Reversing Entries - Part 1 (ACCRUED INCOME & ACCRUED EXPENSES)

Reversing entries are made at the beginning of the new accounting period to enable a smoother
accounting process.

This step is "optional" and is especially useful to companies that use the cash basis method.

In this step, adjusting entries made at the end of the previous accounting period are simply
reversed, hence the term "reversing entries".

However, not all adjusting entries qualify for this step.

The only types of adjusting entries that may be reversed are those that are prepared for the
following:

1. accrued income,

2. accrued expense,

3. unearned revenue using the income method, and

4. prepaid expense using the expense method.

Adjusting entries for unearned revenue under the liability method and for prepaid expense under
the asset method are never reversed. Adjusting entries for depreciation, bad debts and other
allowances are also never reversed.

Reversing Entry for Accrued Income

Example: ABC Company is to receive ₱3,00Prepari

est income at the end of February 2018. It covers 3 months starting December 1, 2017. At the end
of 2017, the accountant properly made an adjusting entry for one month's worth of accrued
income.

Dec31:
Dr. Interest Receivable1,000.00
Cr. Interest Income 1,000.00

At the beginning of 2018, the accountant can prepare this reversing entry:

Jan1:
Dr. Interest Income1,000.00
Cr Interest Receivable 1,000.00
The adjusting entry is simply reversed. Debit what was credited and credit what was debited.

When the ABC Company receives the interest income at the end of February, the accountant will
then prepare this journal entry:

Feb28:
Dr. Cash3,000.00
Cr. Interest Income 3,000.00

Notice that Interest Income is credited for ₱3,000. Now you might be asking this: Under the
concept of accrual, the interest income to be recognized in 2018 should be ₱2,000. Then why
credit ₱3,000 Interest Income?

Very good. Well, in the reversing entry at the beginning of the period, Interest Income was already
debited for ₱1,000. So if we combine them (₱1,000 debit and 3,000 credit), then we'll end up with
₱2,000 Interest Income which is the correct amount to be recognized in 2018.

We said that reversing entries are optional. If the accountant did not make a reversing entry at the
beginning of the year, the accountant will have this entry upon collection of the income.

Feb28:
Dr. Cash3,000.00
Cr. Interest Receivable 1,000.00
Cr. Interest Income 2,000.00

Note: Actually, if you combine the reversing entryand journal entry for collection. You'll come up
with the journal entry above.

Reversing Entry for Accrued Expense

Example: Suppose that ABC Company and its lessor agrees that ABC will pay rent at the end of
January 2018, covering a 3-month period starting November 1, 2017. The entire amount is ₱6,000.
At the end of December 2017, the accountant properly prepared this adjusting entry for two
months worth of rent expense (Nov 1 to Dec 31):

Dec31:
Dr. Rent expense4,000.00
Cr. Rent payable 4,,000.00

At the beginning of 2018, the accountant can prepare this reversing entry:

Jan1:
Dr. Rent Payable4,000.00
Cr. Rent Expense 4,000.00

Again, notice that the adjusting entry is simply reversed.

When the company pays the entire rent, the accountant will then prepare this journal entry:

Jan31:
Dr. Rent Expense6,000.00
Cr. Cash 6,000.00

In effect, Rent Expense for 2017 is ₱2,000 even if the accountant debits ₱6,000 upon payment.
This is because of the reversing entry which includes a credit to Rent Expense for ₱4,000.

If the accountant did not make a reversing entry at the beginning of the year, the accountant will
have this entry upon payment of the rent.

Jan31:
Dr. Rent Payable4,000.00
Cr. Rent Expense2,000.00
Cr. Cash 6,000.00

There you have the first two types of adjusting entries that can be reversed. If you are having
trouble understanding the process, don't worry. It requires some time and a little effort for the
concepts to sink in. In part 2, we'll take a look at the other two types.

Reversing Entries - Part 2 (UNEARNED INCOME & PREPAID EXPENSE)

In part 1, we had an introduction to reversing entries and discussed examples for accrued income
and accrued expense.

In this part, we will cover the two other types of entries that can be reversed:

a. unearned income and

b. prepaid expense.

Reversing Entry for Unearned Income

If the income method is used in recording unearned income, reversing entries can be prepared.

Take note that adjusting entries for unearned income recorded using the liability method are
NEVER reversed.

Example: ABC Company recorded customer advances amounting to ₱5,000 in December 1, 2017.
The company uses the income method in recording unearned income.
Dec1:
Dr. Cash5,000.00
Cr. Service Revenue 5,000.00

At the end of 2017, the company rendered ₱2,000 worth of services. We need to set-up the
unearned income of ₱3,000 and bring Service Revenue to its correct balance (₱2,000). The
adjusting entry would be:

Dec31:
Dr. Service Revenue3,000.00
Cr. Unearned Revenue 3,000.00

At the beginning of 2018, the following reversing entry can be prepared:

Jan1:
Dr. Unearned Revenue3,000.00
Cr. Service Revenue 3,000.00

Notice that the adjusting entry is simply reversed.

At the end of 2018, Service Revenue will again be checked to see if there is any unearned portion
and if an adjusting entry is necessary.

Reversing Entry for Prepaid Expense

If the expense method is used in recording prepaid expense, reversing entries can be prepared.
Adjusting entries for prepaid expense under the asset method are NOT reversed.

Example: On December 1, 2017, ABC Company paid ₱7,500 of rent for 3 months starting
December 1. The expense method was used in recording this transaction.

Dec1:
Dr. Rent Expense7,500.00
Cr. Cash 7,500.00

At the end of 2017, 1 month worth of rent has already expired. Prepaid Rent should be set-up for
the remaining 2 months. The adjusting entry would be:

Dec31:
Dr. Prepaid Rent5,000.00
Cr. Rent Expense 5,000.00

At the beginning of 2018, the following reversing entry can be prepared:

Jan1:
Dr. Rent Expense5,000.00
Cr. Prepaid Rent 5,000.00

Again, notice that the adjusting entry is simply reversed.

At the end of February, the entire rent paid has already expired. We do not need to make an entry
here since we already prepared a reversing entry.

Nonetheless, Rent Expense will be reviewed at the end of the year. Rent Expense and all other
expenses will be checked to see if there are any unexpired portions which will require adjusting
entries.

Author's Notes:

And there you have the four types of adjusting entries that can be reversed. We've covered all of
them and provided examples to guide you. Again, if you are having a hard time understanding the
process, don't worry. It requires some time and a little effort for the concepts to sink in. After all,
the process will always be the same.

LESSON 001: Introduction to Adjusting Entries: Purpose, Types, and Composition

Adjusting entries, or adjusting journal entries (AJE),are made to update the accounts and bring
them to their correct balances. The preparation of adjusting entries is an application of the accrual
concept of accounting and the matching principle.

The accrual concept states that income is recognized when earned regardless of when collected
and expense is recognized when incurred regardless of when paid.

The matching principle aims to align expenses with revenues. Expenses should be recognized in
the period when the revenues generated by such expenses are recognized.

Purpose of Adjusting Entries

The main purpose of adjusting entries is to update the accounts to conform with the accrual
concept. At the end of the accounting period, some income and expenses may have not been
recorded, taken up or updated; hence, there is a need to update the accounts.

If adjusting entries are not prepared, some income, expense, asset, and liability accounts may not
reflect their true values when reported in the financial statements. For this reason, adjusting entries
are necessary.

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 (LESSON 002)

2. Accrued Expense – expenses incurred but not yet paid (LESSON 003)

3. Accrued Income – income received but not yet earned (LESSON 004)

4. Prepaid Expense – expenses paid but not yet incurred (LESSON 005)

Also, adjusting entries are made for:

5. Depreciation (LESSON 006)

6. Doubtful Accounts or Bad Debts, and other allowances (LESSON 007)

Composition of an Adjusting Entry

Adjusting entries affect at least one nominal account and one real account.

A nominal account is an account whose balance is measured from period to period. Nominal
accounts include all accounts in the Income Statement, plus owner's withdrawal. They are also
called temporary accounts or income statement accounts.

Examples of nominal accounts are: Service Revenue, Salaries Expense, Rent Expense, Utilities
Expense, Mr. Gray Drawing, etc.

A real account has a balance that is measured cumulatively, rather than from period to period. Real
accounts include all accounts in the balance sheet. They are also called permanent accounts or
balance sheet accounts.

Real accounts include: Cash, Accounts Receivable, Rent Receivable, Accounts Payable, Mr. Gray
Capital, and others.

All adjusting entries include at least a nominal account and a real account.

Note: "Adjusting entries" refer to the 6 entries mentioned above. However, in some branches of
accounting (especially auditing), the term adjusting entries could refer to any entry that aims to
adjust incorrect account balances.

As a result, there is little distinction between "adjusting entries" and "correcting entries" today. In
the traditional sense, however, adjusting entries are those made at the end of the period to take up
accruals, deferrals, prepayments, depreciation and allowances.
LESSON 002: Adjusting Entry for Accrued Revenue

Accrued income (or accrued revenue) refers to income already earned but has not yet been
collected.
At the end of every period, accountants should make sure that they are properly included as
income, with a corresponding receivable.

When a company has performed services or sold goods to a customer, it should be recognized as
income even if the amount is still to be collected at a future date.
If no journal entry was ever made for the above, then an adjusting entry is necessary.

Pro-Forma Entry

The adjusting entry to record an accrued revenue is:

[Debit] Receivable account*

[Credit] Income account**

*Appropriate receivable account such as Accounts Receivable, Rent Receivable, Interest

Receivable, etc.
**Income account such as Service Revenue, Rent Income, Interest Income, etc.

Here's an Example

In our previous set of transactions, assume this additional information:

On December 31, 2017, Gray Electronic Repair Services rendered ₱300 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 on Dec. 31 would be:

Dr. Accounts Receivable 300.00

Cr. Service Revenue 300.00
Here are some more illustrations.

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, 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 on Dec. 31
would be:

Dr. Rent Receivable 2,000.00

Cr. Rent Income 2,000.00

Example 2: ABC Company lent ₱9,000 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 ₱9,000 principal plus a ₱900
interest will be collected by the company after 1 year. The ₱900 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 ₱75 (i.e. ₱900 x 1/12 ) as interest
income. The adjusting journal entry on Dec. 31 would be:

Dr. Interest Receivable75.00

Cr. Interest Income 75.00

The basic concept you need to remember is recognition of income. When is income recognized?
Under the accrual concept of accounting, income is recognized when earned regardless of when
collected.

If the company has already earned the right to it and no entry has been made in the journal, then
an adjusting entry to record the income and a receivable is necessary.

LESSON 003: Adjusting Entry for Accrued Expenses

Accrued expenses refer to expenses that are already incurred but have not yet been paid.

At the end of period, accountants should make sure that they are properly recorded in the books of
the company as an expense, with a corresponding payable account.

Here's the rule. If a company incurred, used, or consumed all or part of an expense, that expense or
part of it should be properly recognized even if it has not yet been paid.

If such has not been recognized, then an adjusting entry is necessary.

Pro-Forma Entry

The pro-forma adjusting entry to record an accrued expense is:

[Debit] Expense account*
[Credit] Liability account**

*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 2017, Gray Electronic Repair Services used a total of ₱1,800 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.

Dr. Utilities Expense1,800.00

Cr. 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, 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 on Dec. 31
would be:

Dr. Rent Expense1,500.00

Cr. Rent Payable 1,500.00

Example 2: VIRON Company borrowed ₱6,000 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 ₱6,000 principal plus ₱720 interest after a year. The ₱720 interest covers 1
year. At the end of December, a part of that is already incurred, i.e. ₱720 x 5/12 or ₱300. That
pertains to interest for 5 months, from August 1 to December 31. The adjusting entry on Dec. 31
would be:

Dr. Interest Expense300.00

Cr. 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.

LESSON 004: Adjusting Entry for Unearned Revenue

Unearned revenue (also known as deferred revenue or deferred income) represents revenue
already collected but not yet earned.
Hence, they are also called "advances from customers".

Following the accrual concept of accounting, unearned revenues are considered as liabilities.

It is to be noted that under the accrual concept, income is recognized when earned regardless of
when collected.
And so, unearned revenue should not be included as income yet; rather, it is recorded as a liability.
This liability represents an obligation of the company to render services or deliver goods in the
future. It will be recognized as income only when the goods or services have been delivered or
rendered.

At the end of the period, unearned revenues must be checked and adjusted if necessary. The
adjusting entry for unearned revenue depends upon the journal entry made when it was initially
recorded.

There are two ways of recording unearned revenue:

(1) the liability method, and

(2) the income method.

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, 2017, ABC Company made ₱30,000 advanced collections from its
customers. If the liability method is used, the entry on Jan. 10 would be:

Dr. Cash30,000.00
Cr. Unearned Revenue 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 on Jan. 31 would be:

Dr. Unearned Revenue6,000.00

Cr. 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 income account.
Using the same transaction above, the initial entry for the collection on Jan. 10 would be:

Dr. Cash 30,000.00

Cr. 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 on
Jan.31 would be:

Dr. Service Income24,000.00

Cr. Unearned Income 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, 2017, 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:

Dr. Cash60,000.00
Cr. Unearned Rent Income 60,000.00

On December 31, 2017, the end of the accounting period, 1/3 of the rent received has already been
earned (prorated over 3 months).

We should then record the income through this adjusting entry on Dec. 31:

Dr. Unearned Rent Income20,000.00

Cr. Rent Income 20,000.00

In effect, we are transferring ₱20,000, one-third of ₱60,000, from the Unearned Rent Income (a
liability) to Rent Income (an income account) since that portion has already been earned.

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

Dr. Cash 60,000.00

Cr. Rent Income 60,000.00

In this case, we must decrease Rent Income by ₱40,000 because that part has not yet been earned.
The income account shall have a balance of ₱20,000. The amount removed from income shall be
transferred to liability (Unearned Rent Income).

The adjusting entry would be:

Dr. Rent Income40,000.00
Cr. Unearned Rent Income 40,000.00

Conclusion

If you have noticed, what we are actually doing here is making sure that the earned part is
included in income and the unearned part into liability. 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 most challenging (but important) topics for beginners.

LESSON 005: Adjusting Entries for Prepaid Expense

Prepaid expenses (a.k.a. prepayments) represent payments made for expenses which have not yet
been incurred.

In other words, these are "advanced payments" by a company for supplies, rent, utilities and others
that are still to be consumed. Hence, they are included in the company's assets.

Expenses are recognized when they are incurred regardless of when paid. Expenses are considered
incurred when they are used, consumed, utilized or has expired.

Because prepayments they are not yet incurred, they are not recorded as expenses. Rather, they are
classified as current assets since they are readily available for use.

Prepaid expenses may need to be adjusted at the end of the accounting period. The adjusting entry
for prepaid expense depends upon the journal entry made when it was initially recorded.

There are two ways of recording prepayments:

(1) the asset method, and

(2) the expense method.

[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.be

Illustration: Gray Electronic Repair Services made this entry to record the purchase of service
supplies:

Dr. Service Supplies 1,500.00

Cr. Cash 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 3:

Dr. Service Supplies Expense 900.00

Cr. 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:

Dr. Service Supplies Expense 1,500.00

Cr. Cash 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:

Dr. Service Supplies 600.00

Cr. 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, 2017
for a total of ₱6,000.

Under the asset method, the initial entry would be:

Sep 1:
Dr. Prepaid Insurance 6,000.00
Cr. Cash 6,000.00
On December 31, 2017, 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:
Dr. Insurance Expense 4,000.00
Cr. Prepaid Insurance 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 1:
Dr. Insurance Expense 6,000.00
Cr. 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:
Dr. Prepaid Insurance 2,000.00
Cr. 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. Prepari

LESSON 006: Adjusting Entry for Depreciation Expense

When a fixed asset is acquired by a company, it is recorded at cost (generally, cost is equal to the
purchase price of the asset). This cost is recognized as an asset and not expense.

The cost is to be allocated as expense to the periods in which the asset is used.This is done by
recording depreciation expense.
There are two types of depreciation – physical and functional depreciation.

Physical depreciation results from wear and tear due to frequent use and/or exposure to elements
like rain, sun and wind.

Functional or economic depreciation happens when an asset becomes inadequate for its purpose or
becomes obsolete. In this case, the asset decreases in value even without any physical
deterioration.

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 minus Residual Value) divided by 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:

Dr. Depreciation Expense 6,000.00

Cr. Accumulated Depreciation 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.

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

LESSON 007: Adjusting Entry for Bad Debts Expense

Companies provide services or sell goods for cash or on credit. Allowing credit tends to encourage
more sales.

However, businesses that allow credit are faced with the risk that their receivables may not be
collected.

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:
Dr. Bad Debts Expense xx
Cr. Allowance for Bad Debts 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:

Dr. Bad Debts Expense 100.00

Cr. 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:

Dr. Doubtful Accounts Expense 100.00

Cr. Allowance for Doubtful Accounts 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 100
Accounts Receivable - Net Realizable Value ₱ 3,300

PART I

FOB DESTINATION:

The ownership to the merchandise will ONLY be transfered to the buyer if IT HAS REACHED
THE DESTINATION POINT.

✓What if the merchandise is lost while in transit, who suffers the loss?

-Since the ownership is not transferred yet, THE SELLER SUFFERS the loss.

✓On the date of inventory count, to whom will the merchandise inventory belong? Buyer or
Seller?

-The merchandise shipped FOB Destination, while in transit on the date of inventory count, is
INCLUDED in the merchandise of the SELLER.

FOB DESTINATION FREIGHT PREPAID

-The seller shoulders the costs and pays the shipping expenses for inventory.

The Entries will be:

Example:

Selling Price: P10,000.00

Shipping Fee: P250.00

Date of sale:

DR. A/R P10,000.00

DR. Transportation Out P250.00
CR. Sales P10,000.00
CR. Cash P250.00

Date of Payment:

DR. Cash P10,000.00

CR. A/R P10,000.00

FOB DESTINATION FREIGHT COLLECT

-the buyer shoulders the costs to accomodate the seller. In effect, the shipping company will
collect the shipping costs from the buyer. On the payment date, the buyer will deduct the amount
from the payment.

Example:

Selling Price: P10,000.00

LBC Shipping Fee: P250.00

ENTRIES:

Date of Sale:

DR. A/R P9, 750

DR. Transportation Out P250.00
CR. SALES P10,000.00

The shipping fee is deducted from the amount the seller can collect from the buyer because he
owes it to him. The buyer is paying for the expense of the seller. Therefore, the seller has to
reimburse buyer in a form of reduction to the amount that seller can collect.

The Transportation Out is also recognised though no payment happened yet. As per Accrual Basis:
we recognise Expense when incurred, not when payment is made.

Date of Payment:

DR. CASH P9,750.00

CR. A/R P9,750.00.

Paet 2 is here: https://facebook.com/story.php?

story_fbid=1447829885361178&id=1139291592881677

PART II

FOB SHIPPING POINT:

The ownership to the merchandise will immediately transfer to the buyer once the merchandise is
shipped.

✓What if the merchandise is lost while in transit, who suffers the loss?
-Since the ownership is already transferred to the buyer, THE BUYER HIMSELF SUFFERS the
loss.

✓On the date of inventory count, to whom will the merchandise inventory belong? Buyer or
Seller?

-The merchandise shipped FOB Shipping Point, while in transit on the date of inventory count, is
INCLUDED in the merchandise of the BUYER.

FOB SHIPPING POINT FREIGHT COLLECT

-The buyer shoulders the costs and pays the shipping costs for inventory.

Example:

Selling Price: P10,000.00

Shipping Fee: P250.00

FROM THE SELLER'S VIEWPOINT:

Date of Sale

DR. A/R P10,000.00

CR. Sales P10,000.00

The Seller does not bear/shoulder the transportation costs, therefore he does not record
Transpotation Out in his books.

Date of Collection

DR. Cash P10,000.00

CR. A/R P10,000.00

FROM THE BUYER'S VIEWPOINT:

Date of Purchase

DR. Purchases P10,000

DR. Transportation In P250
CR. Accts Payable P10,000
DR. Cash P250

Since the buyer shoulders the transportation costs, he records it in his books the Transportation In.

Date of Payment
DR. A/P P10,000
CR. Cash P10,000.

FOB SHIPPING POINT FREIGHT PREPAID

-the buyer shoulders the costs and does record the Transportation In in his books, BUT FOR THE
MEANTIME the seller pays for the shipping costs, as an accomodation to the buyer.

In effect, the buyer has to reimburse the seller for the transportation costs. On the payment date,
the buyer will add the amount to the payment.

Example:

Selling Price: P10,000.00

LBC Shipping Fee: P250.00

FROM THE SELLER'S VIEWPOINT:

Date of Sale:

DR. A/R P10,250

CR. SALES P10,000
CR. Cash P250

The shipping fee is added to the amount the seller can collect from the buyer.

Again, no Transportation Out is recognised because the seller does not shoulder the shipping costs
anyway. He is merely accomodating the buyer so he pays the shipping company for now.

Date of Collection

DR. CASH P10,250

CR. A/R P10,250

FROM THE BUYER'S VIEWPOINT:

Date of Purchase

DR. Purchases P10,000

DR. Transportation In 250,00
CR. Accts Payable P10,250

Per Accrual Principle, the buyer will recognise Transportation In although no payment has been
made yet.
Date Of Payment

DR. A/P P10,250

CR. Cash P10,250

*Payment for the merchandise (P10,000) + Reimbursement to the seller (P250)