Accounting Fundamentals

Adjusting the Accounts

Periodicity Concept
Division of economic life of a business into artificial time period to provide timely information as to the performance of the business
month quarter Year (most common)
Fiscal (any month that starting with January) Calendar (starts on January 1)

Revenue and Expense Recognition Principles

Revenue recognition principle
A revenue is earned in the accounting period when the services are rendered or the goods sold are delivered

Expense recognition principle

Direct association (costs incurred directly in rendering the service) Systematic and rational allocation (using up of assets such as property and equipment, allocation of prepaid rent and insurance) Immediately (no future benefits)

The Need for Adjustments

Adjusting entries assign:
revenues to the period in which they are earned Expenses to the period they are incurred (used)

Adjusting Entries

General Journal

Ledger

Adjusted Trial Balance

Two Types of Adjustment

Deferral is the postponement of the recognition
Expense already paid but not yet incurred Revenue already collection but not yet earned
Allocating assets to expense (prepaid insurance, supplies and depreciation) Allocating revenues received in advance to revenue to reflect revenues earned during the accounting period

Two Types of Adjustment

Accruals is the recognition of an
Expense already incurred but unpaid Revenue earned but uncollected
Accruing expenses to reflect expenses incurred during the accounting period that are unpaid and unrecorded Accruing revenues to reflect revenues earned during the accounting period that are uncollected and unrecorded

Adjustments for Deferrals

Allocating Assets to Expenses
Prepaid Expense
Rent, insurance, supplies
Jan - Feb Unexpired 2013, 2

Mar - Dec 2012, 10

Expired

Prepaid Rent
Corpuz records an adjustment for 1 month rent he used from the prepaid rent amounting to P21,000 she paid last Dec 1.

Transaction Expiration of one months rent Analysis Rules Entries Assets decreased. Expense increased Decrease in assets = credits Increase in expense = debits Rent expense P7,000 Prepaid Rent P7,000

Prepaid Insurance
Corpuz records the expiration of one-twelfth of the companys one-year insurance policy amounting to P24,000 taken last Dec 1. Transaction Expiration of one months insurance Analysis Rules Entries Assets decreased. Expense increased Decrease in assets = credits Increase in expense = debits Insurance expense P2,000 Prepaid Insurance P2,000

Supplies
Corpuz discovers that she used P500 worth of supplies from

P1,500 supplies she bought last Dec 1.

Transaction Consumption of supplies Analysis Rules Entries Assets decreased. Expense increased Decrease in assets = credits Increase in expense = debits Supplies expense P500 Supplies P500

Depreciation
The estimated amount allocated for the use of longlived assets such as buildings, service vehicles, computers or office furnitures in one accounting cycle.

Three factors are involved:

Cost of the asset Estimated salvage value (is the amount that the asset can probably be sold for at the end of its estimated useful life) Estimated useful life (is the estimated number of periods that an entity can make use of the assets)

Depreciation Expense
Asset cost xx Less: Estimated salvage value (xx) Depreciable cost xx Divided by: Estimate useful life x Depreciation expense xx

Depreciation
Corpuz bought a truck amounting to P300,000 last Dec 1. Corpuz allocates a full months depreciation for property and equipment. It is estimated that the truck will have a useful life of five years and a salvage value of P30,000. [(P300,000 P30,000) / 60 months]
Transaction Analysis Rules Entries Recording of depreciation expense Assets decreased. Expense increased Decrease in assets = credits Increase in expense = debits Depreciation expense P4,500 Accumulated depreciation P4,500

Allocating Revenues Received in Advance to Revenues

On Dec 6, Corpuz received a P13,500 prepayment for six future visits. Since Corpuz completed one of these visits in December, she makes an adjusting entry to reflect this. Transaction Recognition of income where cash is received in advance Analysis Liabilities decreased, Revenue increased Rules Entries Decrease in liabilities = debits Increase in revenue = credits Unearned Revenue P2,250 Lawn Cutting Revenues P2.250

Adjustments for Accruals

Accrued Salaries
Corpuz records an expense for the salaries of her part-time employee who earned P1,600 during the last four days of December but will not be paid until Jan 10.
Transaction Accrual of unrecorded expense Analysis Liabilities increased, Expense increased Rules Entries Increase in liabilities = credits Increase in expense = debits Salaries Expense P1,600 Salaries Payable P1,600

Accrued Revenues
Neither paid by clients nor billed
During the afternoon of Dec 31, Corpuz cuts one lawn, and she agrees to mail the customers a bill for P2,500 which she does on Jan 3. Corpuz makes an adjusting entry in accordance with the revenue recognition principle.
Transaction Accrual of unrecorded revenue Analysis Asset increased, Revenue increased

Rules
Entries

Increase in asset = debits Increase in revenue = credits Accounts Receivable P2,500 Lawn Cutting Revenues P2,500

Accrual for Uncollectible Accounts

Entities often allow clients to purchase goods or avail of services on credit. Some of these accounts will never be collected.
Assume that an entity made credit sales of P1,100,000 and prior experience indicates an expected 1% average uncollectible accounts rate based on credit sales. (P1,100,000 x 1%) is the amount of doubtful of collection. Uncollectible Accounts Expense P11,000 Allowance for Uncollectible Accounts P11,000