ACCOUNTING CYCLE: Service Business

STEP NO. 5
 SHORT REVIEW:

1) What have you learned from our lesson today?

2) Define trial balance.

3) On the board, please illustrate the format of a trial balance.

4) What is the basic purpose of preparing trial balance?

5) Give examples of some errors that cannot be detected by a trial balance.

6) If the trial balance is unbalance, what will you do?

7) Discuss the steps in preparing trial balance.

TODAY’S TOPIC:

After a trial balance has been prepared, it is now time to

perform the step 5 of accounting cycle which is…
Step 5: ADJUTING ENTRIES

NOTE:

If only there is a need for adjustment!

 OBJECTIVES:

1) define adjusting entries;

2) determine the purpose of adjusting entries;

3) learn the two general types of adjusting entries;

4) prepare adjusting entries; and

5) participate actively in class discussion and activities.

ADJUSTING ENTRIES
 Adjusting entries involve changing account balances at the end of
the period from what is the current balance of the account to what
is correct balance for proper financial reporting.
Are made in the accounting books at the end of an accounting
period. These are made after a trial balance (un-adjusted) is
prepared.
 It only involves income and expense account.
THE NEED FOR ADJUSTMENTS
 Accountants make adjusting entries to reflect in the accounts information on
economic activities that have occurred but have not yet been record.
 The purpose of adjusting entries is to adjust revenues and expenses to the
accounting period in which they actually occurred. (revenues are earned, and expenses
are incurred).

 In short, adjustments are needed to ensure that the revenue recognition

and expense recognition principles are followed
 SIX TYPES OF ADJUSTMENTS:

1) ACCRUED REVENUES
2) ACCRUED EXPENSES
3) DEFERRED REVENUES (Unearned Revenue)
4) DEFERRED EXPENSES (Prepaid Expenses)
5) DEPRECIATION
6) ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS
 SIX TYPES OF ADJUSTMENTS:

1) ACCRUED REVENUES
 Accrued revenue consists of income that has been earned from customers but no payment has been
received.
 In other words, a good or service has been provided to a customer, but the customer hasn’t paid for it
by the end of the accounting period.
 Accrued revenues are recorded as receivables at the end of the year to reflect the amount of money
the customers owe the business for the goods or services they purchased.

Example:
Rendered service on account.

The entry is:

Accounts Receivable xxx

Service Revenue xxx
 SIX TYPES OF ADJUSTMENTS:

2) ACCRUED EXPENSES
 Accrued expenses are costs that are incurred in the current period but not paid for until the next period. In other
words, it’s an expense that the company has benefited from but hasn’t paid for or recorded yet. This is why an
accrual is recorded as a liability at the end of a period. It’s the amount of expenses owed to another company. is
an accounting term referring to an expense the firm owes before it pays it.
 The most common form of accruals is a monthly expense like rent or utilities that are consumed
throughout the month and paid for on first of the following month.

Example:
Let’s take rent for example. The business benefits from the rent expense all month, but it doesn’t
actually pay for it until the next month. According to the accrual basis of accounting, expenses must be
recorded when they are incurred, not necessarily when they are paid. Thus, the business should record an
expense for its rental costs in the current month even though it hasn’t actually paid the rent yet.

The entry is:

Rent Expense xxx

Rent Payable xxx
 TWO TYPES OF ADJUSTMENTS:

3 ) Deferred Expense (Prepaid Expense)

A deferral of an expense or an expense deferral involves a payment that was paid in advance of the
accounting period(s) in which it will become an expense.

Example:
A payment made in December for property insurance covering the next six months of January
through June. The amount that is not yet expired should be reported as a current asset such as Prepaid
Insurance or Prepaid Expenses. The amount that expires in an accounting period should be reported as
Insurance Expense.
 TWO TYPES OF ADJUSTMENTS:

Deferred Expense (Prepaid Expense)

Example:
Let's illustrate with a company whose accounting year ends on December 31. On December 1 the
company pays a six-month insurance premium of P12,000. One-sixth of the P12,000, or P2,000, should be
expensed and appear on the December income statement. The remaining 10,000 is said to be deferred and
will be reported as an asset in the account, Prepaid Insurance, on its December 31 balance sheet.

Initial Entry:
Prepaid Insurance 12, 000
Cash 12, 000
Paid insurance for 6 months.

Adjusting Entry:
Insurance Expense 2, 000
Prepaid Insurance 2, 000
To adjust expired portion of prepaid insurance

Prepaid Insurance 10, 000

Insurance Expense 10, 000
To adjust un-expired portion of prepaid insurance
 TWO TYPES OF ADJUSTMENTS:

4 ) Deferred Revenue (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".

Example:
An example is the insurance company receiving money in December for providing insurance
protection for the next six months. Until the money is earned, the insurance company should report the
unearned amount as a current liability such as Unearned Insurance Premiums. As the insurance premiums
are earned, they should be reported on the income statement as Insurance Premium Revenues.
 TWO TYPES OF ADJUSTMENTS:

Deferred Revenue (Unearned Revenue)

Example:
On July 1, 2000, Bacani Company received a P48, 000 check for 2 years’ rent paid in advance. On this
date, Bacani may record a credit in that amount either as unearned rental revenue or rental revenue,
depending on its accounting policy.
At the end of the year, an adjusting entry is needed to establish the proper balances in the rent revenue
and unearned rent revenue account. On Dec. 31, 2000, six month’s rent has bee earned, or rent revenue is
equal to P12, 000. Unearned rent revenues equivalent P36,000 remain. The adjusting entry are as follows.

Initial Entry:
Cash 48, 000
Unearned Rent Revenue 48, 000
Received advance payment from customer.

Adjusting Entry:
Unearned Rent Revenue 12, 000
Rent Revenue 12, 000
To record earned portion of unearned rent revenue

Rent Revenue 36, 000

Unearned Rent Revenue 36, 000
To record un-earned portion of unearned rent revenue
 TWO TYPES OF ADJUSTMENTS:
 5 ) Depreciation
- is the gradual charging to expense of an asset's cost over its expected useful life. The reason for
using depreciation to gradually reduce the recorded cost of a fixed asset is to recognize a portion of
the asset's expense at the same time that the company records the revenue that was generated by the
fixed asset.
Example:
A truck costing P40,000 has a useful life of 10 years and a salvage value of P5,000 at the end
of its useful life. Calculate the annual depreciation using straight-line depreciation method. Also calculate
the net carrying value of the asset at the end of 7th year.

Solution
Since the truck has a salvage value at the end of its useful life, it must be subtracted from the cost of truck
before allocating the cost over the 10 years equally using the straight line method. Therefore the annual
depreciation is given by:

40, 000 − 5, 000

𝑨𝒏𝒏𝒖𝒂𝒍 𝑫𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏 𝑬𝒙𝒑𝒆𝒏𝒔𝒆 =
10

= 3500
QUIZ:
1) Which of the following is/are a purpose of adjusting entries?
A. To update the accounts in the books
B. To apply the matching principle
C. To properly reflect the correct net income
D. All of the above

2 ) ________ It is defined as the systematic allocation of the cost of an asset over its useful life.
A. Deferred income
B. Deferred expense
C. Depreciation
D. Accrued Expense

3 ) The Unearned Revenue account is under what type of major account?

A. Liabilities
B. Assets
C. Expense
D. Income

4 ) If an adjusting entry is not made to accrue expenses, then the balance sheet liabilities will be?
A. Understated
B. Overstated
QUIZ:
5) The depreciation adjusting entry to record the depreciation expense estimate for
the accounting period requires a credit to which account? A.
Accumulated depreciation
B. Depreciation expense

6 ) Adjusting entries are needed to comply with which accounting concept?

A. Business Entity
B. Matching
C. Monetary
D. None of the above

7 ) Expenses paid in advance require what type of adjusting entry?

A. Deferral
B. Accrual

8 ) Adjusting entries never involve which account?

A. Cash
B. Expenses
QUIZ:
9) Accrual accounting involves all of the following except
A. Recording all revenues when cash was received
B. Recognizing expense when incurred
C. Adjusting the accounts
D. None of the above

10 ) Subscriptions received in advance by a publishing company is called unearned

revenue if the subscriptions revenue will be earned in one fiscal period
A. True
B. False