ADJUSTING ENTRIES Financial transactions affect the revenues and expenses of more than one accounting period ADJUSTING

JOURNAL ENTRIES entries required at the end of the period to update the accounts before financial statements are prepared Purposes To record any revenue earned or expense incurred that have not been recorded prior to the end of the period To apportion revenues and expenses properly between accounting periods affected Characteristics Adjusting entries are based on the concepts of accrual accounting - states that revenue should be recognized when earned, regardless when cash is received and expenses be recognized when incurred, regardless when cash is paid Every adjusting entry involves the recognition of either revenues or expenses and a corresponding change in either assets or liabilities

Adjusting Entries and Generally Accepted Accounting Principles Revenue Realization principle states that revenue should be recognized at the time goods are sold or services are rendered Matching Principle states that revenue earned during an accounting period is matched with the expenses incurred in generating this revenue Year-End Adjustments 1. Accrued Expense 2. Accrued Income 3. Prepaid Expense 4. Unearned Income 5. Depreciation 6. Doubtful Accounts

ADJUSTING ENTRIES 1. Accrued expense expenses incurred but not yet paid. Purpose To record unrecognized expense Adjustment required Recognizes expense incurred but not yet paid Records liability account AJE: Expense Liability to record accrued expense xxx xxx

TYPE OF REASON FOR ACCOUNTS ADJUSTING ADJUSTME ADJUSTMEN BEFORE ENTRY NT T ADJUSTME NT Accrued Expenses have Expenses Dr. Expense Expense been incurred Understated Cr. Liability but not yet Liabilities paid in cash or Understated not yet recorded

Ex. The company failed to pay October-December rent, P12,000. Adjusting Entry Rent expense Rent Payable To record accrued rent expense 12,000 12,000

2. Accrued income income already earned but not yet collected. Purpose To record unrecognized revenue Adjustment required Recognizes revenue earned but not yet recorded Records asset account AJE: Asset (Receivable) Revenue to record accrued income xxx xxx

TYPE OF REASON FOR ACCOUNTS ADJUSTING ADJUSTME ADJUSTMENT BEFORE ENTRY NT ADJUSTME NT Accrued revenue already Asset Dr. Asset Income earned but not Understated Cr. REvenue yet collected or Revenue not yet recorded Understated

Ex. Services rendered was not yet recorded and paid amount to P20,000. Adjusting Entry Accounts receivable Service income To record accrued income 20,000 20,000

3. PREPAID EXPENSES expenses already paid but not yet incurred or expenses paid in advance. Ex. Paid rent for 1 year, P60,000. The place was occupied on August 1, 2011. Prepare adjustment as of December 31, 2011. Asset Method Adjusting Entry Rent expense 25,00 0 Prepaid Rent 25,000 To record rent expense Expense Method Adjusting Entry Prepaid Rent Rent expense To record rent expense 35,00 0 35,000

4. UNEARNED REVENUE cash already received (collected) but services are not yet rendered. Ex. Collected rent for 1 year, P60,000. The place was occupied on October 1, 2011. Prepare adjustment as of December 31, 2011. Revenue Method Adjusting Entry Rent revenue Unearned Rent revenue To record unearned rent. Liability Method Adjusting Entry Unearned Rent 45,00 revenue 0 Rent revenue To record rent income

15,000 15,000

45,000

5. DEPRECIATION gradual decrease in value of fixed assets due to use, inadequacy (decrease in value caused by a business expansion such that the asset although in good condition can no longer fulfill the needs of the business) and

obsolescence (decrease in value caused by introduction of new models or inventions) Depreciation Expense assigned portion of the cost of fixed asset to the period during which it is used. Accumulated Depreciation total accumulated amount of depreciation that has been recorded for the fixed asset Straight-Line Method depreciation method wherein an equal portion of the assets cost is allocated to depreciation expense in every period of the assets estimated useful life Scrap Value / Salvage Value / Residual Value estimated amount at which the asset can be sold or exchanged at the end of its serviceable life; an estimate of the assets value at the end of its benefit period Depreciable Cost difference between the cost of the fixed asset and the scrap value; amount subject to depreciation Estimated Useful Life estimated serviceable life of a fixed asset Carrying Value difference between the cost of the fixed asset and the accumulated depreciation

Computation of Depreciation Cost Less: Scrap Value Depreciable Cost Divided by Useful Life Annual depreciation Adjusting Entry Depreciation expense Accumulated depreciation To record depreciation. P 100,000 5,000 P 95,000 10 years P 9,500 9,50 0 9,500

Note : if the equipment was purchased on September 1, 2011. The adjusting entry would have been: Adjusting Entry Depreciation expense Accumulated depreciation To record depreciation. Annual depreciation 3,16 7 3,167

P9,500

If acquired 9/12 Depreciation

x 4/12 P3,167 =====

Notes to Financial Statement Presentation Asset Less: Accumulated Depreciation Carrying value P xxx xxx P xxx =======

6. BAD DEBTS/DOUBTFUL ACCOUNTS/ UNCOLLECTIBE ACCOUNTS loss due to worthless or bad accounts caused by unforeseen events or errors in granting credit Methods of Accounting for Doubtful Accounts 1. Allowance method recognizes estimated losses in the period in which the credit sales are made regardless of when the specific accounts are determined to be uncollectible 2. Direct write-off method recognizes a loss only when specific accounts are determined to be uncollectible

Adjustment required AJE: Bad Debts Expense xxx Allowance for Bad Debts to record bad debts xxx

Doubtful Accounts Expense amount of receivables estimated to be doubtful of collection Allowance for Doubtful Accounts a valuation account which is deducted from the Accounts Receivable Net Realizable Value difference between the Accounts Receivable and the Allowance for Doubtful Accounts Method of estimating probable loss from Doubtful Accounts a. Balance Sheet Approach 1. Allowance for Bad Debts is based on percentage of Accounts Receivable
Bad debts estimate: Accounts Receivable x percent doubtful less: Allowance for Doubtful Accounts, beginning Adjustment xxx xx xx

2. Aging of Accounts Receivable thorough analysis of every Accounts Receivable account to determine past due accounts and establish estimates for uncollectible accounts Bad debts estimate
Amount based on Aging Analysis less: Allowance for Doubtful Accounts, beginning Adjustment xxx xx xx

Notes to Financial Statement Presentation Accounts P Xxx Receivable Less: Allowance Xxx for Bad Debts Net realizable value P Xxx Writing-Off Worthless Accounts occurs when an account is definitely known to be uncollectible JE: Allowance for Bad Debts Accounts Receivable write-off xxx xxx

Recovery of Worthless Accounts occurs when an account previously written-off as uncollectible is later paid by the customer JE: Accounts Receivable Allowance for Bad Debts Recovery Ca sh Accounts Receivable Collection xxx xxx

xxx xxx

Examples: 1. The allowance for doubtful accounts before adjustment on December 31, 2011, had a debit balance of P4,026. It is estimated that 3% of the accounts receivable of P245,300 was doubtful of collection. Required allowance ( P245,300 x 3%) 7,359 Add: Debit balance in 4,026 Adjustment P11,385 = Adjusting Entry Doubtful Account 11,38 expense 5 Allowance for Doubtful Account To record doubtful account. P allowance

=====

11,385

2. Uncollectible account is estimated 2.5% of the accounts receivable balance. Before adjustment, the accounts receivable had a balance of P230,000 and P1,500 for allowance for uncollectible accounts.

Required allowance ( P230,000 x 2.5%) 5,750 Less: Credit balance in 1,500 P4,250

P allowance Adjustment ===

== Adjusting Entry Doubtful Account 4,25 expense 0 Allowance for Doubtful Account To record doubtful account.

4,250