ACT1101 FAR EASTERN UNIVERSITY PROF.

BERNADETTE RAMOS

The Adjusting Process

Why is there a need for adjusting journal entries

Per PAS 1, the financial statements prepared must be fairly presented. The trial
balance is the source of data needed in the preparation of financial statements.
However, this trial balance does not show all information needed in the preparation of
financial statements. Why? Because some elements of the financial statements are not
completely or fairly stated.

At this point, it is important to make the distinction between the accrual and the
cash basis of accounting.

Accrual accounting records the effect of each transaction as it occurs. .

Income is recognized as earned, meaning, as services or goods are delivered by the
entity regardless of collection. Expenses is recorded as it is incurred, meaning, as
goods and services are consumed regardless of payment or non-payment.

Cash-basis accounting records only cash receipts and cash payments. It

ignores receivables, payables, and depreciation.

GAAP requires that a business use the accrual basis accounting. Presented
below are the basic end of period adjustment of a service business and the objective of
adjustment:

Type of adjustment Reason for adjustment

Deferred Expense/Prepaid Recognize the used/consumed (expense) portion of the
Expense –Asset Method mixed account (the unadjusted balance of Prepaid
Expense.)

Deferred Expense/Prepaid Recognize the remaining (asset) portion of the mixed

Expense –Expense Method account (the unadjusted balance of Prepaid Expense.)

Deferred Income/Unearned Recognize the earned portion of the mixed account (the
Income – Liability Method unadjusted balance of Unearned Income.)

Deferred Expense/Prepaid Recognize the remaining (liability) portion to be earned

Expense –Expense Method of the mixed account (the unadjusted balance of
Unearned Income.).

Accrued Expense/Accrued Recognize the unrecorded and unpaid expense .

Liabilities

Accrued Income/Accrued Recognize the unrecorded and uncollected income .

Assets
ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

Depreciation Recognize the systematically and rationally allocated

expense from the use of Property, Plant & Equipment
(except Land).

Doubtful Accounts/Bad Recognize the possible loss from non-collection of

Debts/Uncollectible Accounts Receivable.
Accounts

The preparation of adjusting entries is perceived to be the most difficult topic in

Basic Accounting Part 1. But it is not. Actually, you just have to do it step by step.

First, you have to know if its adjustment for an income or expense. Income is
recognized under accrual basis as earned, meaning there is delivery of goods and/or
services. Expense is recorded as incurred, meaning upon consumption of goods and
services.

Next is to know whether it’s an accrual or deferral. So how do we differentiate

accrual and deferral?

Accrual
1. Income is earned or expense is
incurred in the current period
2. Collection or payment happens on
the subsequent period.
Deferral
1. An advance collection from customers
or advance payment to suppliers
happens in the current period.
2. Income is earned or expense is
incurred in the future period/s.

Another way of distinguishing a deferral from accrual is that a deferral account as

per unadjusted trial balance is a mixed account. For example supplies per unadjusted
trial balance will be a mixture of asset and expense since the consumed supplies is not
yet recorded/adjusted in the unadjusted trial balance.

To illustrate recording and subsequent adjustments well use the following

comprehensive problem :

In December 2014, John Ramos started his own accounting practice in Macabebe,
Pampanga. The following are his transactions for the first month of operations.

December 2 –John invested cash of P20,000 and land and building worth P2,000,000.
The land has an appraised value of P1,000,000. He invested as well his accounting
and taxation books worth P10,000 and a personal laptop worth P20,000.

2 – Borrowed P400,000 cash from the bank and issued 12% one year promissory note.

3- Spent P15,000 for business permits.

ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

4- Purchased from Office Warehouse – office furniture P10,000 and office supplies
P1,000 in cash.

4- Acquired a computer P15,000 and a printer P5,000 from Octagon Computers,

payable on Dec.15

6- Hired one (1) assistant who will be paid P1,000 per day.

9- Rendered accounting services for cash P20,000.

9- Received P30,000 as payment from one client for accounting services to be rendered
for the months of December, January, and February.

10- Performed accounting services to clients on account, P60,000.

12- Paid salary of the assistant P10,000.

15- Paid Octagon Computer.

16- Paid Meralco P3,000, Maynilad P1,000, and PLDT P1,000

22- Collected partial payment of P40,000 from clients on account

24- Made a personal withdrawal of P20,000.

26- Paid salary of assistant, P10,000.

John Ramos is using the following chart of accounts:

John Ramos, CPA

Chart of Accounts

Asse
ts Income
101 Cash 401 Service Income
102 Accounts Receivable 402 Other income
102-
A Allowance for Doubtful Accounts
103 Office Supplies Expenses
50
104 Research Resources 1 Salaries Expense
50
105 Land 2 Repairs & Maintenance
50
106 Building 3 Utilities Expense
106- 50
A Accumulated Depreciation-Building 4 Communication Expense
ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

50
107 Office Equipment 5 Taxes && Licenses
107- Accumulated Depreciation-Office 50
A Equipment 6 Depreciation Expense - Building
50 Depreciation Expense -Office
108 Furniture & Fixtures 7 Equipment
108- Accumulated Depreciation-Furniture 50 Depreciation Expense -Furniture
A & Fixtures 8 & Fixtures
50
Liabilities 9 Office Supplies Expense
51
201 Accounts Payable 0 Interest Expense
51
202 Notes Payable 1 Doubtful Accounts Expense
203 Unearned Revenues
204 Interest Payable
205 Utilities Payable
206 Salaries Payable

Capit
al
301 John Ramos, Capital
302 John Ramos, Drawing
303 Income Summary

Based on what we have discussed in Chapter 2, we will prepare the necessary

entries in the journal and ledger.

General Journal

Date Account Titles P.R Debit Credit

.
Dec.2 Cash 101
20,000
Land 105
1,000,000
Building 106
1,000,000
Office Equipment 107
20,000
Research Resources 104
10,000
John Ramos, Capital 301
2,050,000
ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

To record original investment.

2 Cash 101
400,000
Notes Payable 202
400,000
To record borrowing and issuance of
promissory note.

3 Taxes && Licenses 505

15,000
Cash 101
15,000
Payment of business permit.

4 Furniture & Fixtures 108

10,000
Office Supplies 103
1,000
Cash 101
11,000
Purchase of furniture and supplies for
cash.

4 Office Equipment 107

20,000
Accounts Payable 201
20,000
Purchase of equipment on account.

9 Cash 101
20,000
Service Income 401
20,000
Rendered services for cash

9 Cash 101
30,000
Unearned Revenues 203
30,000
To record collection for services not yet
delivered

10 Accounts Receivable 102

ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

60,000
Service Income 401
60,000
Performed services on account

12 Salaries Expense 501

10,000
Cash 101
10,000
Payment of Salary

15 Accounts Payable 201

20,000
Cash 101
20,000
Payment of equipment purchased on
account

16 Utilities Expense 503

4,000
Communication Expense 504
1,000
Cash 101
5,000
Payment of bills - Meralco, Maynilad,
PLDT

22 Cash 101
40,000
Accounts Receivable 102
40,000
Collection of partial payment from clients
on account.

24 John Ramos, Drawing 302

20,000
Cash 101
20,000
Withdrawals made by the owner.

26 Salaries Expense 501

10,000
Cash 101
10,000
ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

Payment of Salary

These journal entries will be posted to the ledger as follows:

Cash Furniture & Fixtures Service Income

12/2 20,000 12/3 15,000 12/4 10,000 12/9 20,000

12/3 12/1
12/2 400,000 12/4 11,000 1 10,000 0 60,000
12/1 12/3
12/9 20,000 2 10,000 1 80,000
12/1
12/9 30,000 5 20,000 Accumulated Depreciation-Furniture & Fixtures
12/2 12/1
2 40,000 6 5,000 Other income
12/2
4 20,000
12/2
6 10,000

510,000 91,000 Accounts Payable Salaries Expense

12/3 12/1 12/1
1 419,000 5 20,000 12/4 20,000 2 10,000
12/3 12/2
1 - 6 10,000
12/3
Accounts Receivable 1 20,000
12/1 12/2
0 60,000 2 40,000 Notes Payable
12/3
1 20,000 12/2 400,000 Repairs & Maintenance
12/3
1 400,000

Office Supplies

12/4 1,000 Unearned Revenues Utilities Expense

12/3 12/1
1 1,000 12/9 30,000 6 4,000
12/3 12/3
1 30,000 1 4,000
Research Resources

12/2 10,000 Interest Payable Communication Epense

12/3 12/1
1 10,000 6 1,000
12/3
1 1,000
Land

12/2 1,000,000 Taxes && Licenses

12/3
1 1,000,000 Utilities Payable

Building

12/2 1,000,000 Depreciation Expense - Building

ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

12/3
1 1,000,000 Salaries Payable

Accumulated Depreciation-Building
John Ramos, Capital Depreciation Expense -Office Equipment

12/2 2,050,000
12/3
1 2,050,000
Office Equipment
Depreciation Expense -Furniture &
12/2 20,000 John Ramos, Drawing Fitures
12/2
12/4 20,000 4 20,000
12/3 12/3
1 40,000 1 20,000

Accumulated Depreciation-Office
Equipment Income Summary Office Supplies Expense

Interest Expense

And the ledger will be summarized in a trial balance. The following is the trial balance of John Ramos,
CPA:

John Ramos, CPA

Trial Balance
For the month ended December 31, 2014

Debit Credit
101 Cash 419,000
102 Accounts Receivable 20,000
103 Office Supplies 1,000
104 Research Resources 10,000
105 Land 1,000,000
106 Building 1,000,000
106-
A Accumulated Depreciation-Building
107 Office Equipment 40,000
107-
A Accumulated Depreciation-Office Equipment
108 Furniture & Fixtures 10,000
108-
A Accumulated Depreciation-Furniture & Fixtures
ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

201 Accounts Payable

202 Notes Payable 400,000
203 Unearned Revenues 30,000
204 Interest Payable
205 Utilities Payable
206 Salaries Payable
301 John Ramos, Capital 2,050,000
302 John Ramos, Drawing 20,000
303 Income Summary
401 Service Income 80,000
402 Other income
501 Salaries Expense 20,000
502 Repairs & Maintenance
503 Utilities Expense 4,000
504 Communication Epense 1,000
505 Taxes && Licenses 15,000
506 Depreciation Expense – Building
507 Depreciation Expense -Office Equipment
508 Depreciation Expense -Furniture & Fitures
509 Office Supplies Expense
510 Interest Expense
Totals 2,560,000 2,560,000

At year end the following data are made available prior to the preparation of financial statements:

1 Salary of assistant is P1,000 per day. Last payment of her salary was made December 26. She
went to work Dec. 29 and 30.
2 P15,000 worth of accounting services were rendered but not yet recorded.
3 Unused supplies, P200
4 Out of the P30,000 advance collection from a client, at Dec. 31, P10,000 was earned.
5 The furniture & fixtures , building and office equipment had the following estimated values

Estimated Useful Life Residual Value

Furniture & fixtures 5 0
Office equipment 4 0
Building 10 0

6 Interest on the 12% note payable. The P400,000 note was issued to bank on December 2 and
will be due a year after.
7 5% of Accounts Receivable is deemed uncollectible.
ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

We should take a step by step procedure or a slow but sure analysis of the adjustments to be made.
First we classify the type of adjustment that we need to do:

1. Using the perspective of the entity, salaries is always an expense. It’s an expense because there
is consumption of services. And the incurred expense is not yet paid, therefore, this is classified
as Accrued Expense.
2. An income must be recognized because there is delivery of services and since it is not yet
collected a receivable must be recorded. This is Accrued Income.
3. Supplies is always a deferral because as of the unadjusted trial balance, its balance is a mixture
of asset and expense. This is an example of a prepaid expense.
4. Unearned revenue or deferred revenue is a deferral.
5. The data gave us property, plant & equipment which is subject to depreciation.
6. Interest incurred in the notes payable is another example of accrued expense.

So what will be the adjusting entries of John Ramos, CPA. Let’s do more of our careful analysis. Let
us start with the accruals.

Accrued Expense/Accrued Liability – an accrued expense is an expense already incurred but not yet
paid by the entity. Because it was not yet paid, it was not yet recorded in the books

Omission of this adjustment will misstate Profit or Loss Statement Expense will be understated,
profit will be overstated. The Statement of Financial Position’s Liability will be understated. In the
preceding problem we have classified no 1 & no 6 as accrual of expense, so to correct the
understatement in expense, we’ll debit expense and to correct the understatement in liability, we
increase payables by credit.

Date Account Titles P.R. Debit Credit

Dec.31 Salaries Expense 501 2,000
Salaries Payable 206 2,000
To take up accrued salaries.

31 Interest Expense 104 *4000

Interest Payable 301 4,000
To take up accrued salaries.
*400,000 x .12 x 1/12

Accrued Income/Accrued Asset – an accrued income is an income already earned but not yet
collected by the entity. Because it was not yet collected, it was not yet recorded in the books

Omission of this adjustment will misstate Profit or Loss Statement - Income will be understated,
profit will be understated. The Statement of Financial Position’s Asset will be understated. In the
preceding problem we have classified no 2 as accrual of income, so to correct the understatement in
ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

income, we’ll credit income and to correct the understatement in asset, we increase receivables by
a debit.

31 Accounts Receivable 102 15,000

Service Income 401 15,000
To take up accrued income

Deferred Expense/Prepaid Expense – Prepaid expense or prepayments are expenses not yet
incurred but already paid. (Note that this is the opposite of accrued expense)

The adjustment for deferred expense depends on the initial recognition of the deferral. We have
classified adjustment no 2 as a prepaid expense . In the trial balance what was recorded is Office
Supplies, P2,000 meaning the entity used asset method. In asset method, asset is initially recorded,
so the amount to be adjusted is that of expense,P800.

Supplies per trial balance (mixed) 1000

Supplies unused (asset) 200

Supplies used (expense) 800

31 Office Supplies Expense 509 800

Office Supplies 103 800
To take up the used supplies.

If instead the entity used the expense method, meaning, Supplies Expense is initially recorded
(therefore the P1,000 was shown as Office Supplies Expense in the trial balance) the amount to be
adjusted is that of asset,P200 and the adjustment will be:

31 Office Supplies 103 200

Office Supplies Expense 509 200
To take up the remaining supplies.
Deferred Income/Unearned Income – Unearned revenues are income not yet earned but already
collected. (Note that this is the opposite of accrued income)

The adjustment for deferred income depends on the initial recognition of the deferral. We have
classified adjustment no42 as a unearned revenue . In the trial balance what was recorded is
Unearned Revenue (Liability), P30,000 meaning the entity used Liability method. In Liability
method, liability is initially recorded, so the amount to be adjusted is that of income,P10,000.
ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

Unearned revenue per trial balance (mixed) 30,000

Unearned revenue not yet earned (liability) 20,000

Unearned revenue already earned (income) 10,000

31 Unearned Revenue 203 10,000

Service Income 401 10,000
To take up the earned portion of unearned revenue

If instead the entity used the income method, meaning, Service Income is initially recorded
(therefore the 30,000 was added to the P80,000 balance of Service Income and will be shown as
Service Income P110,000 in the trial balance) the amount to be adjusted is that of liability,P20,000
and the adjustment will be:

31 Service Income 401 20,000

Unearned Revenue 203 20,000
To take up the unearned portion.

Depreciation – The decrease in value of property, plant and equipment (except land) because of
usage and passage of time . Also, it is the systematic and rational allocation of cost less any
estimated residual value over its estimated useful life. From this definition we can come up with
the formula of depreciation:

Cost – Residual Value

Annual Depreciation =
Useful life

Since the entity started only in December, we are to provide for a one month depreciation:

Depreciable cost (cost / Annual Monthly

less residual value) life Depreciation Depreciation

Furniture & fixtures /5 167

10,000 2,000
Office equipment /4 833
40,000 10,000
Building / 10 8333
1,000,000 100,000

The adjusting entry will be

ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

31 Depreciation Expense – Building 506 8,333

Depreciation Expense -Office Equipment 507
833
Depreciation Expense -Furniture & Fixtures 508 167
Accumulated Depreciation-Building 106-A 8,333
Accumulated Depreciation-Office Equipment 107-A
833
Accumulated Depreciation-Furniture & Fixtures 108_A
167
To take up depreciation

Doubtful Accounts Expense – or bad debts are possible losses from non-collection of accounts
receivable. Provision for doubtful accounts can be based on balance sheet approach (aging or doubtful
accounts as a percentage of accounts receivable) or income statement approach (doubtful accounts as a
percentage of income). Why is it balance sheet approach and income statement approach, observe the
following:

Accounts Receivable(BS) x % = Allowance for Doubtful Accounts (BS)

Income x % = Doubtful Accounts Expense (IS)

It is called balance sheet approach because if we use balance sheet account (AR)as a factor in the
formula, the yield is also a balance sheet account (ADA). On the other hand, it is called income
statement approach because if we use income statement account (Income)as a factor in the formula,
the yield is also an income statement account (ADA).

Will the two approaches provide the same amount of adjustment, the answer is no. Let us assume
the following data:

Accounts Receivable P10,000

Allowance for Doubtful Accounts 100
Income 10,000
Probability of non collection 10%

BS Approach
10% x 10,000 = 1,000 ADA

Allowance for Doubtful Accounts

Beg. 100
DAE 900
End 1,000
ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

IS Approach
10% x 10,000 = 1,000 DAE

Allowance for Doubtful Accounts

Beg. 100
DAE 1000
End 1,100

Observe that amounts for Doubtful Accounts Expense and Allowance for Doubtful Accounts are
different in both approaches. Adjusting entries are also not the same.

Balance Sheet Approach Income Statement Approach

Doubtful Accounts Expense 900 Doubtful Accounts Expense 1,000
Allowance for Doubtful Accounts 900 Allowance for Doubtful Accounts 1,000

In the problem, John estimated that 5% of Accounts Receivable will be uncollectible. That will be
P20,000 x .05 = P1,000. There is no beginning balance for Allowance for Doubtful Accounts, so the
adjusting entry will be

Doubtful Accounts Expense 511

31 1,000
Allowance for Doubtful Accounts 102-A
1,000
To take up uncollectible accounts.

Take note that all entries in the journal must be recorded in the ledger. So if the adjusting entries
will be posted, ledger will be

Cash Furnitures & Fixtures Service Income

12/2 20,000 12/3 15,000 12/4 10,000 12/9 20,000

12/3 12/1
12/2 400,000 12/4 11,000 1 10,000 0 60,000
12/3
12/9 20,000 12/12 10,000 1 80,000
12/3
12/9 30,000 12/15 20,000 Accumulated Depreciation-Furnitures & Fixtures 1 15,000
12/2 12/3 12/3
2 40,000 12/16 5,000 1 167 1 10,000
12/3 12/3
12/24 20,000 1 167 1 105,000
12/26 10,000 Other income

510,000 91,000 Accounts Payable

12/3 12/1
1 419,000 5 20,000 12/4 20,000
12/3
1 - Salaries Expense
ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

12/1
Accounts Receivable 2 10,000
12/1 12/2
0 60,000 12/22 40,000 Notes Payable 6 10,000
12/3 12/3
1 20,000 12/2 400,000 1 20,000
12/3 12/3 12/3
1 15,000 1 400,000 1 2,000
12/3 12/3
1 35,000 1 22,000

Allowance for Doubtful Accounts Unearned Revenues Repairs & Maintenance

12/9 30,000
12/3 12/3
12/31 1,000 1 10,000 1 30,000
12/3
12/31 1,000 1 20,000
Interest Payable Utilities Expense
12/3 12/1
Office Supplies 1 4,000 6 4,000
12/3 12/3
12/4 1,000 12/31 800 1 4,000 1 4,000
12/3
1 200
Communication Epense
12/1
Research Resources Utilities Payable 6 1,000
12/3
12/2 10,000 1 1,000
12/3
1 10,000
Taxes && Licenses

Land Salaries Payable 12/3 15,000

12/3 12/3
12/2 1,000,000 1 2,000 1 15,000
12/3 12/3
1 1,000,000 1 2,000
Depreciation Expense - Building
12/3
Building 1 8,333
12/3
12/2 1,000,000 John Ramos, Capital 1 8,333
12/3
1 1,000,000 12/2 2,050,000
12/3
1 2,050,000 Depreciation Expense -Office Equipment
12/3
Accumulated Depreciation-Building 1 833
12/3
12/31 8,333 John Ramos, Drawing 1 833
12/2
12/31 8,333 4 20,000
12/3
1 20,000 Depreciation Expense -Furniture & Fixtures
12/3
Office Equipment 1 167
12/3
12/2 20,000 Income Summary 1 167

12/4 20,000
12/3
1 40,000 Office Supplies Expense
ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

12/3
1 800
12/3
Accumulated Depreciation-Office Equipment 1 800

12/31 833

12/31 833 Interest Expense

12/3
1 4,000
12/3
1 4,000

Doubtful Accounts Expense

12/3
1 1,000
12/3
1 1,000

And the adjusted trial balance will be

John Ramos, CPA

Adjusted Trial Balance
For the month ended December 31, 2014

Accou
nt Trial Balance Adustment Adjusted trial balance
Code Account titles Debit Credit Debit Credit Debit Credit

101 Cash 419,000 419,000

102 Accounts Receivable 20,000 15,000 35,000

102-A Allowance for Doubtful Accounts 1,000 1,000

103 Office Supplies 1,000 800 200

104 Research Resources 10,000 10,000

105 Land 1,000,000 1,000,000

106 Building 1,000,000 1,000,000

106-A Accumulated Depreciation-Building 8,333 8,333

107 Office Equipment 40,000 40,000

Accumulated Depreciation-Office
107-A Equipment 833 833

108 Furnitures & Fixtures 10,000 10,000

Accumulated Depreciation-Furnitures &
108-A Fixtures 167 167
201 Accounts Payable

202 Notes Payable 400,000 400,000

ACT1101 FAR EASTERN UNIVERSITY PROF. BERNADETTE RAMOS

203 Unearned Revenues 30,000 10,000 20,000

204 Interest Payable 4,000 4,000

205 Utilities Payable

206 Salaries Payable 2,000 2,000

301 John Ramos, Capital 2,050,000 2,050,000

302 John Ramos, Drawing 20,000 20,000

303 Income Summary

15,000
401 Service Income
80,000 105,000
10,000
402 Other income

501 Salaries Expense 20,000 2,000 22,000

502 Repairs & Maintenance

503 Utilities Expense 4,000 4,000

504 Communication Epense 1,000 1,000

505 Taxes && Licenses 15,000 15,000

506 Depreciation Expense - Building 8,333 8,333

507 Depreciation Expense -Office Equipment 833 833

Depreciation Expense -Furnitures &
508 Fitures 167 167

509 Office Supplies Expense 800 800

510 Interest Expense 4,000 4,000

511 Doubtful Accounts Expense 1,000 1,000

Totals 2,560,000 2,560,000 42,133 42,133 2,591,333 2,591,333