Completing the Accounting Cycle

This module covers the following learning objectives:

1. Adjusting the Journal Entries that will update the Matching Process
2. The use of worksheet as a useful device for collecting and
summarizing data
3. Preparation of the adjusting and closing entries from the worksheet
4. The Adjusting and Closing Entries
5. Preparation of Post Closing Trial Balance
6. Finalizing the multi-step and single-step income statement and
statement of owner’s equity
7. Balance sheet for a merchandising and service business
8. Completing the Accounting Cycle

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MATCHING PRINCIPLE

❑ Under this principle, the expenses incurred during the

period whether paid or not are matched against the
revenue earned for the same period whether collected
or not for the correct determination of the net profit.

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ADJUSTING ENTRIES

Adjusting Entries are journal

entries which are to be recorded
in the General Journal and are Purpose of Adjusting Entries

usually prepared at the end of an Generally, adjusting entries are prepared

for the following reasons:
accounting period of one year
a) to bring records or balances of
following the preparation of a
accounts updated
Trial Balance.
b) to properly match revenues against
expenses during the period

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Types of Adjusting Entries
1. Accruals
a) Accrued Income
b) Accrued Expenses
2. Deferrals
a) Pre-collection of Income
b) Prepayment of Expenses
3. Provision for Depreciation of Property and Equipment or Fixed Asset
4. Provision for Estimated Uncollectible Accounts (Bad Debts)
5. Adjustment on Inventories - this is typical in merchandising and manufacturing
concern.

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1. ACCRUALS
ACCRUED INCOME AND ACCRUED
EXPENSE ADJUSTMENTS
 Accruals
❑ In accounting, the term "accrual" means to recognize
revenue or income earned regardless of when it is
collected and to record expense incurred whether paid
or not.
 Accrued Income - it is an income that is already
earned but not yet collected
 Accrued Expense - it is an expense that is already
incurred but not yet paid

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Illustration
A building owned by Metro Davao Hotel was partly rented by Allied
Banking Corporation for P50,000 per month payable every 5th day
of the following month. The rental for the month of December 20A
will be paid on January 5, 20B.
20A Book of Metro Davao Hotel 20A Book of Allied Banking Corp
Dec 31 Accrued Rent Income 50,000 Dec 31 Rent Expense 50,000
Rent Income 50,000 Accrued Rent Expense 50,000

To record rent income that was earned To record rent expense that was incurred

Failure to Record Effect on BS Effect on IS Failure to Record Effect on BS Effect on IS

Accrued Rent Accrued Rent

Understate Assets No effect Understate Liability No effect
income expense

Understate expense
Rent Income Understate Equity Understate income & profit Rent Expense Overstate Equity
Overstate profit
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2. DEFERRALS
PRE-COLLECTED INCOME AND
PREPAID EXPENSE ADJUSTMENTS
 Deferrals
❑ Pre-collected Income is an income that is already collected but
not yet earned.
There are two methods or approaches that can be used in
recording pre-collections, namely:
1. Income Method - an income account is credited upon
collection or receipt of cash. This method is also called "nominal
approach"
2. Liability Method - a liability account is credited upon collection
or receipt of cash. This method is also called "real approach“.

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Illustration
On October 1, 20A, Cordillera Realty Co. collected P12,000 from a tenant representing
an advance collection from building rental for one year. The accounting period ends on
December 31, 20A.
20A Income Method 20A Liability Method
Oct 1 Cash 12,000 Oct 1 Cash 12,000
Rent Income 12,000 Unearned Rent income 12,000
To record collection of advance rental for To record collection of advance rental for
the period from Oct. 1 20A to Oct 1, 20B the period from Oct. 1 20A to Oct 1, 20B

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Illustration
On October 1, 20A, Cordillera Realty Co. collected P12,000 from a tenant representing
an advance collection from building rental for one year. The accounting period ends on
December 31, 20A.

Adjusting Entry
20A Income Method 20A Liability Method
Dec 31 Rent Income 9,000 Dec 31 Unearned Rent income 3,000
Unearned Rent income 9,000 Rent income 3,000
To record unearned portion of rental To record earned portion of rental
collection in advance collection in advance

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Illustration
On October 1, 20A, Cordillera Realty Co. collected P12,000 from a tenant representing
an advance collection from building rental for one year. The accounting period ends on
December 31, 20A.
20A Income Method 20A Liability Method
Oct 1 Cash 12,000 Oct 1 Cash 12,000
Rent Income 12,000 Unearned Rent income 12,000
To record collection of advance rental for To record collection of advance rental for
the period from Oct. 1 20A to Oct 1, 20B the period from Oct. 1 20A to Oct 1, 20B

Adjusting Entry
20A Income Method 20A Liability Method
Dec 31 Rent Income 9,000 Dec 31 Unearned Rent income 3,000
Unearned Rent income 9,000 Rent income 3,000
To record unearned portion of rental To record earned portion of rental
collection in advance collection in advance
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Illustration

Failure to record Adjusting Entry

INCOME APPROACH LIABILITY APPROACH
Account Effect on BS Effect on IS Account Effect on BS Effect on IS

Unearned Rent Unearned Rent

Understate Liability No effect Overstate Liability No effect
income income

Overstate income & Understate income

Rent Income Overstate Equity Rent Income Understate Equity
profit Understate profit
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 Deferrals
❑ Prepaid Expense - this is an expense that is already paid but not
incurred.
There are two methods or approaches that can be used in
recording prepayments, namely:
1. Expense Method - under this method or approach, an expense
account is debited upon payment of the prepaid expense. This
method is also called "nominal approach“.
2. Asset Method - an asset account is debited upon payment of
the prepaid expense This method is also called "real approach“.

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Illustration
On September 1, 20A, Rajah Buayan Commercial paid an insurance premium covering
the period from September 1, 20A to September 1, 20B in the amount of P3,600. The
accounting period ends on December 31, 20A..
20A Expense Method 20A Asset Method
Sept. 1 Insurance Expense 3,600 Sept. 1 Prepaid Insurance 3,600
Cash 3,600 Cash 3,600
To record insurance premium paid. To record insurance premium paid.

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Illustration
On September 1, 20A, Rajah Buayan Commercial paid an insurance premium covering
the period from September 1, 20A to September 1, 20B in the amount of P3,500. The
accounting period ends on December 31, 20A..

Adjusting Entry
20A Expense Method 20A Asset Method
Dec 31 Prepaid Insurance 2,400 Dec 31 Insurance expense 1,200
Insurance Expense 2,400 Prepaid insurance 1,200
To record unexpired portion of the To record expired portion of the
insurance insurance

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Illustration
On September 1, 20A, Rajah Buayan Commercial paid an insurance premium covering
the period from September 1, 20A to September 1, 20B in the amount of P3,500. The
accounting period ends on December 31, 20A..
20A Expense Method 20A Asset Method
Sept. 1 Insurance Expense 3,600 Sept. 1 Prepaid Insurance 3,600
Cash 3,600 Cash 3,600
To record insurance premium paid. To record insurance premium paid.

Adjusting Entry
20A Expense Method 20A Asset Method
Dec 31 Prepaid Insurance 2,400 Dec 31 Insurance expense 1,200
Insurance Expense 2,400 Prepaid insurance 1,200
To record unexpired portion of the To record expired portion of the
insurance insurance
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Illustration

Failure to record Adjusting Entry

EXPENSE APPROACH ASSETS APPROACH
Account Effect on BS Effect on IS Account Effect on BS Effect on IS

Prepaid Insurance Understate Assets No effect Prepaid Insurance Overstate Asset No effect

Overstate expense & Understate expense

Insurance Expense Understate Equity Insurance Expense Overstate Equity
Understate profit Overstate profit 19
3. ACCOUNTS RECEIVABLE
AND ITS RELATED
PROVISION FOR DOUBTFUL
ACCOUNTS
Accounts Receivable
❑ amount collectible arising from rendering of services to
clients or customers and sale of merchandise to
customers on account and other similar transactions
which are referred to as trade receivables.
❑ Accounts Receivable should be valued at estimated
realizable value/ Net Realizable Value which is derived by
deducting the Estimated Uncollectible Accounts from
the Accounts Receivable.

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Accounts Receivable
❑ Extending credit is one way of increasing the sales of a
company but there are times when the customers could
not pay anymore their accounts. When this happens,
the business should anticipate a loss that may be
incurred arising from these doubtful or hopeless
accounts.

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Accounts Receivable
Ways of estimating uncollectible accounts:
1. by setting up a certain percent (%) of uncollectible
account based on the outstanding receivable
2. by aging the accounts receivable
3. by setting up a certain percent (%) of uncollectible
account based on sales

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ILLUSTRATION
Required allowance computed from Aging of Accounts
Receivable is P50,000. If the Allowance for Doubtful accounts has
a credit balance of P10,000 before adjustment, the doubtful
accounts expense is determined as follows:
Required Allowance 50,000

Less: Allowance balance before Adjustment 10,000

Doubtful Accounts expense 40,000

Doubtful Accounts 40,000

Allowance for Doubtful Accounts 40,000

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ILLUSTRATION
The company reported a sale of P3,000,000. If doubtful accounts
are estimated at 1% of sales, the doubtful accounts is P30,000
(300,000x1%)

Doubtful Accounts 30,000

Allowance for Doubtful Accounts 30,000

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4. PROPERTY AND
EQUIPMENT AND ITS
RELATED DEPRECIATION
Depreciation

❑ The portion of the property that should be allocated over

the number of years and chargeable as expense during
the period.
❑ The reason for this is that it helps in generating revenue
and the revenue it generates should be matched
against depreciation expense. (Matching Principle)

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Methods of Computing Depreciation
The most common and simplest method of computing depreciation
is the ‘straight-line method’.
There are three (3) factors that must be considered in determining
depreciation. These are:
1. Acquisition cost – the amount paid, or liability incurred when the
asset is acquired. (Purchase price + incidental cost)
2. Scrap Value – the estimated value of the asset at the end of its
economic or useful life.
3. Estimated Economic or useful life – the estimated length of
time that the assets can be used.

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Computation of Depreciation

Illustration:
On Oct. 1, 20A, Metro Davao Commercial acquired air conditioning unit for office
use costing P80,000. Freight paid was P5,000 and cost of installation was
P15,000. The estimated useful life is 5 years and a residual value of P10,000.

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Illustration:
On Oct. 1, 20A, Metro Davao Commercial acquired air conditioning unit for office
use costing P80,000. Freight paid was P5,000 and cost of installation was
P15,000. The estimated useful life is 5 years and a residual value of P10,000.

20A Adjusting entry

Dec. 31 Depreciation Expense 4,500
Accumulated Depreciation 4,500
To record depreciation expense from the
period Oct. 1 to Dec. 31,20A.

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5. ADJUSTMENT ON
INVENTORY
Merchandise Inventory Adjustment

❑ Adjusting Entry Method

- close the beginning inventory to Income Summary account and
establish the ending inventory.

❑ Closing Entry Method or Direct Extension Method

- beginning inventory is extended to the debit column of income
statement and the ending inventory to the debit column of the
balance sheet and credit column of the income statement without
passing the adjustment section.
WORKSHEET PREPARATION

❑ The preparation of a worksheet is "optional", which means, it may or may

not be prepared at all .Worksheet or working paper is a columnar sheet
used as a tool or bridge connecting the Trial Balance and Financial
Statements.
❑ Its purpose is to determine the performance or results of the operation
and financial condition of the enterprise in a fast manner even before
adjusting and closing entries can be recorded in the General Journal.

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1) A 10-Column worksheet. The columnar sheet provides for the following sections:
a) Trial Balance
b) Adjustments
c) Adjusted Trial Balance
d) Income Statement
e) Balance Sheet
2) An 8-Column worksheet. The columnar sheet provides columns for the following sections:
a) Trial Balance
b) Adjustments
c) Income Statement
d) Balance Sheet
3) A6-Column worksheet. The columnar sheet provides for the following sections:
a) Trial Balance
b) Income Statement
c) Balance Sheet

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ANSWER PROBLEM 1 - 27

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CLOSING , OPENING & REVERSING
ENTRIES

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Financial Statements

after the worksheet has been prepared, the format

financial statements (end-products of accounting) will be
prepared. The financial statements are; Statement of
Comprehensive Income, Statement of Changes in Equity,
Statement of Financial Condition and Statement of Cash
flows.

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❑ Financial Statements - are the accounting reports prepared at the end
of an accounting period.
❑ Statement of Comprehensive income - a statement that shows the
results of operations for a given period of time. This statement will
show whether the business made a profit or incurred a loss.
❑ Statement of Changes in Equity - a statement that shows the ending
capital of the owner as of a given date.
❑ Statement of Financial Condition -a statement that shows the financial
condition of the business as of a given date. It shows the assets,
liabilities and capital of the business.
❑ Statement of Cash Flows - a statement that shows the sources and
uses of cash for a given period of time.

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Statement of Comprehensive Income

❑ Single-step income statement presents the revenue,

expenses and ultimately the profit or loss generated by a
business, but it reports on this information by using just
one equation to calculate profits. The equation used in a
single-step income statement is:
❑ Net Income = (Revenues + Gains) – (Expenses + Losses)

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Statement of Comprehensive Income

❑ A multi-step income statement reports much of the same

general information included in a single-step income
statement, but it uses multiple equations to determine the
net income, or profit, of the company.
❑ GROSS PROFIT = NET SALES – COST OF GOODS SOLD
❑ OPERATING INCOME = GROSS PROFIT – OPERATING EXPENSES
❑ NET INCOME = OPERATING INCOME + NON-OPERATING ITEMS

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Single step Multi Step

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Statement of Financial Condition

❑ Report Form – is presented in a vertical orientation

❑ Account Form – is presented in a horizontal format

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Report Form

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Account Form

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ANSWER PROBLEM 28-50

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