op Chapter 9 BUSINESS TRANSACTIONS AND THEIR ANALYSIS AS APPLIED TO ACCOUNTING CYCLE OF A SERVICE BUSINESS (PART 2) (Coverage: Adjusting Entries, Adjusted Trial Balance-Worksheet, Financial Statements, Closing Entries, Post-closing Trial Balance and Reversing Entries) Leaming Objectives: [At the end ofthis chapter, we willbe able to: 1. described the nature of transaction n a service business; 12. record the transactions ofa service business inthe general journal 3. post transactions inthe general ledger; 4. prepare o trol balance; s. 6 prepare adjusting journal entry; : complete the accounting cycle. Leen eee ee el [ADJUSTING JOURNAL ENTRIES {a Step of the Accounting Process) NEED FOR ADJUSTING JOURNAL ENTRIES Itis our objectives to present financial statements that are truly reflective of the business’ financial condition as of a given date and results of operation at the tend of the accounting period. There are transactions that will occur mostly at the end of the period that if without adjusting the book of accounts these entries busines Trensetons ad the Anal os Applied to Accounting Cycle of Serie Business 195, pecgacespameane Reactscould not be recorded and therefore, our financial statement will be lacking of financial information ajusting Yournal Entries are journal entries WHIT Coe to be recorded in the Aus orn and are usualy prepared at sheend of "he ‘accounting period of cee yest flowing the preparation of a Til Balance: Generally, adjusting entries are prepared forthe folowing reasons: ) te bring record or bolones of accounts Ueda 2) Te properly match revenues against expenses urn the period “TYPES OF ADJUSTING ENTRIES. ‘he following ar the usual ems which require adlusting entries at the end of ‘an accounting period 2. Accruals a. Aecrued Income _- income tats already eamed Put rot yet collected (Receivable) b. Accrued Expenses - expense that i aleeady incurred but not Yet paid (Payable). Deferrals 2) Precalletion of Income (Unearned Income) 3) Prepayment of Expenses (Prepaid Exnense) provision fr Estimated Uncollectible Accounts (824 Debts) provision for Depreciation of Property and Equipment Fixed Asset Unused Supplies Inventory Adjustment ~° Yo ee a ae‘ACCRUALS OF INCOME AND EXPENSES 1. INCOME THAT IS ALREADY EARNED BUT NOT YET COLLECTED (RECEIVABLE) ACO TENSE INCURRED BUT NOT YET PAID. (PAYABLE). WHEN The FeerenTING PERIOD ENDED. We call this, Accruals of Income ore Expenses. To illustrate ani er Soumed by Metro Davao Hotel was partly rented by Philippine National Park J" 50,000 per month payable every 3” day ofthe following ments ne ‘ental forthe month of December 31, 20A will be pald on lanuary 3 208 Analysis: Maeand 208 are two diferent and separate accounting petiods..On the part of recone Hotel, the revenue.was already eamed in 208 but collection gic dire ncaa, On the part of Philippine National Bank, the ental expenve woe slready incurred in 208 but payment will be made in 208 pes, Dav2o Hotel shouidlrecord thalincome earned although not yet received pr Getting Accrued Rent income’and credting Rental cme, On wre hand, Philppine National Bank should record the expense inewred although not deceaten y titne Rent Expense and crediting Accrued Rent Exper nn December 31, 20A for both serra emt Income has semblance of a receivable account or it can be Suuiuted by Rent Receivable while Accrued Rent Expense has o semblance a ® payable account or can also be substituted by Rent Payable are rua Hotel records Accrued Rent Income which is a Recelvable sccount soem Pine National Bank records Accrued Rent Expense whch is # Parable account. . Fronnneemeanes record income and expenses in 208, both violates the jnetchin principle as this principe calls forthe recognition of come esc s and expense paid in the period of 20A, The following were the respecive adjusting journal entries by both companies ines Transom nd het An osRent Income iacred Rent Expense ‘orecord rent incom that Torecord rent expense that waveaned F se hemadigel imme, Paton | been Petraes fc AGO FINANCIAL STATEMENTS PRESENTATION accrued Rent income or Rent Receivable is {Current Asset account ands 16 re presented in the Statement of Financial Postion while Rent income oe oe er erveount and it i to be presented in the Stafement of Comprehensive Income. _ rent Expense isan Expense account ands to be presented in the Siateriers of “comprehensive income while Accrued Rent Expense or Rent Payable is 2 Carrere Uablity account which fs to be presented in the Statement of Financ DEFERRALS OF INCOME AND EXPENSES 2. INCOME THAT IS ALREADY COLLECTED BUT NOT YET EARNED (Fi COLLECTED INCOME) AND EXPENSE THAT IS ALREADY PAID BUT NOT ver INCURRED (PRE-PAYMENT) WHEN THE ACCOUNTING PERIOD ENDED, Wis ‘allthis, DEFERRALS of Income and Expenses. Pre-collected Income ‘This is an income that Is already collected although not yet earned. ‘unearned Income is a Liability Account. Toillustrate: ‘on October 3, 20A, Ichiro Saberon Realty Co. collected P12,000 from 2 tenant Gre puting towns forthe period of one (2) year from Oct. 4, 20A to Oct. 2+ 208. ‘The accounting period will end on December 31, 208. (Oe i a 198Journal Entry on October 1, 20A (Upon Collection) cash 000 Unearned Rent income P12,000 To record collection of advance rental for perio from Oct. 1, 20, to October 1,208, Analysis: Counting from Oct. 1, 20A to Dec. 31, 20A, the rental income that was already ‘earned was P3,000 computed as follows: 3/2 x P1200 = 3,000 = (Earned) (ct. 1 to Dec. 3, 208) income 9/12 P1200 = 9,000 - (Uneamed) Jan, 1, 208 to Oct. 1,208 Income P2000 ‘Adjusting Journal tryon December 33,208 Unearned Rent Income _P3,000 Rent Income 3,000 To record earned portion of rent ald in advance from Oct. 1, 208 to Dec. 31,204, The general ledger of Unearned Rent Income account showed a balance of 9,000 after the adjustment. Before Adjustment UUneamed Rent Income 12,000 Oci.1, 208 2usnesTensctions andthe Anahi ox Apple to Acounting Cc of Service Businessict hsnoearnestinert i Rent Income ‘Uneamed Rent Income 7 paooo 12/31/A Taya P3,000 | PLA 000. 30/3/ NE AE [29,000 tp your adjusting Journal entry, you are decane ‘the Unearned Rent Income wr nt fom 12,000 to P9,000. Unearned Rent OAT ‘account is 2 lability ate to reduce a Vabllty which has 2 norma alance of 2 credit is BY roe gg the sald account. In other words You 2° 77 removing therefrom the oe Myton ofthe rental paid in advance of 73,000 Financial Statements Presentation Unearned Rent Income wil be presented in the Come Liability section of the Ucar of Financial Postion with a balance of F9.990 while Rent income will sestoented in the income section of the Statement ‘of Comprehensive Income ‘with a balance of P3,000- . ze propiald Expenses smrese are expenses that ae pad in advance fore IN Oe inqurred, Examples Thee aes that usually require an advance PaYT=rN A insurance premium ot eg contract, fase rental ete Prepald EXPSNS is a Current Asset ‘Account. Toillustrate: con september 1,208, uno Commercial pai an eAf=the premium covering the oeod from september 2,204 to September 1-202 ‘the amount of P3,600. ThE rerunting period ends on December 32,208 Journal Enfry on Sept 3.208 (Upon Payment) prepaid Insurance 3,600 Cash 3,600 To record insurance premium paid Bit te igi42 x P3,600 = (Expired) (Sept 1 to Dec. 33, 208) Expense er ec OO = gO. Ural an. 1,208 to Oct. 1, 208 2p a laa —Fas00 ‘Adjusting Journal Entry on December 31, 208 Insurance Expense Prepaid insurance To record the expired portion of Insurance Expense from Sept 1, 208 0 Dee. 31, 208, Total Pre-payment P1,200 1,200 Before Adjustment Se Prepaid insurance Sebt 1,208 p3,600 | Thsatane eee After Adjustmen insurance Expense a.z00 |Financial Statements Presentation Prepald insurance will be presented in Current Asset section of the Statement of Finencial Position with a balance of 2,400 while Insurance Expense will Be presented in the Expense section of the Statement of Comprehensive Income with a balance of P1,200. 13, PROVISION FOR ESTIMATED UNCOLLECTIBLE ACCOUNTS (Bad Debts) When we extend credit to our customers, we don't expect from them to be ‘ble to pay their accounts. Some will transfer residences, abscond, bankrupt or may have died. Because of uncertainty of collection, some of the customers’ accounts are considered doubtful and hopeless for collection. The Sticpated joss thet the business may incur is called “doubtful account expense” of “uncollectible account expense”. To illustrate Let us assume that Gabby Company has an outstanding accounts receivable ‘of P60,000. Based on past experience, itis estimated that 2% is doubtful of Collection atthe end of the accounting period on December 31, 208. Journal Entry: 208 Dec. 31 Uncollectible Account Expense P1,200 ‘Estimated Uncollectible Account P1200 To record provision for uncolectible ‘accounts whichis computed of 2% ‘of P60,000. Financial Statements Presentation Uncollectible Account Expense will be presented In the Expense Section of the ‘Statement of Comprehensive Income while the Estimated Uncollecible Account will be presented in the Statement of Financial Position as reduction from ‘Recounts Receivable to arrive atthe Estimated Realzable Value as at the end of ‘the period as shown on the next page:‘Statement of Financial Position ‘43.031 December 204 Current Asset: Ee ‘Accounts ReceWvable 60,000 Fre: Estimated Uncollectible Accounts ‘be pt the The unt Estimated Uncollectble Account p30 ‘Accounts Receivable 300 To write-off the Accounts ‘ble Receivable, lof wed is depreciation expense. This is ‘There are three (3) factors that are to itline method: aS acquired. It includes the ‘quisition, % Sera Value ~ the estimated value ofthe asset at the end of Its economic or Useful life, This isso salvage or residual vaive. metimes called 2 fatimated Useful or Economic Lethe estimated length of time usually stated in years that the asset is usable. "Tomecion onthe Ana: Np w aconing Go Service Bates 203(WITH SCRAP VALUE ‘The Straight-line method computes depreciation by using this formula: Annwal Depreciation = Cost of the Asset - Scrap Value Expense Estimated life in years To illustrate: ‘On September 1, 20A, Adi Machine Shop acquired a brand new machine at 2 Cost of P100,000. The estimated life of the machine is 5 years and with 2 residual value of P10,000. Solution Costof the Asset - Salvage Value = Estimated life in years 16,000 = Annual Depreciation 24,500 - Monthly Depreciation Journel Entry: 20a Sept. 30 Depreciation Expense 1,500 ‘Accumulated Depreciation 1,500 To record monthly depreciation of the machine Financal Statements Presentation Depreciation Expense will be presented in the Expense section of the Statement of Comprehensive Income while Accumulated Depreciation is an asset-offset account ‘which wil be shown in the Statement of Financial Position as a reduction from the cost ofthe asset asshown below: = ‘Statement of Financial Position ‘As of 30 September 200 Non-current Asset: Property and Equipment Machine Less: Accumulated DepreciationAeeumarence Between the cost of the machine of 100,000 and the related pono. tts DEPtecaton of PA.500 is called Net Book Value or Carving Von 98,500, WITHOUT SCRAP VALUE ‘Using the same illustration, depreciation i computed as follows: Solution f th °: Estimated ite in years Syears ~ 18.000 - Annual Depreciation + 2months * PL.S00_. Monthy Deorecation 5. UNUSED SUPPLIES INVENTORY ADJUSTMENT sence: Poles are purchased, these are debited to an asset account, Supplies Inventory. “At the end of the month, the portion of what ae Sraraly recorded as Asst will tun Into an Expense. Based on physal imet& of supplies on hand, we will determine the actual cost of suppice inventory. For example, if we purchase supplies worth P20,000 and eras Fasoagtne month 8,000 worth of supplies were on hand, meaning the £27000 worth of supplies should have been used. These series of event ne be recorded as follows: Supplies inventory. = 20,000 ‘Cash in Bank 20,000 To record supplies purchased. ‘To.take up the Supplies Used ‘Supplies Expense 12,000 Supplies inventory 12,000 To record cost of supplies thot were used. ‘eines Tetons and he Acie Aphed wo hcg Oe of aS ues OOYou noticed that the Supplies Inventory which is an Asset was credited BY 712,000 in the second entry This mieans that Supplies Inventory has been tiecreased by P12,000 and transferred to Supplies Expense of P12,000. This hes the effect of decreasing Supplies Inventory to have a balance only P8,000 as gleaned from the accounts below: supestpventory Twerease Side (Deb) Decrease Sie (reat) serey 20.0 | p12.000 2 Enty oe ___ supplies xp ees Tnereave Side (Deb) ‘Decrease Side (Great) Peentry a ‘Therefore: 1) Supplies Iventory will be presented as an Asset inthe Statemen of Financial Position showing a balance of 8,000. Supplies Expense will be presented as an Expense in the Starement of comprehensive Income showing 2 balance of 712,000. a Going back to our illustrative problem. Davao Auto Repair Services, the THM tolence that was found on page 185 of Chapter 8 was again presented on = ext page with addtional informative data relative to the adjustments ro Us eae oa thet you can have a clear understanding on how adjusting entries are recorded in the General Journal.Davao Auto Repair Services Trial Balance 31 January 208 | ‘Account Tities (Cash tn Bank Accounts Receivable | Prepaid insurance | Prepaid Rent ‘Shop Supplies Inventory Shop Equipment Accounts Payable Unearned Service income A. Suelan, Capital 2 A. Suelan, rawing 13 10,000 Service Income 15 | Salaries Expense 38 25,000 Taxes & Licenses 20 __5.600 Totml____________—paaa.c09 449,000 | Additional Data for Adjustments: 3. Physical counting of shop supplies inventory revealed that P10,000 remains unused. evouannls S| Ent Jon. 31 204 Shop Supplies Expenses 15,009 ‘Shop Supplies Inventory 15,000 To record the shop supplies Used forthe month of January '. Insurance premium was pald for one (1) year period starting January 1, 20a, Adlusting Ene Jon. 31 204 Insurance Expenses Prepaid Insurance To record the expired portion of prepaid insurance forthe ‘month of lanuary 204 computed os folows: —P13.800_ Tames. ‘SualnesTronsction ond thelr Anas es Applet Accounting Cyl of Service erin P1.150/month‘¢ Rental was paid in advance for one (1) year period starting January 1, 20a. Adjusting Entry: Jon. 34 204 Rent Expenses 1,000 Prepaid Rent 1,000 To record the expired portion of prepaid rent forthe ‘month of Janvory 208 computed as ow Eee nL ents d. Property and Equipment was acquired on January 1, 20A. It has an estimated life of five (5) years without scrap value: Aalusting Entry: Jon. 34 208 Depreciation Expenses +P2,000 | ‘Accumulated Depreciation 2,000 To record depreciation of 2 units Hobart welding machine ‘computed os follows: __cost__- _P120,000 = _ P24,000 Annual Dep Bei Seen ne 2 mos 2.000monthly Dep’ @. tis estimated that 3% of the outstanding Accounts Receivable of P61,000 {is doubtful of collection: Aausting Entry: Jan 31 204 Uncollecible Accounts 1,830 Estimated Uncollectible Accounts 1,830 To record 3% of uncollectible ‘counts. {Unpaid light and water expenses for the month of January 20A: Alusting Entry: Jon. 31 ‘204 UbIties Expense 850.00 Accrued Utilities Expense +P850.00 To record light and water expense ‘incurred in January 204.® January 1, continuation [4on. 134 ‘The foregoing adjusting journal entries | Shop Supplies of previous journal entries, ‘re recorded in the General Journal as a ‘on page 2 that was found on page 158. 2 ae Tea ae Shop Supplies inventory 6 1,000 Torecord the shop supplies wed for ‘hemonth of lan 2h, ‘insurance Fepenie 6 1150 Prepaid insurance La To record the expired parton of ‘repaid insurance forthe month of tt has an Jen. 208 Tent pense 1.000, PrepaisRent us To record the expired portion of prepaid ‘en forthe month ofan. 208. 2.000 Desreciation Expense 2000 Accumulated Depreciation Shop Fauipment 2,000 To record deprecation of units Hobart welding machine for The month of aan 204, ‘eof P61,000 ‘Urcollectbe Aecounts 10 ‘Estimated UncolecibleAeourts To recor 3% of uncolectible rom acsountsRecevabie ilies Expense ‘Accrued Units Expense 130 To record unposd ight and water expensd For the month Jon 204 Spats for ClesingErries