ACCT 1A&B BCSV

ADJUSTING JOURNAL ENTRIES

~LECTURE~

Accrual basis accounting – recognizes transactions as they occur. Income is recognized

when earned and expenses are recognized when incurred, regardless of the inflow or outflow of
cash.
Cash basis accounting – recognizes income only when cash related to income is collected
and expenses are recognized only when paid.

 Adjusting process is made in order to comply with the GAAP regarding revenue
recognition and matching principles.
Adjusting entries – adjustments used to bring the assets, liabilities, revenues and expenses
up-to-date at the end of accounting period.
- They are usually made at the end of the accounting period.
- Necessary to properly report the truthful net income or loss at the end of the accounting
and to appropriately report assets, liabilities, and equity.

Query: Why is there a need to adjust the accounts at the end of the period?

Answer: Because, during the reporting period, cash receipts and cash payments
primarily serve as the bases for recording income and expenses, the
accounting records need to be updated for revenues and expenses earned
and incurred but not yet collected or paid and for cash receipts and cash
payments made during the period but are not yet earned or incurred.

Journalizing and Posting Adjusting Entries

 Follows the principle of accrual basis of accounting.
 Follows the principles of matching (properly match revenues earned for the period with
expenses incurred for same period) and going concern (the entity is assumed to
continue its operations for an indefinite future period of time, unless liquidation appears
imminent).
 The going concern assumption provides the basis for the recognition of depreciation and
deferrals.
 An adjusting entry affects both real and a nominal account.

Calendar year – one where the period ends in December 31.

Fiscal year – a period of 12 months that ends at any time except December 31.

Types of adjusting entries:

1. ACCRUALS – means to recognize revenue earned and expenses incurred, regardless of
inflow or outflow of cash.

Revenues earned Cash received

-or- -or-
Expenses incurred Cash paid
(reporting period)

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Accrued expenses – expenses incurred during the accounting period but has not
been paid and is still unrecorded at year-end.
 Affects 3 concepts: (1) Expense recognition principle (2) liability
recognition principle (3) accrual basis assumption
 If not adjusted, expenses will be understated, profit will be overstated,
Liabilities will be understated, Equity will be overstated.
Pro-forma entry:
Expense xx
Liability xx

Accrued revenues – revenue earned during the accounting period for which no
cash has been collected yet.
 If not adjusted, income will be understated, profit will be understated,
assets will be understated, Equity will be understated.
 Affects 3 concepts: (1) income recognition (2) asset recognition principle
(3) accrual basis assumption
Pro-forma entry:
Asset xx
Income xx

2. DEFERRALS - receipts of assets or payments of cash in advance of revenue or expense

recognition.

Cash received Revenues earned

-or- -or-
Cash paid Expenses incurred
(reporting period)

Prepayments – cash paid not but not yet incurred.

 Opposite of accrued expense.
 3 concepts are involved: (1) expense recognition principle (2) asset
recognition principle (3) accrual basis assumption
Pro-forma entries:
Asset method: Expense method:
Original journal entry:
Prepaid expense xx Expense xx
Cash xx Cash xx

Adjusting entry:
Expense xx Prepaid expense xx
Prepaid expense xx Expense xx
Recognize the used portion Recognize the unused portion

Deferred revenues – cash received but not yet earned.

 Opposite of accrued income.
 3 concepts are involved: (1) income recognition principle (2) liability
recognition principle (3) accrual basis assumption.

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Pro-forma entries:
Liability method: Income method:
Original journal entry:
Cash xx Cash xx
Liability xx Income xx

Adjusting entry:
Liability xx Income xx
Income xx Liability xx
Recognize the earned portion Recognize the unearned portion

NOTE: the method mentioned above is based on the ORIGINAL entry and whatever method
you may use in your computations, you will always arrive at the same answer.

Adjusting entries involving estimates

1. DEPRECIATION
 The concept of depreciation involves the systematic and rational allocation of the
cost of long-lived assets over multiple accounting periods it is used to generate
revenue (cost allocation, not valuation concept).
 Follows the matching principle.
 PPE, with the exception of land, are subject to depreciation.

Straight-Line method of depreciation: (the simplest and most widely used method of
depreciation)

Cost − Residual value

Annual Depreciation =
Estimated useful life

Pro-forma entry:
Depreciation Expense xx
Accumulated Depreciation xx

 The use of the contra account allows the disclosure of the original cost of the asset
in the statement of financial position.
 Carrying value of PPE is computed as the difference of the cost and the accumulated
depreciation account.

2. BAD DEBTS EXPENSE

 Estimating uncollectible accounts on receivable accounts.
 Also known as Impairment of Receivables.
 The total amount of uncollectible accounts is an expense that arises by selling on
credit.
 Net realizable value of Accounts receivable is equal to the difference of Accounts
receivable ending balance and Allowance for doubtful accounts balance.

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Two methods of recording bad debts:

1. DIRECT WRITEOFF – directly removes the estimated uncollectible amount from
receivables whether it is probable or not that the amount will not be collected.
o The only method allowed for income tax purposes.

Pro-forma entries:
Bad debts expense xx
Accounts receivables xx

Recovery of accounts written off

Accounts receivables xx
Bad debt recovery* xx

Cash xx
Accounts receivable xx

* Bad debt recovery is other income account.

2. ALLOWANCE METHOD – a more prudent method of estimating uncollectible accounts.

It sets up first an allowance account for the estimation of uncollectible accounts. Once it
is probable that the account is uncollectible, derecognize the allowance and remove the
amount from receivables.
 The accounts receivable account is not directly credited,
 If the base used for estimating uncollectible account is:
o A balance sheet account, the amount estimated is the required balance of
the allowance account.
o An income statement account, the amount estimated is an addition to the
balance of the allowance account.
 In contrast to the direct write-off method, recording write-offs and recoveries
under the allowance method does not affect profit.

Pro-forma entries:
Bad debts expense xx
Allowance for bad debts xx

Probable that the account is uncollectible

Allowance for bad debts xx
Accounts receivable xx

Recovery of accounts written off

Accounts receivable xx
Allowance for bad debts xx

Cash xx
Accounts receivable xx

Aging analysis of receivables – bad debt expense is computed under the premise
that the longer an amount is past due, the more likely it is to be uncollectible.

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- Higher percentage (%) will be assigned to older receivables and the lowest percentages
to new receivables or to those which are not yet due.

~APPLICATION~

Accrued expense
On September 1, 2015, ABC Co. issued a 6-month note to a supplier amounting to P 300,000,
12% interest per annum. Also, there was an unpaid and unrecorded salaries at the end of the
year dated December 31, 2015 amounting to P 25,000. Give the adjusting entries.

Accrued revenue
On October 1, 2015, DEF Co. received a 5-month note from a customer amounting to P
500,000, 10% interest per annum. Record the adjusting entry as of December 31, 2015.

Prepayment
GHI Co. purchased a two-year insurance policy on August 1, 2015 for P 28,800. Give the
adjusting entries as of December 31, 2015 assuming the company uses:
a. Asset method
b. Expense method

Pre-collection
JKL Co. is engaged in constructing and renting office space to various businesses. On
September 1, 2015 one tenant gave P 240,000 cash for six month’s rent. Give the adjusting
entries as of December 31, 2015 assuming the company uses:
a. Liability method
b. Revenue method

Depreciation
MNO Co. acquires a building on January 1, 2015 at a cost of P 5,500,000. The building has an
estimated useful life of 40 years and an estimated salvage value of P 500,000. Record the
provision for depreciation for year 2015.

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Uncollectible accounts
A company estimates that 5% of accounts receivable will be uncollectible. The total credit
service revenue for the year 2015 were P 1 Million, accounts receivable as of December 31,
2015 was P 200,000, and the allowance for bad debts’ beginning balance was P 10,000. The
company also wrote off P 5,000 accounts receivable which was deemed to be worthless and
recovered P 3,000 of accounts receivable previously written off. Record the adjusting entries.

Uncollectible accounts
A company estimates that 3% of the credit service revenue will be uncollectible. The total credit
service revenue for the year 2015 were P 1 Million, accounts receivable as of December 31,
2015 was P 200,000, and the allowance for bad debts’ beginning balance was P 10,000. The
company also wrote off P 5,000 accounts receivable which was deemed to be worthless and
recovered P 3,000 of accounts receivable previously written off. Record the adjusting entries.

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