Centro Escolar University – Manila

School of Accountancy and Management

Fundamentals of Accounting 1
ADJUSTING ENTRIES

Prepared By: Judicarlo Magno V. Ulep

Learning Objectives:

After the discussion, the following are expected of the students:

1. To be able to explain why adjusting entries are needed.

2. To be able to identify and discuss the different types of adjusting entries.
3. To be able to prepare all adjusting entries.

Why Adjusting Entries are needed?

The output of the accounting process is the financial statement. In preparing

financial statements, such cannot be prepared directly from the trial balance due to fact
that some of the account balances may not be updated and must first be adjusted. The
unadjusted accounts have both balance sheet portions and income statement
portions hence, termed mixed accounts.

Examples:

1. Supplies and other assets may have been partially used up.
2. Revenues may have been earned but not yet received and Expenses may have
been incurred but not yet paid.
3. Overstated net income due to uncollectible accounts (Bad Debts) for which no
receipt of cash is expected.

Deferrals and Accruals distinguished

Should there be an existence of deferrals and accruals, adjusting entries are
necessary.

Deferral refers to the postponement of the recognition of income already received

and expenses already paid. (Prepaid Expenses and Unearned Income)

Example:

Income: Advanced payment made by a customer for a corresponding service that

are yet to be performed.

Expense: Advanced payment made by the firm for a corresponding service that
are yet to be received.
 Accrual refers to the recognition of income earned but not yet received and
expenses incurred but not yet paid.

Example:

Income: Interest already earned but not yet received.

Expense: Interest already incurred but not yet paid.

What are the different types of adjusting entries?

The adjusting entries are sorted into 6 categories:

1. Prepaid Expenses
These are expenses paid in advance before being used or consumed. They
expire through consumption (supplies) or passage of time (rent or insurance).

Note: Prepaid Expense is an asset, not an expense.

Methods in recording prepaid expenses:

Asset Method: An asset account is debited.

Pro-forma Entry: Adjusting Entry:

Supplies xxx Supplies Expense xxx

Cash xxx Supplies xxx

Expense Method: An expense account is debited.

Supplies Expense xxx Supplies xxx

Cash xxx Supplies Expense xxx

Note:
It must be in mind that either method will produce the same adjusted balance of the
asset and expense account.

2. Unearned Income
These are collections in advance before income is earned. Unearned
Income can also be called as deferred Income.

Note: Unearned Income is a liability, not an income.

Methods in recording unearned income:

Liability Method: A liability account is credited.

Pro-forma Entry: Adjusting Entry:

Cash xxx Unearned Income xxx

Unearned Income xxx Income xxx

Income Method: An income account is credited.

Cash xxx Income xxx

Income xxx Unearned Income xxx

Note:
It must be in mind that either method will produce the same adjusted balance of the
liability and income account.

3. Accrued Expenses
These are expenses incurred but not yet paid. From the account title itself,
these expenses accrue until the payment is made. These expenses should
be charged in the period in which it is incurred regardless of the date of
payment.

Adjusting Entry:

Accrued Expense xxx

Accrued payable xxx

4. Accrued Income
These are income earned but not yet received. From the account title itself,
the income is being accumulated until the collection is made. This is the
reverse point of view in an accrued expense.

Adjusting Entry:

Accrued Receivable xxx

Accrued Income xxx
 5. Depreciation
This refers to the cost allocated in one accounting period over the non-
current asset’s estimated useful life. In other words, it is an allocation of cost
over the period the non-current asset is used to generate income.

Pro-forma Entry:

Depreciation Expense – (name of the asset) xxx

Accumulated Depreciation – (name of the asset) xxx

Note:
Accumulated Depreciation is a contra-asset account. It decreases the value of the
non-current asset.

Method of Depreciation
The very common method of depreciation is the straight-line method (SLM).

Formula:

Cost – Salvage Value (Scrap Value)

Annual Depreciation =
Estimated Useful Life

Wherein:

Cost
This consists of the acquisition cost and other costs attributable to the
acquisition including but not limited to the costs of installation and freight charges.

Salvage Value (Scrap Value)

This refers to the amount at which the non-current asset may be sold upon
termination of its life.

Estimated Useful Life

From the name itself, it is the estimate of the non-current asset’s productive
life. It may be expressed in terms of time units, output units and activity units (machine
hours).

*The difference between the cost and the salvage value (scrap value) is called
depreciable cost and the difference between the non-current asset’s cost and
corresponding accumulated depreciation is called book value (carrying value).
 6. Doubtful Accounts Expense (Bad Debts Expense)
This refers to the portion of receivables that is unlikely to be collectible. The
uncollectible portion of the receivable is charged to doubtful accounts
expense (bad debts expense).

Pro-forma Entry:

Doubtful Accounts Expense xxx

Allowance for Doubtful Accounts xxx

Note:
The allowance for doubtful accounts is a contra-asset account. It decreases the
amount of the receivables.

Should the portion of the receivables be proved to be uncollected, the write-off

entry is as follows:

Allowance for doubtful accounts xxx

Receivables xxx

Methods in computing doubtful accounts expense:

Statement of Comprehensive Income Method

Portion of uncollectible is based on the income on credit (SCI account).

Doubtful Accounts Expense = % of uncollectible * Income (on credit)

Statement of Financial Position Method

Portion of uncollectible is based on the receivable (SFP account).

Doubtful Accounts Expense = % of uncollectible * Receivables

*The difference between the receivable and its corresponding allowance for doubtful
accounts is called the net realizable value.