of every month,
quarter, or year).
The entry to record the $6,000 depreciation every year would be:
Dec

31

Depreciation Expense
Accumulated Depreciation

6,000.00
6,000.00

Depreciation Expense: An expense account; hence, it is presented in the income statement. It

is measured from period to period. In the illustration above, the depreciation expense is
$6,000 for 2012, $6,000 for 2013, $6,000 for 2014, etc.
Accumulated Depreciation: A balance sheet account that represents the accumulated balance
of depreciation. It is continually measured; hence the accumulated depreciation balance is
$6,000 at the end of 2012, $12,000 in 2013, $18,000 in 2014, $24,000 in 2015, and $30,000
in 2016.

Accumulated depreciation is a contra-asset account. It is presented in the balance sheet as a

deduction to the related fixed asset. Here's a table illustrating the computation of the
carrying value of the delivery van.

Delivery Van - Historical Cost

2012

2013

2014

2015

2016

$40,000

$40,000

$40,000

$40,000

$40,000

6,000

12,000

18,000

24,000

30,000

$34,000

$28,000

$22,000

$16,000

$10,000

Less: Accumulated Depreciation

Delivery Van - Carrying Value

Notice that at the end of the useful life of the asset, the carrying value is equal to the
residual value.

Depreciation for Acquisitions Made Within the Period

The delivery van in the example above has been acquired at the beginning of 2012, i.e.
January. Therefore, it is easy to calculate for the annual straight-line depreciation. But what if
the delivery van was acquired on April 1, 2012?
In this case we cannot apply the entire annual depreciation in the year 2012 because the
van has been used only for 9 months (April to December). We need to prorate.
For 2012, the depreciation expense would be: $6,000 x 9/12 = $4,500.
Years 2013 to 2016 will have $6,000 annual depreciation expense.
In 2017, the van will be used for 3 months only (January to March) since it has a useful life of
5 years (i.e. April 1, 2012 to March 31, 2017).
The depreciation expense for 2017 would be: $6,000 x 3/12 = $1,500, and thus completing
the accumulated depreciation of $30,000.
2012 (April to December)

$ 4,500

2013 (entire year)

6,000

2014 (entire year)

6,000

2015 (entire year)

6,000

2016 (entire year)

6,000

2017 (January to March)

1,500

Total for 5 years

$ 30,000

Adjusting Entry for Bad Debts Expense

Accounts receivable should be presented in the balance sheet at net realizable value, i.e. the
most probable amount that the company will be able to collect.
Net realizable value for accounts receivable is computed like this:
Accounts Receivable - Gross Amount

$ 100,000

Less: Allowance for Bad Debts

3,000

Accounts Receivable - Net Realizable Value

$ 97,000

Allowance for Bad Debts (also often called Allowance for Doubtful Accounts) represents the
estimated portion of the Accounts Receivable that the company will not be able to collect.
Take note that this amount is an estimate. There are several methods in estimating doubtful
accounts.The estimates are often based on the company's past experiences.
To recognize doubtful accounts or bad debts, an adjusting entry must be made at the end of
the period. The adjusting entry for bad debts looks like this:
Dec

31

Bad Debts Expense

xxx.xx

Allowance for Bad Debts

xxx.xx

Bad Debts Expense a.k.a. Doubtful Accounts Expense: An expense account; hence, it is
presented in the income statement. It represents the estimated uncollectible amount for
credit sales/revenues made during the period.
Allowance for Bad Debts a.k.a. Allowance for Doubtful Accounts: A balance sheet account that
represents the total estimated amount that the company will not be able to collect from its
total Accounts Receivable.
What is the difference between Bad Debts Expense and Allowance for Bad Debts?

Bad Debts Expense is an income statement account while the latter is a balance sheet
account. Bad Debts Expense represents the uncollectible amount for credit sales made during
the period. Allowance for Bad Debts, on the other hand, is the uncollectible portion of
the entire Accounts Receivable.
You can also use Doubtful Accounts Expense and Allowance for Doubtful Accounts in lieu of Bad
Debts Expense and Allowance for Bad Debts. However, it is a good practice to use a uniform
pair. Some say that Bad Debts have a higher degree of uncollectibility that Doubtful
Accounts. In actual practice, however, the distinction is not really significant.

Here's an Example
Gray Electronic Repair Services estimates that $100.00 of its credit revenue for the period
will not be collected. The entry at the end of the period would be:
Dec

31

Bad Debts Expense

100.00

Allowance for Bad Debts

100.00

Again, you may use Doubtful Accounts. Just be sure to use a logical (and uniform) pair every
time. For example:
Dec

31

Doubtful Accounts Expense

Allowance for Doubtful Accounts

100.00
100.00

If the company's Accounts Receivable amounts to $3,400 and its Allowance for Bad Debts is
$100, then the Accounts Receivable shall be presented in the balance sheet at $3,300 the
net realizable value.
Accounts Receivable (Gross Amount)

$ 3,400

Less: Allowance for Bad Debts

Accounts Receivable - Net Realizable Value

100
$ 3,300

Adjusted Trial Balance

An adjusted trial balance is prepared after adjusting entries are made and posted to the
ledger.
This is the second trial balance prepared in the accounting cycle.

Its purpose is to test the equality between debits and credits after adjusting entries are
entered into the books of the company.
To illustrate how it works, here is a sample unadjusted trial balance:

Gray Electronic Repair Services

Unadjusted Trial Balance
December 31, 2014

Account Title

Debit

Cash

Credit

7,480.00

Accounts Receivable

3,400.00

Service Supplies

1,500.00

Furniture and Fixtures

3,000.00

Service Equipment

16,000.00

Accounts Payable

9,000.00

Loans Payable

12,000.00

Mr. Gray, Capital

13,200.00

Mr. Gray, Drawing

7,000.00

Service Revenue

9,550.00

Rent Expense

1,500.00

Salaries Expense

3,500.00

Taxes and Licenses

Totals

370.00
$ 43,750.00

$ 43,750.00

At the end of the period, the following adjusting entries were made:

Dec

31 Accounts Receivable
Service Revenue

300.00
300.00

31 Utilities Expense

1,800.00

Utilities Payable

31 Service Supplies Expense

1,800.00

900.00

Service Supplies

31 Depreciation Expense

900.00

720.00

Accumulated Depreciation

720.00

After posting the above entries, the values of some of the items in the unadjusted trial
balance will change. Take the first adjusting entry. Accounts Receivable is debited hence is
increased by $300. Service Revenue is credited for $300.
The balance of Accounts Receivable is increased to $3,700, i.e. $3,400 unadjusted balance
plus $300 adjustment. Service Revenue will now be $9,850 from the unadjusted balance of
$9,550.
Next entry. Utilities Expense and Utilities Payable did not have any balance in the unadjusted
trial balance. After posting the above entries, they will now appear in the adjusted trial
balance.
Third. Service Supplies Expense is debited for $900. Service Supplies is credited for $900.
The Service Supplies account had a debit balance of $1,500. After incorporating the $900
credit adjustment, the balance will now be $600 (debit).
And fourth. There were no Depreciation Expense and Accumulated Depreciation in
theunadjusted trial balance. Because of the adjusting entry, they will now have a balance of
$720 in the adjusted trial balance.

Adjusted Trial Balance Example

After incorporating the adjustments above, the adjusted trial balance would look like this.
Just like in the unadjusted trial balance, total debits and total credits should be equal.

Gray Electronic Repair Services

Adjusted Trial Balance
December 31, 2014

Account Title
Cash
Accounts Receivable
Service Supplies
Furniture and Fixtures
Service Equipment

Debit
$

Credit

7,480.00
3,700.00
600.00
3,000.00
16,000.00

Accumulated Depreciation

720.00

Accounts Payable

9,000.00

Utilities Payable

1,800.00

Loans Payable

12,000.00

Mr. Gray, Capital

13,200.00

Mr. Gray, Drawing

7,000.00

Service Revenue

9,850.00

Rent Expense

1,500.00

Salaries Expense

3,500.00

Taxes and Licenses

Utilities Expense

370.00
1,800.00

Service Supplies Expense

900.00

Depreciation Expense

720.00

Totals

Outstanding Expenses:

$ 46,570.00

$ 46,570.00

1. Fewa expense Dr. (EXPENSE

Fewa payable (LIABILITY)
2. WHEN PAID EXPENSE
FEWA PAYBALE
DR
Bank/cash CR
SALARIES EXPENSE
SALARIES PAYABLE CR

DR

WHEN PAID
SALARIES PAYABLE
BANK/ CASH

DR
CR

Prepaid Expenses
PREPAID RENT

ADVANCE RENT entered prepaid a/c --dr to bank/cash

a/c,then end of the time we enter rent a/c--dr to prepaid rent a/c
Option A:
1 Jan 2012
- Dr Rent expense 3000
- Cr Bank 3000
31 Dec 2013
- Dr Prepaid rent expense 600
- Cr Rent expense 600
Option 2 (suggested approach)
1 Jan 2012
- Dr Prepaid rent expense 3000
- Cr Bank 3000
31 Dec 2012
-Dr Rent expense 2400

Accrued Revenue
Receivable account*x,xxx.xx
Income account** x,xxx.xx or rent income /service revenue/interest income

Rent receivable or interest receibale

More Examples: Adjusting Entries for Accrued Income

Example 1: Company ABC leases its building space to a tenant. The tenant agreed to pay
monthly rental fees of $2,000 covering a period from the 1st to the 30th or 31st of every
month. On December 31, 2014, 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
Rent Income

2,000.00
2,000.00