CHAPTER 2

THE ACCOUNTING PROCESS

(Part 2)
Ninia C. Pauig-Lumauan, MBA, CPA
2nd Semester 2021
Lyceum of Aparri

Intermediate Accounting Part 1

 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.
• All adjusting entries involve at least one
statement of financial position account and
one statement of profit or loss and other
comprehensive account income account.
Moreover, all adjusting entries affect the
comprehensive income for the period.

Intermediate Accounting Part 1

PURPOSE OF ADJUSTING ENTRIES
a. To take up unrecorded income and
expense of the period (e.g. Accruals for
income and expenses).
b. To split mixed accounts into their real
and nominal elements (e.g. Adjustments
to prepayments and unearned income.)

Intermediate Accounting Part 1

 METHODS OF INITIAL RECORDING OF INCOME AND
EXPENSES

• INCOME
Advance collections of income may initially be
recorded using either the (1) liability method or (2)
income method.
1. LIABILITY METHOD – under this method,
advanced collections 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.

Intermediate Accounting Part 1

METHODS OF INITIAL RECORDING OF INCOME AND
EXPENSES
2. INCOME METHOD – under this method, advanced
collections 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 an income.
ILLUSTRATIVE EXAMPLE:
A business rents out its building. On April 1, 2019,
the business receives one year rent in advance of P
120,000. The rent per month is P 10,000.

Intermediate Accounting Part 1

 METHODS OF INITIAL RECORDING OF
INCOME AND EXPENSES
• The receipt of the advance rent is recorded as
follows:
LIABILITY METHOD INCOME METHOD
Debit Credit Debit Credit
April 1, 2019 April 1, 2019
Cash 120,000 Cash 120,000
Unearned Rent 120,000 Rent Income 120,000
To record the receipt of 1 year rent To record the receipt of 1 year rent
in advance. in advance.

Intermediate Accounting Part 1

METHODS OF INITIAL RECORDING OF
INCOME AND EXPENSES
• The adjusting entries on December 31, 2019
are as follows:
LIABILITY METHOD INCOME METHOD
Debit Credit Debit Credit
December 31, 2019 December 31, 2019
Unearned Rent 90,000 Rent Income 30,000
Rent Income 90,000 Unearned Rent 30,000
(Note 1)
To recognize the earned portion of To recognize the unearned portion
the 1-year rent paid in advance. of the 1-year rent paid in advance.

Intermediate Accounting Part 1

METHODS OF INITIAL RECORDING OF
INCOME AND EXPENSES
Computational Schedules:
Note 1 - Schedule to Compute Earned Income (INCOME METHOD)
Rental Income Per Month 10,000
Multiply by 9 months (April to December, 2019) or 9
(120,000 x 9/12)
Total Rent Income Earned 90,000

Note 2 - Schedule to Compute Unearned Income (LIABILITY METHOD)

Rental Income Per Month 10,000
Multiply by 3 months (January to March, 2020) or 3
(120,000 x 3/12)
Total Unearned Rent Income 30,000

Intermediate Accounting Part 1

 METHODS OF INITIAL RECORDING OF
INCOME AND EXPENSES
• EXPENSES
Prepayments of expenses may initially re
recorded using either the (1) asset method or
(2) expense method.
1. Asset Method - under this method,
prepayments 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.
Intermediate Accounting Part 1
 METHODS OF INITIAL RECORDING OF
INCOME AND EXPENSES
2. Expense Method - under this method,
prepayments 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.
ILLUSTRATIVE EXAMPLE:
A business pre-pays one year insurance for P
120,000 on October 01, 2019.

Intermediate Accounting Part 1

 METHODS OF INITIAL RECORDING OF INCOME
AND EXPENSES

• The prepayment of insurance is recorded as

follows:
ASSET METHOD EXPENSE METHOD
Debit Credit Debit Credit
October 01, 2019 October 01, 2019
Prepaid 120,00 Insurance 120,000
Insurance 0 Expense
Cash 120,00 Cash 120,00
0 0
To record the prepayment of 1-yr To record the prepayment of 1- yr
insurance insurance

Intermediate Accounting Part 1

METHODS OF INITIAL RECORDING OF
INCOME AND EXPENSES
• The adjusting entries on December 31, 2019
are as follows:
ASSET METHOD EXPENSE METHOD
Debit Credit Debit Credit

December 31, 2019 December 31 2019

Insurance Expense 30,000 Prepaid 90,000
Insurance
Prepaid 30,000 Insurance 90,000
Insurance Expense
To recognize the expired portion of the 1- To recognize the unexpired portion of
yr insurance. the 1-yr insurance.

Intermediate Accounting Part 1

 METHODS OF INITIAL RECORDING OF
INCOME AND EXPENSES
• Computational Schedules:
Note 1 - Schedule to Compute Incurred Portion (ASSET METHOD)
Insurance Payment for 1 Year 120,000
Divided by 12 months 12
Monthly Insurance Premiums 10,000
Multiply by number of months used (October-December) 3
Insurance Expense for 2019 30,000

Note 2 - Schedule to Compute Not Yet Incurred Portion (EXPENSE METHOD)

Insurance Payment for 1 Year 120,000
Divided by 12 months 12
Monthly Insurance Premiums 10,000
Multiply by Number of Months Not Yet Used (January-September, 9
2020)
Prepaid Insurance 90,000
Intermediate Accounting Part 1
 BASIC ADJUSTING ENTRIES
• The following basic adjusting entries are
usually made at the end of the accounting
period:
1. Accruals
2. Prepayments
3. Pre-collections
4. Depreciation and Amortization
5. Estimated Uncollectible Accounts

Intermediate Accounting Part 1

 BASIC ADJUSTING ENTRIES
• In summary, the usual adjustments needed
prior to the preparation of the financial
statements are for the following:
a. Prepayment of expenses
b. Supplies acquired for use
c. Expired or lapsed prepayment of expenses
d. Supplies used
e. Collection of income in advance
f. Earned portion of unearned income
Intermediate Accounting Part 1
 BASIC ADJUSTING ENTRIES
f. Income earned but not collected
g. Expenses due but not paid
h. Understatements
i. Overstatements
j. Omissions
k. Misclassifications
l. Inventories on hand year end
m. Depreciations
n. Bad Debts
Intermediate Accounting Part 1
 ACCRUALS
• The term “accrual” as used in accounting,
means to recognize (to accrue) revenue earned
regardless of when it was collected and to
record expenses incurred whether paid or not.
• ACCRUED REVENUE means recognizing an
income that is already earned but not yet
received. Examples are services performed
but not yet billed or collected, or accumulating
income due to passage of time, as in the case
of rent income and interest income.
Intermediate Accounting Part 1
 ACCRUALS
Date Account Title Debit Credit
12/31/2019 Accrued Interest Receivable 12,000.00
Interest Income 12,000.00
To record interest earned
on bank deposits.

• ACCRUED REVENUE
The above entries recognizes interest income
earned on bank deposits on December 31, 2019
which was only reflected on the passbook on
January 2, 2020.
Intermediate Accounting Part 1
 ACCRUALS
• ACCRUED EXPENSE
Accruing expense means recognizing an incurred
expense for the period that remains unpaid by
debiting accrued expense and crediting accrued
liability.
Date Account Title Debit Credit
12/31/2019 SSS Premiums and 12,000.00
Contributions
Accrued SSS Payable 12,000.00
To record SSS premiums (company share) of
employees for the quarter ending December 31,
2019 and to be remitted on January 15, 2020.

Intermediate Accounting Part 1

 DEPRECIATION
• Depreciation is the allocation of the cost of
tangible assets used in the business over its
estimated useful life in years in accordance with
the systematic and rational allocation expense
principle of accounting.
• The decrease in value of permanent, tangible
assets because of wear, tear and timed is
termed depreciation.
• Wear is caused by use; tear signifies breakage
or damage, and time implies the passage of
time so that the asset may have become old or
obsolete.
Intermediate Accounting Part 1
 DEPRECIATION
• The assets subject to depreciation are
property, plant and equipment or fixed assets
(tangible assets except land) such as building,
furniture and fixtures, and equipment which
are used in business but not recorded as
inventory for sale.
• Depreciation may also be considered as an
asset’s expired cost or the asset cost spread
over its useful life.

Intermediate Accounting Part 1

 DEPRECIATION
• Since they are expected to provide benefit over
several years to the business, they should first be
recorded as assets and their cost is gradually
expensed over its useful life. This used portion is
called “depreciation expense.”
• Some of the methods in computing depreciation
are: (1) straight line, (2) sum of the years digit, (3)
declining, and (4) double-declining methods. For
basic accounting, only straight line method is
discussed and is the only method acceptable to
BIR.
Intermediate Accounting Part 1
 DEPRECIATION
• A building constructed a year ago has a
depreciation expense of Php 12,000.00 per month.
Date Account Title Debit Credit
12/31/2019 Depreciation Expense 12,000.00
Accumulated Depreciation- 12,000.00
Building
To record depreciation expense for building for the month of
December, 2019.
• The formula for computing a straight line method
of depreciation is:
Depreciation = Acquisition Cost – Scrap Value
Expense Useful Life
Intermediate Accounting Part 1
 DEPRECIATION
• Estimated Life refers to the asset’s useful life,
that is, the length of time or number of years
over which the company is expected to
benefit from the use of the asset.
• There are many assets that may still be sold at
the end of their estimated useful life. The
amount that can be realized from such sale is
termed scrap value or salvage value. This
scrap value or the amount realizable at the
end of the asset’s life, is deducted from cost in
the computation for depreciation.

Intermediate Accounting Part 1

 DEPLETION
• There are resources that are reduced as they are used.
These are termed wasting assets, such as Mineral
Deposits and Timber Concessions.
• The decrease in the value of wasting assets is called
depletion, which may also be accumulated over the
years that the asset is expected to last.
• Accumulated Depreciation, Accumulated Amortization
and Accumulated Depletion are considered valuation
accounts because they are shown as deductions from
the corresponding assets for their proper presentation
at book values in the Statement of Financial Position.

Intermediate Accounting Part 1

 AMORTIZATION
• Amortization is the allocation of the
acquisition costs of an intangible asset over its
legal or accounting estimated life.
• An intangible asset is an asset that has no
physical existence but provides the owner
some selling and operational advantages over
competitors. Examples are goodwill,
franchise, copyright, patent and trade names.

Intermediate Accounting Part 1

 AMORTIZATION
• As a rule, goodwill that is internally developed is
expenses immediately but if acquired through
purchase, goodwill is recorded as assets and
amortized according to its usefulness. If the
intangible asset ceases to provide competitive
advantage to the owner, it must immediately be
written off.
• The formula of amortizing intangible assets is:
Annual Amortization = Acquisition Cost
Expense Legal Life or
Useful Life
Intermediate Accounting Part 1
 AMORTIZATION
Date Account Title Debit Credit
01/02/2019 Franchise 15,000,000
Cash 15,000,000
To record purchase of Jollibee
Franchise for a store outlet in
Tuguegarao City.
12/31/2019 Amortization-Franchise 1,500,000
Franchise 1,500,000
To record amortization of
franchise of Jollibee with a useful
life of 10 years.

Intermediate Accounting Part 1

 ESTIMATED UNCOLLECTIBLE ACCOUNTS
• Business entities sell on credit rather than only for
cash to increase total sales and thereby increase
income.
• However, an entity that sells on credit assumes the
risk that some customers will not pay their
accounts.
• When an account becomes uncollectible, the entity
has sustained a bad debts loss. This loss is simply
one of the costs of doing business on credit. It is
prudent practice to provide an allowance, based on
the experience of previous years, for the amount
that the company estimates as uncollectible.
Intermediate Accounting Part 1
 ESTIMATED UNCOLLECTIBLE ACCOUNTS
• There are two methods of accounting for bad
debt loss, namely: (1) Allowance Method; and
(2) Direct Write Off Method.
1. Allowance Method
The allowance method requires recognition
of bad debt loss if the accounts are doubtful
of collection. The “allowance for doubtful
accounts” is a deduction from accounts
receivable.
Intermediate Accounting Part 1
ESTIMATED UNCOLLECTIBLE ACCOUNTS
2. Direct Write Off Method
The direct write off method requires recognition
of a bad debt loss only when the accounts
proved to be worthless or uncollectible.
However, the direct write off method violates
the matching principle because the bad debts
loss is often recognized in later accounting period
than the period in which the sales revenue was
recognized.

Intermediate Accounting Part 1

 ESTIMATED UNCOLLECTIBLE ACCOUNTS
1. Allowance Method
Date Account Title Debit Credit
12/31/2019 Bad Debts 15,000
Allowance for Bad Debts 15,000
To record estimated uncollectible accounts
receivable from customers.
2. Direct Write Off Method

Date Account Title Debit Credit

12/31/2019 Bad Debts 15,000
Accounts Receivable 15,000
To record uncollectible accounts receivable from a customer.

Intermediate Accounting Part 1

 METHODS OF ESTIMATING
DOUBTFUL ACCOUNTS
• There are three methods of estimating
doubtful accounts, namely:
1. Aging the accounts receivable or “statement
of financial position approach”
2. Percent of accounts receivable or also
“statement of financial position approach”
3. Percent of sales or “income statement
approach”

Intermediate Accounting Part 1

 WORKSHEET
• A worksheet is an analytical device used to
facilitate the gathering of data for adjustments and
the preparation of financial statements and closing
entries.
• Although optional and not part of the formal
accounting records, worksheets are usually
prepared because they greatly facilitate the
orderly preparation of the financial statements . In
practice, worksheets are most commonly prepared
using spreadsheet application (e.g. Microsoft
Excel).
Intermediate Accounting Part 1
 WORKSHEET

• The heading of the worksheet shows the

following:
1. Name of the Entity
2. Title of the Report
3. Date covered by the Report
• With the exception of Account Names, each
column of the worksheet is composed of a
debit and a credit, and the total for each
column should always be equal at all times.
Intermediate Accounting Part 1
 WORKSHEET
• Components of the Worksheet
1. Account Names
2. Trial Balance
3. Adjustments
4. Adjusted Trial Balance
5. Income Statement
6. Balance Sheet
7. Closing Entries
8. Post Closing Trial Balance
Intermediate Accounting Part 1
 TRIAL BALANCE in the WORKSHEET
• The Trial Balance ends with the equal totals of
the Debit and Credit balances. Below the
equal totals are written two lines. These
double lines signify the end or completion of
the statement. The double lines also signify
the equality of the debits and the credits.
• The two lines (or double lines) are also used in
the other components of the Worksheet with
the same purpose.

Intermediate Accounting Part 1

 FINANCIAL STATEMENTS

• Financial statements are the means by

which the information accumulated and
processed in financial accounting is
periodically communicated to the users.
Financial statements are the end
products of the accounting process.

Intermediate Accounting Part 1

 FINANCIAL STATEMENTS
• A complete set of financial statements consists
of:
1. Statement of Financial Position
2. Statement of Profit or Loss and Other
Comprehensive Income
3. Statement of Changes in Equity
4. Statement of Cash Flows
5. Notes;
(5.a) Comparative information
6. Additional Statement of Financial Position
(required only when certain instances occur)
Intermediate Accounting Part 1
HEADING OF THE FINANCIAL STATEMENTS
• The heading of the financial statements shows the
following:
a. Name of the reporting entity
b. Title of the financial statements
c. Reporting period
• The statement of financial position is dated as at the
end of the reporting period. The statements of
profit or loss and comprehensive income; changes in
equity, and cash flows are dated covering the
reporting period. In practice, notes to financial
statements are simply dated by the end of the
reporting period.
Intermediate Accounting Part 1
HEADING OF THE FINANCIAL STATEMENTS
TYPE OF FINANCIAL STATEMENT DATE
1. Statement of Financial Position  As of (or As at)
December 31, 20xx
2. Statement of Profit or Loss  For the year ended
and Other Comprehensive December 31, 20xx
Income
3. Statement of Changes In Equity  For the year ended
December 31, 20xx
4. Statement of Cash Flows  For the year ended
December 31, 20xx
5. Notes  December 31, 20xx

Intermediate Accounting Part 1

 CLOSING ENTRIES
• Closing the books is the process of preparing
closing entries for nominal accounts and ruling
and balancing the real accounts.
• Closing entries are entries prepared at the
end of the accounting period to “zero out” all
temporary or nominal accounts in the ledger.
This is done so that the transactions in a
period will not comingle with the next period’s
transactions. Closing the books is an
application of the periodicity concept.
Intermediate Accounting Part 1
 CLOSING ENTRIES
• Only income statement accounts, i.e.
those that enter into the determination
of profit or loss are closed to the
“Income Summary” account.
• Income accounts are closed by debiting
them. Expense accounts are closed by
crediting them.

Intermediate Accounting Part 1

 CLOSING ENTRIES
• The dividend account is directly closed to
retained earnings because dividends
declared do not enter into the
determination of profit or loss. The
dividends account is similar to the
“drawing” account used in sole
proprietorships and partnerships. The
dividends account may be used if dividends
are declared more than once within a year.
Intermediate Accounting Part 1
 POST CLOSING TRIAL BALANCE

• The post closing trial balance is prepared in

order to prove the equality of debits and
credits in the ledger after the closing process.
It contains statement of financial position
accounts only because all the income
statement accounts are already closed. The
post closing trial balance contains the
balances that are extended to the next
accounting period.

Intermediate Accounting Part 1

 REVERSING ENTRIES
• Reversing entries are entries usually made on the
first day of the accounting period to reverse certain
adjusting entries in the immediately preceding
period.
• The following are the purposes of reversing entries:
1. To facilitate recording of cash receipts and
disbursements in the next accounting period.
2. To promote convenience in recording the next
period’s year end adjustments for accruals, and
3. To promote consistency of accounting procedure.

Intermediate Accounting Part 1

 ADJUSTING ENTRIES THAT MAY BE
REVERSED
• Not all adjusting entries may be reversed.
Only the adjusting entries made for the
following 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

Intermediate Accounting Part 1