Quarter 2 – Week 5

Topic: LESSON 1 The Adjusting Entries- Prepayments using the Asset

method
Learning 1. Define adjusting entries, and its purpose ; and
2. Make the required adjusting journal entries for prepayments
Targets:
using the asset method.

References: Ballada, W. (2019) Financial Accounting and Reporting​.​ DomDane

Publisher & Made Easy Books
Millan, Z. (2019) Financial Accounting & Reporting. ​Bandolin
Enterprise
Ong, F. (2016) Fundamentals of Accounting, Business and
Management 1. C & E Publishing, Inc.
1. TO ENGAGE

Try to recall your lesson “The trial balance” try to identify a trial balance, and
what is its purpose?

2. TO EXPLORE

Yes, you are correct. A Trial balance is a list of accounts found in the ledger
together with the account’s balance or total. This is a proof that for every debit, there is
a corresponding credit. Hence, it is also a proof that the ledger is in balance
(Ong,2016).

The purpose of a trial balance is it serves as a control device that will help
minimize accounting errors. When the total is equal, the trial balance is in balance
although it does not signify the absence of errors. For example, if there is any failure on
the part of the bookkeeper to record payment of insurance expense, the trial balance
columns are equal but the accounts are incorrect since the insurance expense is not
recorded leading to understatement of the insurance expense account and
overstatement of cash (millan,2019).

In order to make sure that all accounts are updated, do we need to make some
adjustments? What is meaning of adjusting entries and its purpose?

3. TO EXPLAIN
 To verify your answers to the questions above, consider these discussions:

Adjusting entries ​are entries made prior to the preparation of financial

statements to ​update ​certain accounts so that they reflect correct balances as of the
designated time (Millan, 2019).

The Purposes of adjusting entries (Millan,2019)are:

1. To take up unrecorded income and expense of the period.

2. To split mixed accounts into their real and nominal elements.

In this course, however, we will just focus our discussion making the required
adjusting journal entries for prepayments using the asset method.

4​. ​TO ELABORATE (to extend, connect, rationalize, and apply​.

Following are the accounts subjected to adjustments under prepayment.

When a business will make an advance payment of rent for the space they
occupy, the accountant can record it using a) Asset method or b) Expense method.

1. Asset Method
Under this method, the pro forma journal entry is presented below:

Journal Entry upon payment

Prepaid Expense xx

Cash xx

Adjusting Journal Entry at the end of the accounting period

Expense xx
Prepaid Expense xx

Note: The amount on the adjusting journal entry represents the expired or used portion
of the prepayment.

Example 1
 On January 1, 2020, Star Company paid P360, 000 worth of insurance premium
good for three (3) years. The accountant uses the ​asset method​ upon payment on
January 1, 2020.

Prepaid Insurance 360,000

Cash 360,000
Paid three-year insurance

Computation

The P360, 000 amount of insurance premium represents insurance premium for
three years or 36 months. Divide P360, 000 by 36 to get the monthly premium. Then,
multiply it by 12 months representing the premium from January 1, 2020 to December
31, 2020.

P360, 000/36mos.x 12 mos.= P120,000

P120, 000 is therefore the expired insurance from January 1, 2021 to December 31,
2022.

Analysis: ​When you paid P360, 000 for the three-year insurance premium on
January1, 2020, you debited the asset account Prepaid Insurance representing 36
month’s insurance. On December 31, 2020, the P360, 000 Prepaid Insurance is not
totally asset since it includes the 12-month expired or used up portion. Hence, an
adjusting entry is necessary to recognize the insurance expense for 12 months by
debiting it and decreasing the balance of Prepaid Insurance by crediting it.

Example 2

On April 30, 2020, Moonlight Company paid a one-year advance rent for P72,
000 and used the ​Asset method​ when paying it on April 30, 2020.

Required: Prepare the following:

a. Journal entry on April 30, 2020.
b. Adjusting journal entry on December 31, 2020.

A). April 30, 2020

 Prepaid Rent 72,000
Cash 72,000
Paid two-year rent

b). December 31, 2020

Rent Expense 48,000

Prepaid Rent 48,000
To record the expired portion.

Computation:

The P72, 000 amount of rent represents one-year or 12-month rent. Divide P72, 000 by
12 to get the monthly rent. Then, multiply it by 8 months representing the rent from May
1, to December 31, 2020.

P72, 000/12 mos. 8 months = P48, 000

P48, 000 is therefore the expired/used rent from May 1 to December 31, 2020

Analysis​: When you paid P72,000 for one-year rent on April 30,2020, you debited the
asset account Prepaid Insurance representing 12 months’ rent. On December 31,
2020, the P72, 000 Prepaid Rent is not totally asset since it includes the 8-months
expired or used up portion. Hence, an adjusting entry is necessary to recognize the
Rent expense for 8 months by debiting it and decreasing the balance of Prepaid
Insurance by crediting it.

To split mixed accounts into their real and nominal components, we need an adjusting
entry at the end of the year.

The Adjusting Journal Entry on December 31, 2020 is:

Rent Expense 48,000

Prepaid Rent 48,000

Example 3
 Supplies account showed a balance of P10, 000. Supplies used during the year
amounted to P 3,500. Give the Adjusting Journal Entry on December 31, 2020.

Solution​: Adjusting Journal entry on December 31, 2929.

Supplies Expense 3,500

Supplies 3,500

Computation

There is no computation necessary because the P3,500 supplies used during the
year was already given in the problem.

Analysis: ​The asset account Supplies showed a balance of P6, 500 at the beginning of
the year. Supplies used during the year amounted to P3, 500. This should be recorded
as expense by debiting Supplies Expense and crediting the asset account Supplies to
decrease its balance.

Example 4

Supplies account on January 1, 2020, showed a balance of P20, 000. On

December 31, 2020, supplies on hand amounted to P12, 500.

Adjusting Journal Entry on December 31, 2020

Supplies expense 7,500

Supplies 7,500

Computation

The Supplies at the beginning of the year is P20, 000. At the end of the year, the
remaining balance is P 12,500. The difference represents the supplies used during the
year. Deduct P12, 500 from P20, 000 to get the supplies used during the year.

P 20,000- P12, 500= P P7,500.

Analysis: ​On January 1, 2020, the asset account Supplies has a balance of P20, 000.
At the end of the year, the balance of the asset account Supplies decreased to P
12,500. The difference represents the supplies used during the year. You will have to
recognized the used supplies as an expense by debiting Supplies Expense and
decrease the asset account Supplies by crediting it.

5.​ ​TO EVALUATE

Instruction: Answer the questions briefly. Write your answer on the space
provided below.

1. What are prepayments?

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2. Give at least three examples of prepayments using the asset method showing
the a) journal entry upon payment and adjusting journal entry on December 31,
2020.

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