CHAPTER 2) Unearned Income

4 

Liability Method
Income Method
ADJUSTING ENTRIES b) ACCRUALS
1) Accrued Expenses
2) Accrued Income
4.1 Adjusting Entries
Enterprises need to assess their financial position and c) Provision for DEPRECIATION
performance time to time to enable them to check their d) Provision for estimated DOUBTFUL
efficiency and effectiveness against their target goals and ACCOUNTS or BAD DEBTS
competitors. Also, the financial statements may provide them e) Correction of Errors
relevant information to improve their strategies and create
plans for the future. Thus, all accounts must be updated and 4.3 Prepaid Expenses (ASSET METHOD)
should reflect true balances. This account is expenses paid in advance. Thus, it is recorded
as an asset. At the end of the period, this asset may already
However, an enterprise cannot wait for the entity to stop its expire and part of such asset must be presented as an
operation just to compute its real value. This is where the time expense.
period assumption (periodicity concept) becomes of great
importance. Usually at the end of one year, the entity updates Illustration:
or adjusts some of its accounts that do not reflect their true An example for this is the use of prepaid cards for cell phones.
balances. As a result, adjusting entries should be made. When prepaid card is bought for P300, text messages or calls
are paid in advance. Hence, it is not yet expense, but
Another assumption that plays an important role in adjusting considered as an asset. But after a month, the prepaid card
entries is the accrual assumption that states income is to be bought can no longer be valued at P300 unless no text
recognized when earned (earned means when services are messages or calls have been made. Thus to assets are worth
rendered or the goods sold are delivered) regardless of when of the prepaid card at the end of the month, an update must be
received and expense is recognized is incurred (incurred made.
means when an obligation to pay starts to arise) regardless of
when paid. Common Prepaid Expenses are Prepaid Rent and Prepaid
4.2 Summary of Adjusting Entries insurance.
The typical adjusting entries are outlined below. This will be
explained one by one in this chapter. Case 1: Flying Cars, a taxi business owned by Sisa, bought
a 2-year insurance policy from Philamlife dated
a) DEFERRALS January 1, 2008 amounting P20,000.
1) Prepaid Expenses and Unused Supplies
 Asset Method
 Expense Method
 account, asset method is used and _ insurance expense,
Initial Entry: expense method is used.
Jan. 1 Prepaid Insurance 20,000
Cash 20,000 4.4 Supplies (ASSET METHOD)
This asset account is also considered as a prepaid expenses.
Adjusting Entry: Companies may buy papers, ball pens, clips, ink, etc. at their
Dec. 31 Insurance Expense 10,000 office. This supplies will be utilized in the future and must be
Prepaid Insurance 10,000 adjusted at the end of the period.

Key Question: How much should be expensed at the end of Illustration (A):
the period? On May 23, 2008, Junanak’s Finanial Consultancy firm bought
supplies amounting to P15,000.
4.3.1 Prepaid Expenses (EXPENSE METHOD)
Some company may ignore prepaid expenses as an asset and Initial Entry:
record it immediately as an expense. This is an Alternative May 23 Supplies 15,000
method, if the problem is silent use asset method. Cash 15,000

Case 2: Flying Cars, a taxi business owned by Sisa, bought Case 1. Assuming at December 31, 2008, supplies on hand
a 2-year insurance policy from Philamlife dated amount only to P4,000.
January 1, 2008 amounting P20,000.
Adjusting Entry:
Initial Entry: Dec. 31 Supplies Expense 11,000
Jan.1 Insurance Expense 20,000 Supplies 11,000
Cash 20,000

Adjusting Entry: Case 2. Assuming at December 31, 2008, Supplies expense

Dec. 31 Prepaid Insurance 10,000 is P9,500.
Insurance Expense 10,000
Adjusting Entry:
Key Question: How much should be the asset at the end of Dec. 31 Supplies Expense 9,500
the period? Supplies 9,500

Both methods will have the same effect to the financial

Key Question: How much should be expensed at the end of
statements. Be aware that an enterprise may use either asset
the period?
method or expense method but not both.
4.4.1 Supplies (EXPENSE METHOD)
Most problems may not tell you which method__ enterprise. As
Other companies prefer expensing supplies immediately and
a hint, look at the company’s trial____ prepaid expense
at the end of the year adjust it to reflect the remaining asset.
 This is an Alternative method, if the problem is silent use asset 4.5 Unearned Income (LIABILITY METHOD)
method. Some calls this account as “Precollected Income”. This is an
“income” that is already collected but not yet earned. Thus it is
Illustration (B): On May 23,2008, Junanak’s Financial recorded as a liability. At the end of the period, this liability
Consultancy firm bought supplies amounting to may already be earned and part of such liability must be
P15,000. presented as an income.

Initial entry: Illustration: On September 1, 2008, Gorio, a carpenter

May 23 Supplies Expense 15,000 engaged in furniture making, received P50,000 from Mr.
Cash 15,000 Tukmol for 400 chairs.

Case 1. Assuming at December 31, 2008, Supplies on hand Initial entry:

amounts only to P4,000. Sept. 1 Cash 50,000
Unearned Service Revenue 50,000
Adjusting Entry:
Dec. 31 Supplies 4,000 Case 1. Assuming at December 31, 2008, P40,000 worth of
Supplies Expense 4,000 chairs have been delivered to Mr. Tukmol.

Adjusting Entry:
Dec. 31 Unearned Service Revenue 40,000
Service Revenue 40,000

Case 2. Assuming at December 31, 2008, Supplies expense

is P9,500. Case 2. Assuming at December 31, 2008, P20,000 worth of
chairs is not yet finished.
Adjusting Entry:
Dec. 31 Supplies 5,500 Adjusting Entry:
Supplies Expense 5,500 Dec. 31 Unearned Service Revenue 30,000
Service Revenue 30,000

Key Question: How much should be the asset at the end of

the period? Key Question: How much should be the income at the end of the
period?
Most problems may not tell you which method is used by the
enterprise. As a hint, look at th company’s trial balance. If you 4.5.1 Unearned Income (INCOME METHOD)
see a supplies account, asset method is used and if you see a A number of entities prefer to record an income upon collection
supplies expense, expense method is used. or receipt of cash even though services are not yet rendered.
This is an Alternative method, if the problem is silent use
liability method.
 Illustration (B): Interests from Notes Payable. On October 1, 2008, Mr.
Illustration: On September 1, 2008, Gorio, a carpenter engaged in B. Kang borrowed P100,000 by issuing a 1-year note with 5%
furniture making, receiving P50,000 from Mr. Tukmol for 400 annual interest to Metrobank.
chairs.
Interest = Principal x interest Rate x Length of Time
Initial entry: = P100,000 x 0.5 x 3/12
Sept. 1 Cash 50,000 = P1,250
Service Revenue 50,000 The length of the time covers October 1 to December 31,2008.

Case 1. Assuming at December 31, 2008, P40,000 worth of chairs Adjusting Entry:
have been delivered to Mr. Tukmol. Dec. 31: Interest Expense 1,250
Accrued Interest Payable 1,250
Adjusting Entry:
Dec. 31 Service Revenue 10,000
4.7 Accrued Income
Unearned Service Revenue 10,000
Accrued Income is an income already earned by the enterprise
but not yet collected at the end of the period.
Key question: How much should be the liability at the end of the
Caution: The specific account “accrued income” is presented
period?
as an asset.
4.6 Accrued Expense
Common Accrued Income transactions are Interests from
Accrued expense is an expense that is already incurred by an
Notes Receivable and Unrecorded Accounts Receivable.
entity but not yet paid at the end of the period.
Illustration (A): Interests from Notes Receivable. On July 1, 2008, Mr.
Caution: The specific account “accrued expense” is presented
Matambaka, engaged in leasing warehouse spaces,
as a liability.
received a P100,000, 8%, 3-year note from a costumer.
Common Accrued Expense transactions are Salaries and
Interest = Principal x interest Rate x Length of Time
Interests from Notes Payable.
= P100,000 x .08 x 6/12
Illustration (A): Salaries. At December 31,2008, C. Kat enterprise
has two-day salaries unpaid. Salaries are P80,000 for a five- Adjusting Entry:
day work week. Dec. 31: Accrued Interest Income 4,000
Interest Income 4,000
Adjusting Entry:
Dec. 31 Salaries Expense 32,000
Accrued Salaries Payable 32,000
(80,000/5) x 2 = 32,000
Illustration (B): Unrecorded Accounts Receivable. Mrs. Fra Ning, a Adjusting Entry:
CPA engaged in management consultancyservices, received a Dec. 31: Depreciation Expense 7,500*
call from a devoted client to rush a feasibility study regarding Accumulated Depreciation-Machinery 7,500
Duck raising in South Cotabato for a charge of P20,000. At * 7,500 = (40,000 – 2,500)/5
December 31,2008 the study is finished but no payment is
received (unbilled).
The cost of a depreciable asset less accumulated depreciation
Adjusting Entry: is called book value.
Dec. 31: Accounts Receivable 20,000
Service revenue 20,000 4.9 Allowances for Doubtful Accounts
When a company sells on credit, some customers may not pay
their accounts. Thus, the company provides estimates, usually
4.8 Depreciation based on experience, and give an allowance to arrive at the
Asses such as Machinery, Furniture and Fixtures, Equipments, net realizable value of their accounts receivable. Net
Buildings, and Vehicles are susceptible to a decrease in value Realizable Value is the face amount of accounts receivable
in the future. The accounting standard requires the allocation less any allowances. Doubtful Accounts is synonymous with
of the cost of the asset over its estimated useful life. In Bad Debts.
computing for depreciation. three factors are considered.
Case 1A: Artsy Gutsy, a graphic design center, has accounts
a) Cost of the asset which is the amount paid to buy the receivable worth P50,000. At December 31,2008, 5% of
depreciable asset. the accounts receivable are doubtful of collection.
b) Estimated Salvage Value is the amount that can be
recovered when the asset is fully depreciated. Other terms
Adjusting Entry:
for salvage value are scrap value and residual value.
Dec. 31: Doubtful Accounts Expense 2,500
c) Estimated Useful life is the number of periods an entity
Allowance for Doubtful Accounts 2,500
expects the depreciable asset to be used.

There are many ways to depreciate depreciable assets. But for Case 1B: Using the same problem in Case 1A, assume that there is a
basic accounting purposes, straight-lined method ill be credit balance for allowance for doubtful accounts of
discussed. This method and is commonly used by sole P1,500 before adjustments.
proprietors.
Cost – Salvage Value Adjusting Entry:
Annual Depreciation Expense = Life Dec. 31: Doubtful Accounts Expense 1,000
Allowance for Doubtful Accounts 1,000
Illustration: On January 1, 2008, Mrs. Curacha bought Machinery for
Milling mongo seeds into flour amounting P40,000. The
machinery is expected to last for 5 years. At the end of five The required allowance is P2,500 (5% x P50,000), however
years, the fully depreciated machinery can be sold to a junk there is already a credit balance for Allowance for Doubtful
shop for P2,500. Accounts of P1,500. So, the need to adjust P1,500 allowance
to become P2,500 is P1,000 (2,500 – 1,500).
4.10 Correction of Errors Accounts Payable 500,000
There are many ways to commit an error in recording
economic transactions. When noticed, this erroneous entries To correct the error made by the bookkeeper, an adjustment should
must be corrected to give the financial statements reliability. be made. Assume that the books of 2008 are still open.
Some recording errors are presented below.
Adjusting Entry:
Illustration (A). Wrong Use of Account title. Mr. Silva bought Dec. 31: Cash 500,000
machinery worth 50,000. At December 31,2008, it was Transportation Expense 500,000
recognized that the bookkeeper recorded the
transaction as: Delivery Truck 500,000
Accounts Payable 500,000
Office Equipment 50,000
Cash 50,000
Illustration (C): Transportation Error. Mr. Gonzaga paid P345,000 to
The correct entry should be: Agri-tech for its accounts payable due. At December 31, 2008,
it was recognized that the bookkeeper recorded the
Machinery 50,000 transaction as:
Cash 50,000
Accounts Payable 354,000
To correct the error made by the bookkeeper, an adjustment should Cash 354,000
be made.
To correct the error made by the bookkeeper, an adjustment should
Adjusting Entry: be made.
Dec. 31: Machinery 50,000
Office Equipment 50,000 Adjusting Entry:
Dec. 31: Cash 9,000
Accounts Payable 9,000
Illustration (B): Incorrect Entry. Mrs. Alitagtag purchased an
automobile worth P500,000 on account to be used as a
delivery truck. At December 31, 2008, it was Once the adjusting and correcting entries are made, the financial
recognized that the bookkeeper recorded the statements can be prepared.
transaction as:

Transportation Expense 500,000

Cash 500,000

4
The correct entry should be:
Exercises and Problems
Delivery Truck 500,000
4-A The Ansly Company accumulates the following adjustment 5. Insurance expires at the rate of P2,000 per month.
data at December 31.
Instructions:
2. Fees earned but unbilled total P6,000. Prepare the adjusting entries at March 31, assuming that the
3. Store supplies of P3,000 have been used. adjusting entries are made quarterly. Additional
4. Utility expenses of P2,250 are unpaid. accounts are: Depreciation Expense, Insurance
5. Fees of P2,600 collected in advance have been Expense, Interest Payable, Interest Expense and
earned. Supplies Expense.
6. Salaries of P8,000 are unpaid
7. Prepaid insurance totalling P3,500 has expired. 4-C Katrina Guazo, D.D.S., opened a dental practice on January 1,
2008. During the first month operations the following
Instructions: transactions occurred.
(a) Determine the type of adjustment (prepaid expense,
unearned revenue, accrued revenue, or accrued 1. Performed services for patients who had dental plan
expense). insurance companies. At January 31, P7,500 of such
(b) Prepare adjusting entries. services was earned but not yet billed to the insurance
companies.
4-B The ledger of Trouble-free Rental Agency on March 31 of the 2. Utility expenses incurred but not paid prior to January 31
current year includes the following selected accounts before totalled P6,500.
adjusting entries have been prepared. 3. Purchased dental equipment January 1 for P800,000,
paying P200,000 in cash and signing a P600,000, three-
year-note payable. The equipment depreciates P4,000 per
month . Interest is P6,000 per month.
Prepaid Insurance P 36,000 4. Purchased a one-year malpractice insurance policy on
Supplies 28,000 January 1 for P120,000.
Equipment 250,000 5. Purchased P18,000 of dental supplies. On January 31,
Accumulated Depreciation-Equipment P 84,000 determined that P5,000 of supplies were on hand.
Notes Payable 200,000
Unearned Rent Revenue 93,000 Instructions:
Rent Revenue 600,000 Prepare the adjusting entries on January 31. Account titles are:
Wage Expense 140,000 Accumulated Depreciation Dental Equipment; Depreciation Expense;
Fees Earned; Account Receivable; Insurance Expense; Interest
An analysis of the accounts shows the following: Expense; Interest Payable; Prepaid Insurance; Supplies Expense;
Utilities Expense, and Utilities Payable.
1. The equipment depreciates P5,000 per month.
2. One-third of the unearned rent was earned during the 4-D The trial balance before adjustment of Delightful Tours at the
quarter. end of its first month of operations is presented below:
3. Interest of P6,000 is accrued on the notes payable.
4. Supplies on hand total P8,500. DELIGHTFUL TOURS
 Trial Balance
June 30, 2008 4-E The Mooja Co. was organized on July 1, 2008. Quarterly
financial statements are prepared. The trial balance and
Account Titles Debit Credit adjusted trial balance on September 30 are shown below.
Cash P 30,000
Prepaid Insurance 72,000 Cash P 67,000 P 67,000
Office Equipment 18,000 Accounts Receivable 4,000
Buses 1,400,000 Prepaid Rent 15,000 8,000
Supplies 12,000 9,000
Notes Payable P 620,000
Equipment 150,000 10,000
Unearned Fees 150,000 Accumulated 150,000 P 3,500
Tariray, Capital 700,000 Depreciation-Equipment
Fees Earned 159,000 Notes Payable P 50,000 50,000
Salaries Expense 90,000 Accounts Payable 15,100 15,100
Advertising Expense 8,000 Salaries Payable 6,000
Gas and Oil Expenses 11,000 Interest Payable 500
Balance P 1,629,000 P 1,629,000 Unearned Rent 9,000 6,000
Revenue
Mooja, Capital 140,000 140,000
Other data: Mooja, Drawing 6,000 6,000
1. The insurance policy has a one-year beginning June 1, Commission Revenue 140,000 144,000
2008. Rent Revenue 4,000 7,000
2. The monthly depreciation is P500 on office equipment and Salaries Expense 90,000 96,000
P20,000 on buses. Rent Expense 9,000 15,000
3. Interest of P7,000 accrues on the notes payable each Depreciation Expense 3,500
month. Supplies Expense 2,000
4. Deposits of P15,000 each were received for advanced tour Utilities Expense 5,100 5,100
reservations from 10 school groups. At June 30, three of Interest Expense 500
these deposits have been earned. Balance P 358,100 P 358,100 P 372,100 P 372,100
5. Bus drivers are paid a combined total of P4,000 per day. At Instructions:
June 30, 3 days’ salaries are unpaid. (a) Journalize the adjusting entries that were made.
6. A senior citizen’s organization that had not made an (b) Prepare an income statement and owner’s equity
advance deposit took Canyon tour on June 30 for P12,000. statement for the 3 months ending September 30 and a
This group was not billed for the services rendered until balance sheet at September 30.
July 3. (c) If the notes bears interest at 12%, how many months has
its been outstanding?
Instructions: 4-F On November 1, 2008, the account balances of
(a) Journalize the adjusting entries at June 30, 2008 Batumbakal Equipment Repair were as follows:
(b) Post the adjusting entries to their perspective accounts.
(c) Prepare an adjusted trial balance. Debits Credits
Cash P 27,900 Accumulated Depreciation P 5,000 (d) Journalize and post adjusting entries.
Accounts Receivable 25,100 Accounts Payable 21,000 (e) Prepare adjusted trial balance.
Supplies 10,000 Unearned Service Revenue 4,000 (f) Prepare an income statement and owner’s equity statement
Store Equipment 100,000 Salaries Payable 5,000 for November and a balance sheet at November 30.
Batumbakal, Capital 128,000
Total Debits P 163,000 Total Credits P163,000 4-G The Magdalo Security Service began operations on January
1,2008. At the end of the first year operations, the trial balance
before adjustment shows the following:
During November the following summary transactions were
completed.
MAGDALO SECURITY SERVICE
Nov. 8 Paid P11,000 for salaries due employees, of Trial Balance
which P6,000 is for November. December 31,2008
10 Received P12,000 cash from costumers on
account. Account Titles Debit Credit
12 Received P14,000 cash for services performed in Cash P 124,000
November. Accounts Receivable 32,000
15 Purchased store equipment on account P30,000. Prepaid Insurance 36,000
17 Purchased supplies on account P15,000. Automobiles 580,000
20 Paid creditors on account P25,000. Notes Payable P 450,000
22 Paid November rent P3,000. Unearned Fees 25,000
25 Paid salaries P10,000. Trillanes, Capital 180,000
27 Performed services on account and billed Fees Earned 840,000
costumers for P7,000. Salaries Expense 570,000
29 Received P5,500 from costumers for futureservice. Repairs Expense 60,000
Gas and Oil Expense 93,000
Adjustment data consist of: Balance P 1,495,000 P 1,495,000

1. Supplies on hand P16,000

2. Accrued salaries payable P5,000 Other data:
3. Depreciation for the month is P1,200
4. Unearned service revenue of P3,000 is earned. 1. Fees earned but unbilled P15,000 at December 31.
2. Insurance coverage began on January 1 under a 2-
Instructions: year policy.
(a) Journalize the November transactions 3. Automobile depreciation is P150,000 for the year.
(b) Post the journal entries with its beginning balance 4. Interest of P54,000 accrued on notes payable for
using additional accounts: Service Revenue; Depreciation the year.
Expense; Supplies Expense; Salaries Expense; and Rent 5. P10,000 of the unearned fees has been earned.
Expense. 6. Drivers’ salaries total P5,000 per day. At December
(c) Prepare a trial balance at November 30. 31, 4 days’ salaries are unpaid.
 7. Repairs to automobiles of P6,500 have been 2. An Inventory count on August 31 shows P7,000 of supplies on
incurred but bills have not been received prior to hand.
December 31. (Use Accounts Payable) 3. Annual depreciation is P48,000 on cottages and P24,000 on
furniture.
Instructions: 4. Unearned rent of P50,000 was earned prior to August 31.
(a) Journalize the annual adjusting entries at December 5. Salaries of P4,000 were unpaid at August 31.
31, 2008. 6. Rentals of P8,000 were due from tenants at August 31. (Use
(b) Post he adjusting entries and prepare an adjusted trial Accounts Receivable)
balance. 7. The mortgage interest rate is 12% per year. (The mortgage
was taken out on August 1.)
4-H The Rosal White Sand Resort opened for business on June 1
with eight air-conditioned units. Its trial balance before Instructions:
adjustment on August 31 is as follows:
(a) Journalize the adjusting entries on August 31 for the 3-
ROSAL WHITE SAND RESORT month period June 1 to August 31.
Trial Balance (b) Post the adjusting entries and prepare an adjusted trial
August 31, 2008 balance.
Account Titles Debit Credit (c) Prepare an income statement and owner’s equity statement
Cash P 196,000 for the 3 months ending August 31 and a balance sheet as
Prepaid Insurance 54,000 of August 31.
Supplies 33,000
Land 250,000
Cottages 1,250,000
Furniture 260,000
Accounts Payable P 65,000
Unearned Rent Revenue 68,000
Mortgage Payable 800,000
N. Adarna, Capital 1,000,000
N. Adarna, Drawing 50,000
Rent Revenue 800,000
Salaries Expense 510,000
Utilities Expense 94,000
Repair Expense 36,000
Balance P 2,733,000 P 2,733,000

Other data:

1. Insurance expires at the rate of P3,000 per month.