ADJUSTING ENTRIES

Coverage of Discussion:
•Meaning
•Purpose of adjusting entries
•Adjusting entries is subdivided into the ff:
1. Accruals of income and expenses
2. Recognition of depreciation expense and bad debts expense
3. Deferrals of income and expenses
Accounting Cycle:
1. Indentifying and analyzing
2. Journalizing Finished (Chp. 6
and 7)
3. Posting
4. Unadjusted Trial Balance
Now
5. Adjusting Entries
6. Adjusted Trial Balance (Worksheet)
7. Financial Statements
8. Closing Entries
9. Post-Closing Trial Balance
10. Reversing Entries
Adjusting Entries:
• 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:
• To take up unrecorded income and expense of
the period.
• To split mixed accounts into their real and
nominal elements.
 Adjusting entries are subdivided into the
following:
• Accruals of income and expenses
• Recognition of depreciation expense and bad
debts expense
• Deferrals of income and expenses (splitting of
‘mixed accounts’)
Accruals of Income and Expenses:
• In accounting, the term “accrual” (or ‘to accrue’)
means to recognize an:
▫ Income that is already earned but not yet
collected; or
▫ Expense that is already incurred but not yet paid.

Accruals give rise to both income and

receivables (or both expense and payable)
Illustration: Accruals of income and
expense
• Case # 1: Interest Income
▫ Entity A received a 10%, P 180,000, one-year, note receivable from a
customer on October 31, 20x1. Both the principal and interest on the note are
due on November 1, 20x2
• Case # 2: Rent Income
▫ Entity A entered into a 1-year contract for a billboard advertising on August
1, 20x1. The monthly rent for the billboard is P 200,000, payable at the start
of each month. Entity A has paid the rentals for the months of August to
November 20x1.
• Case # 3: Interest Expense
▫ Your business issued a 14%, 300,000, one-year, note payable on April 1,
20x1. Both the principal and interest on the note are due at maturity date.
• Case # 4: Utilities Expense
▫ Your business received its electricity bill for the period amounting to 16,000.
• Case # 5: Salaries Expense
▫ Your employees earned 46,000 compensation during the last week of
December 20x1. The salaries were paid on the first week of January 20x2.
 Recognition of Depreciation Expense
The concept of Systematic and rational
allocations
• Costs that provide economic benefits over
several accounting periods but cannot be
directly associated with the earning of revenues
are recognized as expenses over the periods
where the economic benefits are consumed.
Illustration:
• On January 1, 20x1, a business acquired
equipment for P 50,000. The business expects to
use the equipment over the next 5 years.
• Equipment 50,000
▫ Cash 50,000
▫ Cost-SV/Useful life = 10,000
Depreciation expense 10,000
Accumulated Depreciation 10,000
Recognition of Bad Debts Expense
• Illustration: Bad Debts Expense
• Entity A has total accounts receivable of P
890,000 as of December 31, 20x1. Of that amount,
P 45,000 were estimated to doubtful of collection.
• Bad Debts Expense 45,000
▫ Allowance for bad debts 45,000
▫ Accounts receivable 890,000
▫ Less : ABD (45,000)
▫ CA845,000
The Concept of immediate recognition
• A cost that produces no future economic benefits
or an asset that ceases to provide future
economic benefits is recognized immediately as
an expense.
Summary:
Expense recognition Principles
1. Matching
2. Systematic & rational allocation
3. Immediate recognition
Description
Associated with a earning of revenue
are recognized as expenses in the
same period (e.g., Cost of Goods
Sold)
Associated with the earning of revenue
are recognized as expenses over the
periods the economic benefits are
consumed. (e.g., Depreciation)
Costs that do not provide future
benefits (e.g., Bad debts expense)
Real, Nominal and Mixed Accounts
• Real accounts (Permanent accounts) – are accounts that are not
closed at the end of the accounting period. These are extended to the
next accounting period. Real accounts include all balance sheet
accounts, except the “Owner’s drawings” account.
• Nominal accounts (Temporary accounts) – accounts that are closed
at the end of the accounting period. Nominal accounts include all
income statements accounts, drawing account, clearing
account and suspense accounts
▫ Clearing account – account used temporarily to store amounts
that will eventually be transferred to another account.
 E.g Income Summary – stores amounts of income expenses
during the period.
▫ Suspense account – account used temporarily to store
discrepancies in the accounts pending their analysis and
permanent classification.
 E,g. Cash Shortage or Overage
• Mixed Accounts – accounts that have both real and
nominal account components. These accounts are
subject to adjustment.
▫ Mixed accounts include unadjusted prepayments (‘prepaid
assets’) and deferrals (‘unearned income’) that have both expired
and unexpired components.
 The expired portion is the nominal account component while the
unexpired potion is the real account component.
 At the end of the period, adjusting entries are needed to separate
these components because the nominal account component is
presented in the income statement while the real account component
is presented in the balance sheet.
Real account:
Mixed Account: Adjusting entry: (presented in the
(Real & Nominal (to separate the two balance sheet)
Account Components) components)
Nominal account:
(presented in the
Income Statement)
Methods of Initial Recording of income and
expenses
• Income
▫ Liability Method – under this method, advanced
collections of income are initially credited to a
liability account. As the end of the period, the
earned portion is recognized as income while the
unearned portion remains as liability.
▫ 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 as income.
Illustration:
• Your business is renting out properties. On June
1, 20x1, your business receives one-year
advanced rent of 360,000 from one of your
tenants. The advanced rent covers the months of
June 1, 20x1 to May 31, 20x2.
• Requirements:
▫ Provide the journal entry to record the collection
on June 1, 20x1 under each of the following
methods:
 Liability method
 Income method
• Expenses
• 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.
• 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.
Illustration:
• On August 1, 20x1, Entity C paid one-year
insurance of 360,000.
• Requirements:
▫ Provide the journal entry to record the
prepayments on August 1, 20x1 under each of the
following methods:
 Asset Method
 Expense Method