OBJECTIVES

K. Identify and define adjusting entries and its types

S. Journalizing, posting adjusting entries and preparing
adjusted trial balance; and
A. Reflect on the importance of the rules in journalizing and
posting adjusting entries.

I. WHAT HAPPENED

PRE-TEST
Create the Unadjusted Trial Balance of ABC Computer Repair Shop
for December 2020 using the following balances for each
account. Write your answers on your activity sheets/notebook.

Accounts Receivable P 10,000.00

Computer Equipment 250,000.00
Rent Expense 500.00
Prepaid Rent 3,000.00
Cash 101,150.00
Accounts Payable 2,800.00
Service Income 35,850.00
ABC, Capital 350,000.00
ABC, Drawing 15,000.00
Utilities Expense 5,500.00
Prepaid Insurance 4,000.00

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II. WHAT I NEED TO KNOW
DISCUSSION
This time, let us talk about number 6 of the accounting cycle which is Adjusting
Journal Entries.

What are adjusting/adjusting journal entries?

Adjusting entries, or adjusting journal entries (AJE), are made to update
the accounts and bring them to their correct balances.
The preparation of adjusting entries is an application of the accrual
concept of accounting and the matching principle.
The accrual concept states that income is recognized when
earned regardless of when collected and expense is recognized when
incurred regardless of when paid.
The matching principle aims to align expenses with revenues. Expenses
should be recognized in the period when the revenues generated by
such expenses are recognized.
When to prepare the adjusting entries? In what step of the
Accounting cycle you can see these adjusting entries?

Why is there a need for Adjusting Entries?

The main purpose of adjusting entries is to update the accounts to

conform to the accrual concept. At the end of the accounting period,

some income and expenses may have not been recorded, taken up or
updated; hence, there is a need to update the accounts.

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 If adjusting entries are not prepared, some income, expense, asset,
and liability accounts may not reflect their true values when reported in the
financial statements. For this reason, adjusting entries are necessary.

Types of Adjusting Entries

Generally, there are 4 types of adjusting entries. Adjusting entries are

prepared for the following:

1. Accrued Income
Accrued income (or accrued revenue) refers to income already earned
but has not yet been collected.

When a company has performed services or sold goods to a customer, it

should be recognized as income even if the amount is still to be collected at
a future date.

If no journal entry was ever made for the above, then an adjusting entry
is necessary.

The adjusting entry to record accrued revenue is:

*Appropriate receivable account such as Accounts Receivable, Rent

Receivable, Interest Receivable, etc.
**Income account such as Service Revenue, Rent Income, Interest Income, etc.

2. Accrued Expense

Accrued expenses refer to expenses that are already incurred but have
not yet been paid.

If a company incurred, used, or consumed all or part of an expense,

that expense or part of it should be properly recognized even if it has not yet
been paid.

If such has not been recognized, then an adjusting entry is necessary.

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 The pro-forma adjusting entry to record an accrued expense is:

*Appropriate expense account (such as Utilities Expense, Rent Expense, Interest

Expense, etc.)
**Appropriate liability account (Utilities Payable, Rent Payable, Interest Payable,
Accounts Payable, etc.)

3. Deferred Income

Unearned revenue, also known as unearned income, deferred revenue,

or deferred income, represents revenue already collected but not yet
earned.

Unearned revenues are considered liabilities since these are advance

payments from your customers wherein services are not yet rendered.

At the end of the period, unearned revenues must be checked and

adjusted if necessary. The adjusting entry for unearned revenue depends
upon the journal entry made when it was initially recorded.

There are two ways of recording unearned revenue: (1) the liability method,
and (2) the income method.
Under the liability method, a liability account is recorded when the amount
is collected. The common accounts used are: Unearned Revenue,
Deferred Income, Advances from Customers, etc.

4. Prepaid Expense

Prepaid expenses or prepayments represent payments made for

expenses which have not yet been incurred.

In other words, these are "advanced payments" by a company for

supplies, rent, utilities and others that are still to be consumed.

Since these are prepayments they are not recorded as expenses.

Rather, they are classified as current assets since they are readily available for
use.

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 5. Depreciation
When a fixed asset is acquired by a company, it is recorded
at cost (generally, cost is equal to the purchase price of the asset). This cost is
recognized as an asset and not expense.

The cost is to be allocated as expense to the periods in which the asset

is used. This is done by recording depreciation expense.

There are two types of depreciation - physical and functional

depreciation.

Physical depreciation results from wear and tear due to frequent use

and/or exposure to elements like rain, sun and wind.

Functional or economic depreciation happens when an asset
becomes inadequate for its purpose or becomes obsolete. In this
case, the asset decreases in value even without any physical deterioration.
There are several methods in depreciating fixed assets. The most common
and simplest is the straight-line depreciation method.
Under the straight line method, the cost of the fixed asset is
distributed evenly over the life of the asset.

How to Record Depreciation Expense

Depreciation is recorded by debiting Depreciation Expense and

crediting Accumulated Depreciation. This is recorded at the end of the
period (usually, at the end of every month, quarter, or year).

6. Doubtful Accounts or Bad Debts, and other allowances

Companies provide services or sell goods for cash or on credit.

Allowing credit tends to encourage more sales.

However, businesses that allow credit are faced with the risk that their
receivables may not be collected.

Accounts receivable should be presented in the balance sheet at

net realizable value, i.e. the most probable amount that the company will be
able to collect.

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 Net realizable value for accounts receivable is computed like this:

Accounts Receivable (Gross Amount) P100,000

Less: Allowance for Bad Debts 3,000
Accounts Receivable (Net Realizable Value) P 97,000

Allowance for Bad Debts (also often called Allowance for Doubtful Accounts)
represents the estimated portion of the Accounts Receivable that the
company will not be able to collect.
Take note that this amount is an estimate. There are several methods in
estimating doubtful accounts. The estimates are often based on the
company's past experiences.

To recognize doubtful accounts or bad debts, an adjusting entry must

be
made at the end of the period. The adjusting entry for bad debts looks like this:

Bad Debts Expense or Doubtful Accounts Expense: An expense account; hence,

it is presented in the income statement. It represents the estimated uncollectible
amount for credit sales/revenues made during the period.

Allowance for Bad Debts or Allowance for Doubtful Accounts: A balance sheet
account that represents the total estimated amount that the company will
not be able to collect from its total Accounts Receivable.
What is the difference between Bad Debts Expense and Allowance
for Bad Debts?
Bad Debts Expense is an income statement account while the latter is a
balance sheet account. Bad Debts Expense represents the
uncollectible amount for credit sales made during the period. Allowance for
Bad Debts, on the other hand, is the uncollectible portion of the entire
Accounts Receivable.
You can also use Doubtful Accounts Expense and Allowance for

Doubtful Accounts in lieu of Bad Debts Expense and Allowance for Bad Debts.

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However, it is a good practice to use a uniform pair. Some say that Bad Debts
have a higher degree of uncollectibility than Doubtful Accounts. In
actual practice, however, the distinction is not really significant.

Composition of an Adjusting Entry

Adjusting entries affect at least one nominal account and one real account.

A nominal account is an account whose balance is measured from period

to period. Nominal accounts include all accounts in the Income Statement,
plus owner's withdrawal. They are also called temporary accounts or
income statement accounts.

Examples of nominal accounts are: Service Revenue, Salaries Expense, Rent

Expense, Utilities Expense, Mr. Gray Drawing, etc.

A real account has a balance that is measured cumulatively, rather than from
period to period. Real accounts include all accounts in the balance sheet.
They are also called permanent accounts or balance sheet accounts.

Real accounts include: Cash, Accounts Receivable, Rent Receivable,

Accounts Payable, Mr. Gray Capital, and others.

All adjusting entries include at least a nominal account and a real account.

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 LET’S DO THIS!

Going back to the previous topic on posting and preparation of

the Unadjusted Trial Balance, we have this:

Gray Electronic Repair Services

Unadjusted Trial Balance
December 31, 2020

Account title Debit Credit

Cash 7,480.00
Accounts Receivable 3,400.00
Service Supplies 1,500.00
Furniture and Fixtures 3,000.00
Service Equipment 16,000.00
Accounts Payable 9,000.00
Loans Payable 12,000.00
Mr. Gray, Capital 13,200.00
Mr. Gray, Drawing 7,000.00
Service Revenue 9,550.00
Rent Expense 1,500.00
Sslaries Expense 3,500.00
Taxes and Licenses 370.00
Totals 43,750.00 43,750.00

As you can see, Gray Electronic Repair Services has a total balance of P43,750
for debit and credit columns. This is not yet the final source of our financial
statements since there are still possible adjustments to some of the accounts.

Let us use the same example while we discuss the 5 types of adjusting entries.

In our previous set of transactions, assume this additional information :

1. Accrued Income

On December 31, 2020, Gray Electronic Repair Services rendered P300 worth
of services to a client. However, the amount has not yet been collected.
It
was agreed that the customer will pay the amount on January 15, 2021. The
transaction was not recorded in the books of the company as of 2020.

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 In this case, we should make an adjusting entry in 2020 to recognize the
income since it has already been earned. The adjusting entry would be:

Accounts Receivable Service Revenue

3,400.00 9,550.00
Adj 300.00 adj
300.00
3,700.00 9,850.00

2. Accrued Expense
For the month of December 2020, Gray Electronic Repair Services used a
total of P1,800 worth of electricity and water. The company received the bills
on January 10, 2021. When should the expense be recorded, December
2020
or January 2021?
Answer - in December 2020. According to the accrual concept of
accounting, expenses are recognized when incurred regardless of when
paid. The amount above pertains to utilities used in December. Therefore, if
no entry was made for it in December then an adjusting entry is necessary.

Utilities Payable Utilities Expense

Debit Credit Debit Credit
1,800.00 adj adj 1,800.00

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In the adjusting entry above, Utilities Expense is debited to recognize the
expense and Utilities Payable to record a liability since the amount is yet to be
paid.

3. Deferred Income

Suppose on January 10, 2021, ABC Company made P30,000 advanced

collections from its customers. If the liability method is used, the entry would be:
(not related with Gray electronics)

Cash Unearned Revenue (liability)

Debit Credit Debit Credit
30,0000.00 30,000.00

Take note that the amount has not yet been earned, thus it is proper to record
it as a liability. Now, what if at the end of the month, 20% of the unearned
revenue has been rendered? This will require an adjusting entry.

The adjusting entry will include: (1) recognition of P6,000 income, i.e. 20% of
P30,000, and (2) decrease in liability (unearned revenue) since some of it
has already been rendered. The adjusting entry would be:

Unearned Revenue (liability) Service Income

Debit Credit Debit Credit
30,000.00 6,000.00 adj
Adj 6,000.00

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4. Prepaid Expenses
Recalling the example that we had with Gray Electronic Repair Services, we
had the journal entry below recording the purchase of Service Supplies in
the amount of P1,500.00.

Take note that the amount has not yet been incurred or used, thus it is proper
to record it as an asset not as an expense.

Suppose at the end of the month, 60% of the supplies have been used. Thus,
out of the P1,500, P900 worth of supplies have been used and P600 remain
unused. The P900 must then be recognized as expense since it has already
been used.

In preparing the adjusting entry, our goal is to transfer the used part from the
asset initially recorded into expense - for us to arrive at the proper balances
shown in the illustration above.

The adjusting entry will include: (1) recognition of expense and (2) decrease in
the asset initially recorded (since some of it has already been used). The
adjusting entry would be:

Service Supplies Service Supplies Expense

Debit Credit Debit Credit
1,500.00 Adj 900.00
900.00 adj
Bal 600.00

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The "Service Supplies Expense" is an expense account while "Service Supplies" is
an asset. After making the entry, the balance of the unused Service Supplies is
now at P600 (P1,500 debit and P900 credit). Service Supplies Expense now has
a balance of P900. Now, we've achieved our goal.

1. Depreciation
Gray electronic Repair Services acquired their service equipment for P16,000
at the beginning of 2020. Assume that the equipment can be used for 4 years.
The entire amount of P16,000 shall be distributed over four years, hence
a depreciation expense of P4,000 each year.
Straight-line depreciation expense is computed using this formula:

Depreciable Cost - Residual Value

Estimated Useful Life

Depreciable Cost: Historical or un-depreciated cost of the fixed asset

Residual Value or Scrap Value: Estimated value of the fixed asset at the end of
its useful life
Useful Life: Amount of time the fixed asset can be used (in months or years)

In the above example, there is no residual value. Depreciation expense

is computed as:

= P16,000 - P0
4 years
= P4,000 / year

What if the equipment has an estimated residual value of P4,000 after 4 years?
The depreciation expense then would be computed as:

= P16,000 - P4,000
4 years
= P12,000
4 years
= P3,000 / year

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The entry to record the P4,000 depreciation every year would be:

4,000.00
4,000.00
0
Accumulated Depreciation -
Service Equipment
Depreciation Expense
Debit Credit Debit Credit
4,000.00 adj
adj 4,000.00

Depreciation Expense: An expense account; hence, it is presented in the

income statement. It is measured from period to period. In the illustration
above, the depreciation expense is P4,000 for 2020, P4,000 for 2021, P4,000 for
2022, etc.
Accumulated Depreciation: A balance sheet account that represents the
accumulated balance of depreciation. It is continually measured; hence
the accumulated depreciation balance is P4,000 at the end of 2020, P8,000 in
2021, P12,000 in 2022, and P16,000 in 2023.

Accumulated depreciation is a contra-asset account. It is presented in

the balance sheet as a deduction to the related fixed asset. Here's a
table illustrating the computation of the carrying value of the equipment.

2020 2021 2022 2023

Equipment - Historical Cost P16,000 P16,000 P16,000 P16,000
Less: Accumulated Depreciation 4,000 8,000 12,000 16,000
Equipment - Carrying Value P12,000 P 8,000 P 4,000 P 0

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Notice that at the end of the useful life of the asset, the carrying value is equal
to the residual value.

If equipment is acquired within the period, then, divide the annual

depreciation by 12 months and multiply the product to the number of months
the equipment was used within that year.

Annual Depreciation cost ÷ 12 months = monthly depreciation cost

P4,000 ÷ 12 months = P333.33

So, if the equipment was acquired November of 2019 then its depreciation for
the year 2019 is equal to P666.67 (P333.33 x 2 months) only and shall have a life
value until October 2023 only.

2. Doubtful Accounts or Bad Debts

Gray Electronic Repair Services estimates that P100.00 of its credit revenue
for the period will not be collected. The entry at the end of the period
would be:

Bad Debts Expense Allowance for Bad Debts

Debit Credit Debit Credit
Adj 100.00 100.00 adj

Accounts Receivable (Gross Amount) P 3,400

Less: Allowance for Bad Debts 100

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If the Accounts Receivable - Net Realizable Value P 3,300
company's Accounts Receivable amounts to P3,400 and its Allowance for
Bad Debts is P100, then the Accounts Receivable shall be presented in the
balance sheet at P3,300 - the net realizable value.

What’s next
After posting the adjusting entries, next will be posting it to the worksheet and
create the Adjusted Trial Balance.

Here is the worksheet for Gray Electronic Repair Services.

GRAY ELECTRONICS REPAIR SERVICES
WORKSHEET
DECEMBER 31, 2019

ADJUSTED TRIAL
ACCOUNT TITLES TRIAL BALANCE ADJUSTMENTS BALANCE
Debit Credit Debit Credit Debit Credit

Cash 7,480.00 7,480.00

Accounts Receivable 3,400.00 300.00 3,700.00

Allowance for Bad 100.00 100.00
Debts

Service Supplies 1,500.00 900.00 600.00

Furniture and Fixture 3,000.00 3,000.00

Service Equipment 16,000.00 16,000.00

Accumulated
Depreciation – Service
Equipment 4,000.00 4,000.00

Accounts Payable 9,000.00 9,000.00

Utilities Payable 1,800.00 1,800.00

Loans Payable 12,000.00 12,000.00

Mr. Gray, Capital 13,200.00 13,200.00

Mr. Gray, Drawing 7,000.00 7,000.00

Service Revenue 9,550.00 300.00 9,850.00

Rent Expense 1,500.00 1,500.00

Salaries Expense 3,500.00 3,500.00

Taxes and Licenses 370.00 370.00

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Utilities Expense 1,800.00 1,800.00

Service Supplies Expense 900.00 900.00

Depreciation Expense 4,000.00 4,000.00

Bad Debts Expense 100.00 100.00

TOTALS 43,750.00 43,750.00 7,100.00 7,100.00 49,950.00 49,950.00

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III. WHAT HAVE I LEARNED

POST TEST:
Prepare the journal entries to record the following adjustment information
of September 30, 2019 and at the same time the Adjusted Trial Balance. Write
your answer in a two-column journal and in an 8-column worksheet.
Speedy Ironing Services
Unadjusted Trial Balance
September 30, 2020
Debit Credit
Cash 23,450.00
Accounts Receivable 2,000.00
Prepaid Advertising 600.00
Ironing Supplies 100.00
Ironing Equipment 600.00
Accounts Payable 150.00
Unearned Ironing Revenue 100.00
Capital, Linda Santos 15,000.00
Withdrawals, Linda Santos 300.00
Ironing Revenue 17,000.00
Rent Expense 5,000.00
Telephone Expense 200.00
32,250.00 32,250.00

a. One month of scheduled advertising appeared in the school newspaper

in the amount of P150.
b. An inventory of Ironing supplies revealed approximately P50 onhand.
c. Depreciation was taken on equipment with a useful life of 5 years. Ironing
equipment costs P600.
d. On Thursday, October 1, Linda would pay her first employee, who worked
Tuesday and Thursdays, P120 for the week.
e. Ironing services for one of the two students who had paid in advance had
been performed as of 9/30/2019.
f. On Tuesday, September 29, services had been finished for 2 students who
promised to pay P50 each on 10/5/2019

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