ELE02-Special Topics in Accounting

CHAPTER 5 ADJUSTING ENTRIES

Learning Objectives
 Enumerate the common end-of-period adjustments.
 Prepare adjusting entries.
 Prepare a worksheet.
 Prepare closing entries.
 Prepare a balance sheet and income statement of a service business.
 Prepare reversing entries.

 Adjusting entries
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.

 Purpose of adjusting entries

a. To take up unrecorded income and expense of the period.
b. To split mixed accounts into their real and nominal elements.

 Real, Nominal and Mixed Accounts

1. Real Accounts (Permanent accounts) – accounts that are not closed at
the end of the accounting period. These accounts include all balance
sheet accounts, except the “Owner’s drawings” account.
2. Nominal Accounts (Temporary accounts) – accounts that are closed at
the end of the accounting period. These accounts include all income
statement accounts, drawings account, clearing accounts and suspense
accounts.
3. Mixed accounts – accounts that have both real and nominal account
components. These accounts are subject to adjustment.
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 Methods of Initial Recording of Income

A. Liability method – under this method, cash receipts from items of income
are initially credited to a liability account. At the end of the period, the
earned portion is recognized as income while the unearned portion remains
as liability.
B. Income method – under this method cash receipts from items of income
are initially credited to an income account. At the end of the period, the
unearned portion is recognized as liability while the earned portion remains
as income.

 Methods of Initial Recording of Expenses

A. Asset method – under this method cash disbursements for items of
expenses are initially debited to an asset account. At the end of the
period, the incurred portion (‘used up’ or ‘expired’) is recognized as
expense while the unused portion remains as asset.
B. Expense method – under this method, cash disbursements for items of
expenses are initially debited to an expense account. At the end of the
period, the unused portion (‘not yet incurred’ or ‘unexpired’) is recognized
as asset while the incurred portion remains as expense.

 Worksheet
A worksheet is an analytical device used to facilitate the gathering of data for
adjustments, the preparation of financial statements, and closing entries.
ELE02-Special Topics in Accounting

 Financial statements
The financial statements are the end product of the accounting process.
Information from the journal and the ledger are meaningless to most users
unless they are summarized and communicated through the financial
statements.

 The major processes in accounting are summarized below:

 Financial Statements
A. Statement of financial position (or Balance sheet) – shows information
on assets, liabilities and equity.
B. Statement of profit or loss (or Income statement) – shows information
on income and expenses, and consequently, the profit or loss for the
period.

 Closing entries
Closing entries are entries prepared at the end of the accounting period to
“zero out” all nominal accounts in the ledger. This is done so that the
ELE02-Special Topics in Accounting

transactions during the period will not commingle with the transactions in the
next period.

Closing entries are prepared as follows:

A. All income accounts are debited and all expense accounts are
credited. The resulting balance is recorded in a clearing account
called the “Income summary.”
B. The balance of “Income summary” is closed to the “Owner’s capital”
account.
C. Any balance in the “Owner’s drawings” account is closed to the
“Owner’s capital” account.

 Reversing Entries
Reversing entries are entries usually made on the first day of the next
accounting period to reverse certain adjusting entries made in the
immediately preceding period.

 Adjusting entries that may be reversed

1. Accruals for income or expense
2. Prepayments initially recorded using the expense method
3. Advanced collections initially recorded using the income method
ELE02-Special Topics in Accounting

Reference

FINANCIAL ACCOUNTING AND REPORTING (Fundamentals)

Zeus Vernon B. Millan, CPA
Lecture Notes of Compilation of Dean Rene Boy R. Bacay, CPA, CrFA, CMC, MBA, FRIAcc

For further discussion please refer to the link provided:

Chapter 5- Adjusting entries- https://youtu.be/pl21YY9DBW8

Chapter 5- Preparing Financial Statement- https://youtu.be/myNAkXT9XgY

Chapter 5- Preparing worksheet-https://youtu.be/Veufu1ORfaE