ADJUSTING ENTRIES

FIFTH STEP OF THE ACCOUNTING CYCLE

ADJUSTING ENTRIES

- These are necessary at the end of the accounting period to update the balances of the
accounts.
- Non-cash assets and liability accounts need to be analyzed and adjusted at year-end to
measure income properly, correct errors, and provide adequate valuation of assets,
liabilities and owner’s equity on the balance sheet.
TRANSACTIONS REQUIRING ADJUSTMENTS

1. DEFFERAL. The postponement of the recognition of an expense not yet incurred but
already paid or the postponement of the recognition of an income not yet earned but
already collected.
a. Deferred Expense (Prepaid Expense). The postponement of the recognition of an expense
not yet incurred but already paid.
Example: Insurance Premium for 1 year, paid in advance.
Originally recorded as asset

Original entry made: Prepaid Insurance (asset account) xxx

Cash/ Accounts payable xxx
Adjusting entry made: Insurance Expense xxx
Prepaid Insurance xxx
Originally recorded as expense

Original entry made: Insurance expense xxx

Cash/Accounts payable xxx
Adjusting entry made: Prepaid Insurance xxx
Insurance expense xxx

Illustration: On March 1, 2020, Boracay Ocean Park Hotel paid 1 year insurance premium, P84,000.00.

Originally recorded as Asset Originally recorded as Asset

Original entry (March 1, 2020): Original entry (March 1, 2020):
Prepaid Insurance 84,000 Insurance Expense 84,000
Cash 84,000 Cash 84,000

Adjusting entry (March 31, 2020): Adjusting entry (March 31, 2020):
Insurance Expense 7,000 Prepaid insurance 77,000
Prepaid Insurance 7,000 Insurance expense 77,000
b. Deferred income. The postponement if recognition of income not yet earned but already
collected.
Originally recorded as liability

Original entry made: Cash xxx

Unearned Service Income xxx
Adjusting entry: Unearned Service Income xxx
Service Income xxx
Originally recorded as income

Original entry made: Cash xxx

Service Income xxx

Adjusting entry: Service Income (Unearned portion) xxx

Unearned Service Income xxx
Illustration: On March 27, 2020, Boracay Ocean Park Hotel received Cash from VIP client, Miguel
Pangilinan, as advance payment / reservation for 3 rooms, 7 days accommodation, beginning March 28 to
April 3 , 2020, P117,600.00.

Originally recorded as Liability Originally recorded as Income

Original entry (March 27, 2020): Original entry (March 27, 2020):
Cash 117,600 Cash 117,600
Unearned Hospitality Revenue 117,600 Hospitality Revenue 117,600

Adjusting entry (March 31, 2020): Adjusting entry (March 31, 2020):
Unearned Hospitality Revenue 67,200 Hospital Revenue 67,200
Hospitality Revenue 67,200 Unearned Hospitality Revenue 67,200
II. ACCRUAL. The recognition of an expense already incurred but not yet paid or the recognition
of an income already earned but not yet collected.
a. Accrued Expense. It is an expense already incurred but not yet paid. Expense that has been
incurred by the end of the current accounting period but will be paid in the future accounting
period.
Example 1. Interest expense incurred but not yet paid; to be paid in the future accounting
period.
Adjusting Entry: Interest expense xxx
Interest payable xxx

Example II. Unpaid internet billing/charges for the month.

Adjusting Entry: Communication expense xxx

Accrued expense xxx
Illustration: On April 10, 2020, Boracay Ocean Park Hotel received proceeds of loan from Filipinas Bank
in the amount of P1,000,000 with interest of 8% per annum. Interest is payable every 10 th day of the
month beginning May 10, 2020. Principal repayment of P1,000,00 shall be April 10, 2021.

On the date of receipt of loan:

April 10, 2020 Cash 1,000,000
Loan payable 1,000,000

Adjusting entry:
April 30, 2020 Interest expense 4,383.56
Interest payable 4,383.56
(1,000,000 x 8% x 20/365)

On the date of payment of interest:

May 10, 2020 Interest expense 2,191.78

Interest payable 4,383.56
Cash (1,000,000 x 8% x 30/365 days)
II. ACCRUAL. The recognition of an expense already incurred but not yet paid or the recognition
of an income already earned but not yet collected.
a. Accrued Income. It is an income already earned but not yet collected. Income that has been
earned by the end of the current accounting period but will collected in the future accounting
period.
Example. Interest already earned during the current accounting period but collection will be
in the future accounting period.
Illustration: In the books of Filipinas Bank who extended a loan to Boracay Ocean Park Hotel,
the entries are the following:
On the date if release if loan:
April 10, 2020 Loans receivable 1,000,000
Cash 1,000,000
Adjusting entry:
April 30, 2020 Interest receivable 4,383.56
Interest income 4,383.56
On the date of collection of interest:
May 10, 2020 Cash 6,575.34
Interest income 2,191.78
Interest receivable 4,383.56
III. DEPRECIATION

Noncurrent (long-lived assets except land and precious stones) assets are depreciated over
its useful life. When noncurrent (long-lived) assets are used over time, we say they are
depreciated (for tangible assets such as plant and equipment or amortized (for intangible
assets such as patents on inventions; copyrights on literature, music and films) or depleted
(for wasting assets and natural resources.
Depreciation is the systematic and rational allocation of depreciable amount of an asset
over its useful life.
Depreciation is computed under the following straight-line method using the formula:
Depreciation (1 year) = (Cost of Asset – Residual Value)/ Estimated Useful Life (EUL)
Depreciation ( 1 month) = [(Cost of Asset – Residual Value) / EUL]12 mos.
RESIDUAL VALUE (SCRAP VALUE or SALVAGE VALUE) is the estimated sales price of the asset at the
end of its useful life to the company. Intangible assets do not have a residual value at the end of their
useful lives.

ADJUSTING ENTRY: Depreciation Expense xxx

Accumulated Depreciation xxx

ILLUSTRATION: On March 1, 2020, Boracay Ocean Park Hotel purchased in cash a company car
worth P1,000,000.00. The estimated useful life of the car is 10 years with residual value of P160,000.

Original Entry: March 1, 2020 Vehicle 1,000,000

Cash 1,000,000

Adjusting Entry: March 31, 2020 Depreciation expense-Vehicle 7,000

Accumulated depreciation 7,000

[{(1,000,000-160,000) / 10 years } / 12 mos]

IV. BAD DEBTS

BAD DEBTS EXPENSE. Bad debts expense (provision for doubtful accounts or provision for
uncollectible accounts) is the expense associated with estimated uncollectible accounts receivable.
a. Allowance Method
Adjusting Entry: Bad debts expense xxx
Allowance for bad debts xxx

b. Direct write-off Method

Adjusting Entry: Bad debts expense xxx
Accounts receivable xxx