AAO

FRESHMEN
DAY 2
TUTORIALS
 THE
ADJUSTING
PROCESS
Today's 1 Background Concepts

Agenda 2 Nature of Adjusting Entries

3 Examples

4 Adjusted Trial Balance

 Background Concepts

I. Background Concepts
A. Time Period Assumption- States that the economic period of a
business is divided into artificial time periods.

Accounting Periods that companies may adopt:

Annual Periods
• Calendar Year- Period of time equal in length to that of the year in
the calendar conventionally in use.
• Fiscal Year- The accounting time period of one year in length.
 Background Concepts

Accounting Periods that companies may adopt:

Interim Periods
• Monthly time period- Every Month
• Quarterly time period- Every 3 Months
• Semi-annual time period- Every 6 Months
 Background Concepts

B. Accrual and Cash Basis Accounting

1. Accrual Basis Accounting- Recording transactions in the periods in
which the events occur.

• Revenue Recognition Principle- Recognize revenue in the

accounting period in which the performance obligation is satisfied.

• Expense Recognition Principle- Recognize expenses in the

accounting period in which they are incurred.
 Background Concepts

2. Cash Basis Accounting- Revenues are recognized only when cash is

received and Expenses are recognized only when cash is paid.

Note: Cash-basis accounting is not in accordance with generally

accepted accounting principles (GAAP). It tends to produce misleading
financial statements. It fails to record revenue when the services were
already performed but have yet to receive cash for them. As a result,
expenses are not properly matched with revenues.
 Nature

II. Nature
The Adjusting Process- Entries are adjusted prior to the preparation of
financial statements to update certain accounts so that they reflect
correct balances as of the designated time.
Some accounts require updating for the following reasons:
• Some expenses are not recorded daily.
• Some revenues and expenses are incurred as time passes rather
than as separate transactions.
• Some revenues and expenses may be unrecorded.
 Nature

A. Types of Accounts Requiring Adjustment

1. Accruals- In accounting, the term “accrual” means to accrue or
accumulate.

• Accrued Revenues- Revenues already earned but not yet collected.

⚬ Gives rise to both Revenue and Receivable.
⚬ The adjusting entry for Accrued Revenues will result to an
increase in the Asset account (Receivable) and increase in the
Revenue account.
 Nature

Example
Case #1. Accrual of Income- Interest Income
ABC Co. received a 12%, P100,000, one-year, note receivable on
April 1, 20x1. ABC uses a calendar year period. The principal and
interest on the note are due on April 1, 20x2. Prepare the adjusting
journal entry (AJE) for December 31, 20x1.
 Nature

Initial Entries (On April 1, 20x1)

Date Particulars Debit Credit

April 1, 20x1 Notes Receivable P 100,000

Sales P 100,000

To record sales on
account
 Nature

Adjusting Entries (On December 31, 20x1)

Date Particulars Debit Credit

December 31, 20x1 Interest Receivable P 9,000

Interest Income P 9,000

To record Accrued
Interest Income

Solution
Formula: I = P x r x t
= 100,000 x 0.12 x 9/12
= P 9,000
 Nature

In the next Accounting Period (On April 1, 20x2)

Date Particulars Debit Credit

April 1, 20x2 Cash P 12,000

Interest Income P 3,000

Interest Receivable 9,000
To record Collection of
Interest

Solution
Formula: I = P x r x t
= 100,000 x 0.12 x 3/12
= P 3,000
 Nature

In the next Accounting Period (On April 1, 20x2)

Date Particulars Debit Credit

April 1, 20x2 Cash P 100,000

Notes Receivable P 100,000

To record collection of
Principal Amount
 Nature

• Accrued Expenses- Expenses that are already incurred but not yet
paid.
⚬ Gives rise to both Expense and Payable.
⚬ The adjusting entry for Accrued Expenses will result to an
increase in the Expense account and increase in the Liability
account (Payable).
 Nature

Example
Case #2. Accrual of Expense- Interest Expense
ABC Co. issued a 12%, P 100,000, one-year, note payable on
October 1, 20x1. The principal and interest are due on October 1,
20x2. Prepare the adjusting journal entry (AJE) for December 31,
20x1.
 Nature

Initial Entries (On October 1, 20x1)

Date Particulars Debit Credit

October 1, 20x1 Supplies P 100,000

Notes Payable P 100,000

To record purchase of
supplies on account
 Nature

Adjusting Entries (On December 31, 20x1)

Date Particulars Debit Credit

December 31, 20x1 Interest Expense P 3,000

Interest Payable P 3,000

To record Accrued
Interest Expense

Solution
Formula: I = P x r x t
= 100,000 x 0.12 x 3/12
= P 3,000
 Nature

In the next Accounting Period (On October 1, 20x2)

Date Particulars Debit Credit

Interest Payable P 3,000

October 1, 20x2
Interest Expense 9,000

Cash P 12,000

To record Payment of
Interest
Solution
Formula: I = P x r x t
= 100,000 x 0.12 x 9/12
= P 9,000
 Nature

In the next Accounting Period (On October 1, 20x2)

Date Particulars Debit Credit

October 1, 20x2 Notes Payable P 100,000

Cash P 100,000

To record Payment of
Principal Amount
 Nature

• In accruals, all adjusting entries involve at least one balance sheet

account and one income statement account.
• In accruals, all adjusting entries affect the profit or loss for the
period.
 Nature

2. Deferrals
A. Prepayments or Prepaid Expenses- Expenses already paid in cash
but not yet used.

2 methods on how to record Prepayments:

• Asset Method
• Expense Method
 Nature

Asset Method
• Initial Recognition (for cash disbursement of items)
Asset Account is Debited

• Adjustment Analysis
Calculate for the Used up or Expired portion of the payment.

• Adjusting Entry Result

Debit an Expense Account; Credit an Asset Account.
 Nature

Example
Case #3. Deferrals of Expense
A business prepays one-year insurance for P 120,000 on October
1, 20x1.
 Nature

Asset Method
Initial Recognition (On October 1, 20x1)
Date Particulars Debit Credit

October 1, 20x1 Prepaid Insurance P 120,000

Cash P 120,000

To record for
prepaid insurance
Note: On our Initial Recognition, we debited an Asset Account.
 Nature

Asset Method
Adjusting Entry (On December 31, 20x1)
Date Particulars Debit Credit

December 31, 20x1 Insurance Expense P 30,000

Prepaid Insurance P 30,000

To record insurance used

for the year.
Solution
Solve for Insurance/month= 120,000/12
= 10,000
Solve for EXPIRED portion= 10,000 x 3
= P 30,000
 Nature

Expense Method
• Initial Recognition (for cash disbursement of items)
Expense Account is Debited.

• Adjustment Analysis
Calculate for the Unused or Unexpired portion of the payment.

• Adjusting Entry Result

Debit an Asset Account; Credit an Expense Account.
 Nature

Example
Case #3. Deferrals of Expense
A business prepays one-year insurance for P 120,000 on October
1, 20x1.
 Nature

Expense Method
Initial Recognition (On October 1, 20x1)
Date Particulars Debit Credit

October 1, 20x1 Insurance Expense P 120,000

Cash P 120,000

To record for paid

insurance
Note: On our Initial Recognition, we debited an Expense Account.
 Nature

Expense Method
Adjusting Entry (On December 31, 20x1)
Date Particulars Debit Credit

December 31, 20x1 Prepaid Insurance P 90,000

Insurance Expense P 90,000

To record insurance
unexpired for the year.
Solution
Solve for Insurance/month= 120,000/12
= 10,000
Solve for UNEXPIRED portion= 10,000 x 9
= P 90,000
 Nature

B. Unearned Revenue or Deferred Revenue- Cash is already received

from customers but services are not yet performed.

2 methods on how to record Prepayments:

• Liability Method
• Revenue Method
 Nature

Liability Method
• Initial Recognition (cash receipts from items of income)
Liability Account is Credited.

• Adjustment Analysis
Calculate for the Earned portion of the payment.

• Adjusting Entry Result

Debit a Liability Account; Credit a Revenue Account.
 Nature

Example
Case #4. Deferrals of Revenue
A business rents out its building to various tenants. On April 1,
20x1, the business received one-year rent in advance of P
120,000 from one of its tenants. Rent per month is P 10,000.
 Nature

Liability Method
Initial Recognition (On April 1, 20x1)
Date Particulars Debit Credit

April 1, 20x1 Cash P 120,000

Unearned Rent P 120,000

Received cash for

rent to be rendered
Note: On our Initial Recognition, we credited a Liability Account.
 Nature

Liability Method
Adjusting Entry (On December 31, 20x1)
Date Particulars Debit Credit

December 31, 20x1 Unearned Rent P 90,000

Rent Income P 90,000

To record rent fees

earned.
Solution
Solve for Rent/month= 120,000/12
= 10,000
Solve for EARNED portion= 10,000 x 9
= P 90,000
 Nature

Revenue Method
• Initial Recognition (cash receipts from items of income)
Revenue Account is Credited.

• Adjustment Analysis
Calculate for the Unearned portion of the payment.

• Adjusting Entry Result

Debit a Revenue Account; Credit a Liability Account.
 Nature

Example
Case #4. Deferrals of Revenue
A business rents out its building to various tenants. On April 1,
20x1, the business received one-year rent in advance of P
120,000 from one of its tenants. Rent per month is P 10,000.
 Nature

Revenue Method
Initial Recognition (On April 1, 20x1)
Date Particulars Debit Credit

April 1, 20x1 Cash P 120,000

Rent Income P 120,000

Received rent payment

in advance.
Note: On our Initial Recognition, we credited a Revenue Account.
 Nature

Revenue Method
Adjusting Entry (On December 31, 20x1)
Date Particulars Debit Credit

December 31, 20x1 Rent Income P 30,000

Unearned Rent P 30,000

To record rent fees not

yet earned
Solution
Solve for Rent/month= 120,000/12
= 10,000
Solve for UNEARNED portion= 10,000 x 3
= P 30,000
 Nature

3. Depreciation
-Allocating cost of an asset to expense over its estimated useful life.
-Depreciation is an estimate of the cost that has expired.

Adjusting Entry Result

Debit Depreciation Expense;
Credit Accumulated Depreciation- Equipment
 Nature

Example
Case #5. Depreciation
A building with an estimated useful life of 30 years finished
construction on June 1, 20x1. The cost of the building is 4.8
million pesos with an estimated salvage value of P 300,000.
 Nature

Depreciation
Adjusting Entry (On December 31, 20x1)
Date Particulars Debit Credit

December 31, 20x1 Depreciation Expense P 87,500

Accumulated
Depreciation- P 87,500
Building
To depreciation expense
for building
 Nature

Depreciation
Solution
Formula (Using Straight Line Method):
Annual Depreciation = Initial Cost – Salvage Value
Useful Life

= (4,800,000 – 300,000)/30
= 150,000 – Annual Amount

= 150,000 x 7/12
= P 87,500 – Depreciation for the period
 Nature

4. Doubtful Accounts/ Bad Debts/ Uncollectible Accounts

-Loss of Revenue incurred by the company due to uncollectible
accounts.

Adjusting Entry Result

Debit Bad Debts Expense; Credit Allowance for Bad Debts.

Note: Doubtful Accounts Expense or Uncollectible Accounts Expense

can also be used as Account titles in the Debit Column. While,
Allowance for Doubtful Accounts or Allowance for Uncollectible
Accounts can be used for the Credit Column.
 Nature

Example
Case #6. Doubtful Accounts
Accounts Receivable shows a balance of P100,000. It is
estimated that 8% of this is uncollectible. Give the adjusting
journal entry on December 31, 20x1 for the provision of the
estimated uncollectible account.
 Nature

Doubtful Accounts
Adjusting Entry (On December 31, 20x1)
Date Particulars Debit Credit

December 31, 20x1 Bad Debts Expense P 8,000

Allowance for Bad

P 8,000
Debts
To record uncollectible
accounts
Solution
= 100,000 x 0.08
= P 8,000
 Adjusted Trial Balance

III. Adjusted Trial Balance

Adjusted Trial Balance
• It shows the balances of all accounts at the end of the accounting
period and the effects of all financial events that have occurred
during the period.
• Its purpose is to prove the equality of the total debit and credit
. balances in the ledger after all adjustments have been made.
• Serves as the primary basis for the preparation of the Financial
Statements.
 ANY
QUESTION
S
Thank you!

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