ACTG101 Adjusting Entries

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ADJUSTING JOURNALENTRIES



LESSON OBJECTIVES

After studying the remaining steps of theAccounting Cycle, you should be able to:

Differentiate Cash Basis from Accrual Basis of Accounting

Apply the principle of proper matching of costand expenses against revenue and the differentadjusting entries

Prepare worksheet and financial statements of a

Merchandising Business Perform, at the end of the accounting period, the

last six steps to complete the accounting cycle.



Accounting Cycle

1. Gather Documents

2. Analyze and Record

3. Post to the Ledger

4. Prepare the Trial Balance

5. Prepare Adjusting Entries and

Worksheet

6. Prepare the Financial Statements

7. Prepare Closing Entries

8. Prepare Post-closing TB

9. Prepare Reversing Entries

(optional)



ACCOUNTING PERIOD

Time Period Principle (12-month period)

Calendar vs Fiscal Accounting Period



INACCURATE GENERAL LEDGERBALANCES

At the end of an accounting period, ledgerbalances may not reflect accurateamounts because:

Income earned and Expenses Incurredare not yet recorded

Recorded in the books are Income notyet earned or Expenses not yet expired

Some assets should be expired or used upor should be revalued to its net realizableamount.



ADJUSTING ENTRIES

Needed to reflect the proper amounts of revenues realized and expenses incurredduring a period.

Usually, the following items are adjusted: Accruals (Income and Expense)

Deferrals (Prepayments and UnearnedIncome)

Depreciation Bad Debts or Doubtful Accounts

Merchandise Inventory Ending



REMEMBER

An adjusting entry will NEVER involve a

debit or credit to Cash; and

Each adjusting entry will affect at least

one balance sheet account and oneincome statement account



TWO QUESTIONS

1.What is the TYPE of

Adjustment?2.What is the PERIOD of

Adjustment?



ACCRUED REVENUES (INCOME)and EXPENSES

Accrual vs. Cash Basis of Accounting

Revenue Recognition Principle - Accrual

of Income – arises when services have

been rendered but no amount of payment

have been collected.

Matching Principle (Expense Recognition

Principle) - Accrual of Expense – ariseswhen expenses are already incurred

during the period but are not yet paid.



ACCRUED REVENUES (INCOME)

Example:Your lawn maintenance company agrees to

provide 30 hours of work at $60 per hour for

Company A. As of Dec 31, you have worked 20hours on this contract. The 20 hours’ worth of

revenues earned in December, must be recorded

in December, even though you haven’t billed

your customer yet.



ACCRUED REVENUES (INCOME)GENERAL JOURNAL

DATE DESCRIPTION REF DEBIT CREDIT

Dec 31 Accounts Receivable 1,200

Service Revenue 1,200

To record accrued revenues

12/31 1,200

Accounts Receivable

1,200 12/31

Service Revenue



ACCRUED EXPENSES

Example:Office employees are paid every two weeks. On

December 31, five day’s salaries of an office

employee for PhP300 per day have accrued. The five day’s salaries amounting to PhP1,500

(300 * 5) has to be accrued at December 31.



ACCRUED EXPENSESGENERAL JOURNAL


Dec 31 Salaries Expense 1,500

Accrued Salaries Expense 1,500

To record accrued salaries.

12/31 1,500

Salaries Expense

1,500 12/31

Accrued Sal. Payable



DEFERRALS:PREPAYMENTS

Represents advance payment for service or expense

still to be incurred or used up in the future.

Recorded as ASSET – PREPAID EXPENSES.

Represents a right to receive service for cashalready paid.

Two methods of Recording:

Asset Method – Asset – Initial Recognition – Day 1

Expense Method – Expense – Initial Recognition – Day 1



PREPAID EXPENSES (cont.)

Example: Jervin Drugstore issued a check on Nov. 1,2008 for PhP9,000 as payment of store rent for

six (6) months. Adjusting Entries as of December 31, 2008 using

both methods.



PREPAID EXPENSES (cont.)

To illustrate:

2008 2009

NOV DEC JAN FEB MAR APR TOTAL

1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 1,500.00 9,000.00

EXPIRED UNEXPIRED





ASSET METHOD (AJE)GENERAL JOURNAL


Dec 31 Rent Expense 3,000

Prepaid Rent 3,000To adjust for two months expired rent.

11/1 9,000

Prepaid Rent

3,000 12/31

6,000

Rent Expense

12/31 3,000



EXPENSE METHOD (Day 1)GENERAL JOURNAL


Nov 1 Rent Expense 9,000

Cash 9,000To record advance payment of rent.

11/1 9,000

Rent Expense



EXPENSE METHOD (AJE)GENERAL JOURNAL


Dec 31 Prepaid Rent 6,000

Rent Expense 6,000To adjust for 4 months unexpired rent.

11/1 9,000

Rent Expense

6,000 12/31

3,000

Prepaid Rent

12/31 6,000



UNEARNED REVENUES (INCOME)

Represents a liability of the business since cash

was already collected for service that has not

been rendered yet.

At the end of the year, determine the earnedportion which should be properly separated and

recognized as income.

Two methods of Recording:

Liability Method – Liability – Initial Recognition (Day 1)

Income Method – Income – Initial Recognition (Day 1)



UNEARNED REVENUES (INCOME)cont.

Example: On October 1, 2008, Michael Jay Clinic received

PhP6,000, as advance payment of 4 month- rent

from Anna Tess. Adjusting entry as of December 31, 2008 using

both methods.



UNEARNED REVENUES (INCOME)cont.

To illustrate:

EARNED

UNEARNED

2008 2009

OCT NOV DEC JAN TOTAL

1,500.00 1,500.00 1,500.00 1,500.00 6,000.00



LIABILITY METHOD (Day 1)GENERAL JOURNAL


Oct 1 Cash 6,000

Unearned Rent Income 6,000To record advance collection of rent for four months.

Unearned Rent Income

6,000 10/1



LIABILITY METHOD (AJE)GENERAL JOURNAL


Dec 31 Unearned Rent Income 4,500

Rent Income 4,500To adjust for 3 months rent earned.

12/31 4,500


6,000 10/1

Rent Income

4,500 12/31

1,500



INCOME METHOD (Day 1)GENERAL JOURNAL


Oct 1 Cash 6,000

Rent Income 6,000To record advance collection of rent for four months.

6,000 10/1

Rent Income



INCOME METHOD (AJE)GENERAL JOURNAL


Dec 31 Rent Income 1,500

Unearned Rent Income 1,500To adjust for 1 month unearned rent.

12/31 1,500

Rent Income

6,000 10/1


1,500 12/31

4,500



DEPRECIATION

Property, Plant and Equipment (PPE) are long-lived tangible assets such as land, building,furniture, machinery and equipment used in theoperation of the business.

All plant assets, but LAND, decline inusefulness as they age, becomes obsolete orinadequate.

Cost of PPE (Balance Sheet) is spread orallocated throughout the useful life of such PPE.

This process is called Depreciation. Depreciation Expense (Income Statement)



DEPRECIATION (cont.)

3 factors in determining depreciation: Cost – acquisition price including incidental

expenses necessary to acquire the asset and make itready for use.

Scrap/ Disposal/ Salvage Value – realizable or

recoverable value of the asset at the end of its usefullife. Or, the amount to be received when you sell theasset at the end of its useful life.

Useful Life – productive life of the asset which may beexpressed in number of years, or number of machinehours or number of units produced.

Formula:Straight-Line

Depreciation Expense(per period)

=Asset Cost – Scrap Value

Useful Life



DEPRECIATION (cont.)

Proforma Entry in recording depreciationexpense:

Dr Depreciation Expense – PPE xxx

Cr Accumulated Depreciation –

PPE xxx Accumulated Depreciation is a contra asset

account (normal balance is CR). This is acumulative figure.

Carrying/ Net Book Value is the difference

between Cost and Accumulated Depreciation.Represents the unexpired cost of the asset.



DEPRECIATION (cont.)Your CompanyBalance SheetMay 31, 20XX

AssetsCash $XXXX...

Computer Equipment $ 36,000Less: Accumulated Depreciation (1,000) 35,000

Total Assets $XXXX

Book Value



DEPRECIATION (cont.)Your CompanyBalance SheetJune 30, 20XX

AssetsCash $XXXX...

Computer Equipment $ 36,000Less: Accumulated Depreciation (2,000) 34,000

Total Assets $XXXX

Book Value



DEPRECIATION (example)

On May 1, 2008, Gentess Laundry Shop issued acheck for the purchase of a washing machineworth PhP16,000. It also paid PhP3,000 for theinstallation of this item in the shop. The shopexpects to benefit from this asset for a period of three (3 years) and afterwards sell this forPhP1,000.

Compute and make a journal entry of thedepreciation expense for the month of May.

Total Depreciation Expense in 2008?

Net Book Value/ Carrying Value as of

December 31, 2008.




GENERAL JOURNAL


May 1 Laundry Equipment 19,000

Cash 19,000

Purchased washing machine.

Laundry Equipment

5/1 19,000

Includinginstallation cost.




Cost = PhP19,0000

Scrap Value = PhP1,000

Useful Life = 3 years

6,000 (per year) =19,000 – 1,000

3

Straight-LineDepreciation Expense(per period)

= Asset Cost –

Scrap ValueUseful Life




Cost = PhP19,0000

Scrap Value = PhP1,000

Useful Life = 36 months

P500 (per month) =19,000 – 1,000

36

Straight-LineDepreciation Expense(per period)

= Asset Cost –

Scrap ValueUseful Life




Depreciation in 2008:

PhP500 x 8 months = PhP4,000

Depreciation per month

PhP6,000 x 8/12 = PhP4,000

Depreciation per year




May 31 Depreciation Expense – Laundry Equipment 500

Accumulated Depreciation – Laundry Equipment 500

To record depreciation for the month.

Note: Record the adjustment every

month-end (May – December).

Total Depreciation Expense for the

Year.




Laundry Equipment

5/1 19,000

Accumulated Depreciation -Laundry Equipment

500 5/31500 6/31500 7/31500 8/31500 9/31500 10/31

500 11/31500 12/31

12/31 19,000

4,000 12/31




Balance Sheet:Laundry Equipment 19,000

Accumulated Depreciation

- Laundry Equipment (4,000)

Book Value 15,000

Income Statement:Depreciation Expense 4,000




How much depreciation would be

recognized in 2009?

How much is the AccumulatedDepreciation balance as of 2009?

How much is the Net Book Value as

of 2009?




Depreciation Expense in 2009:

PhP6,000 (yearly depreciation).

Accumulated depreciation as of

12/31/2009: PhP4,000 (2008) plus PhP6,000 (2009)

= PhP10,000.

Net Book Value as of 12/31/2009: PhP19,000 (cost) minus PhP10,000 (AD) =

PhP6,333.



DEPRECIATION (Disclosure)

Property, Plant and Equipment

(PPE) usually is a one line item in

the Balance Sheet, net of

Accumulated Depreciation amount,

in total.

A Note to Financial Statements is

used to disclose the details of PPE.



BAD DEBTS (DOUBTFUL ACCOUNTS)

In spite of great caution in the

granting of credits to customers, the

business may suffer some loss from

its inability to collect the receivables.

This is known as bad debts.

An expense is recognized for the

estimated uncollectible accounts.



BAD DEBTS

Two methods to record:

Direct Write-Off – recognizes bad debts only when it is certain

that the company will not be able to collect the account

anymore.

Entry:

Dr Bad Debts Expense xxx

Cr Accounts Receivable xxx

Allowance Method – provides for bad debts at the time the sales

is recorded. The uncollectible account is determined by

estimation based on the company’s past experience or experience

of other companies within the same business industry.

Entry:

Dr Bad Debts Expense xxx

Cr Allowance for Bad Debts xxx



BAD DEBTS

Balance Sheet Presentation:

Accounts Receivable xxx

Less Allowance for Bad Debts (xxx)Net Amortized Cost xxx

Income Statement Presentation:

Operating Expenses – Bad Debts xxx



BAD DEBTS

At the end of the current period, the

accounts receivable account has a

debit balance of PhP80,000.

Analysis of the accounts in the

customer’s ledger indicates that 10%

will be uncollectible.Entry:

Dr Bad Debts Expense 8,000

Cr Allowance for Bad Debts 8,000



BAD DEBTS



debit balance of PhP80,000. Analysis of the accounts in the customer’s ledger

indicates that 10% will be uncollectible. Assume

that Allowance for Bad Debts has a PhP2,000

credit balance.

Entry:





BAD DEBTS



debit balance of PhP80,000. Analysis of the accounts in the customer’s ledger

indicates that 10% will be uncollectible. Assume

that Allowance for Bad Debts has a PhP3,000

debit balance.

Entry:





BAD DEBTS

Ageing Analysis – another method of

estimating bad debts. Receivables

are provided with allowance for

uncollectible accounts based on

their age (days past due). Please see excel file.



Merchandise Inventory, End

At yearend, a physical count is made to

determine the unsold merchandise which

represent an asset.

This is an adjustment (periodic inventory system) to account for merchandise inventory

ending

Merchandise Inv, End xxx

Income Summary xxx Considered as a deduction from COS.



SUMMARY

Types of Adjustment

Account Balance Before Adjustment Adjusting Entry

Balance SheetAccounts

Income StatementAccounts Account Debited Account Credited

Accrued Expenses Liabilities - U Expense - U Expense Payable (L)

Accrued Revenues Asset - U Income - U Receivable (A) Revenues

Prepaid Expenses:

Asset Method Asset - O Expense - U Expense Prepaid Expense (A)

Expense Method Asset - U Expense - O Prepaid Expense (A) Expense

Unearned Revenues:

Liability Method Liability - O Income - U Unearned Rev (L) Revenues

Income Method Liability - U Income - O Revenues Unearned Rev (L)

Depreciation Assets - O Expense - U Expense Contra Asset

Bad Debts Assets - O Expense - U Expense Contra Asset



Preparation of Adjusted TrialBalance and Financial Statements

After preparing and posting the adjusting

entries to the ledger, the adjusted trial

balance is prepared.

The financial statements can then beprepared from the figures shown in its

adjusted trial balance.

A 10-column worksheet is used tofacilitate efficiency in preparing financial

statements.



S 3-10

Scissors Hair Stylists Worksheet

December 31, 2008 Trial Balance Adjustments

Adjusted Trial Balance

Account Title Dr. Cr. Dr. Cr. Dr. Cr. Cash 400 400

Supplies 700 a. 500 200

Equipment 17,000 17,000

Accum. depr. - Equip. 1,000 b. 1,000 2,000

Accounts payable 200 200

Interest payable c. 100 100

Note payable 3,000 3,000

Suzanne Byrd, capital 6,000 6,000

Service revenue 12,000 12,000

Rent expense 4,000 4,000

Supplies expense a. 500 500

Depreciation expense b. 1,000 1,000

Interest expense 100 c. 100 100

Totals 22,200 22,200 1,600 1,600 23,300 23,300



Scissors Hair Stylists

Worksheet

December 31, 2008

Adjusted

Trial Balance

Account Title Dr. Cr.

Cash

Supplies

Equipment

Accum. depr. - Equip. Accounts payable

Interest payable

Note payable

Suzanne Byrd, capital

Service revenue

Rent expense

Supplies expense

Depreciation expense

Interest expense

Totals

400200

17,000

4,000500

1,000200

23,300

2,000200

1003,0006,000

12,000

23,300

Net Income $6,300




Worksheet

December 31, 2008

Adjusted

Trial Balance


Cash

Supplies

Equipment

Accum. depr. - Equip. Accounts payable

Interest payable

Note payable


Service revenue

Rent expense Supplies expense


Interest expense

Totals

400200

17,000

4,000500

1,000200

23,300

2,000200

1003,0006,000

12,000

23,300

Income StatementAccounts

Balance Sheet

Accounts




Worksheet

December 31, 2005

Adjusted

Trial Balance


Cash

Supplies

Equipment Accum. depr. - Equip.

Accounts payable

Interest payable

Note payable


Service revenue

Rent expense

Supplies expense


Interest expense

Totals

400200

17,000

4,000500

1,000200

23,300

2,000

200

1003,0006,000

12,000

23,300

Income StatementAccounts

Scissors Hair Stylists Income Statement

For the Year Ended December 31, 2008 Service revenue $12,000

Expenses: Rent expense $ 4,000

Supplies expense 500

Depreciation expense 1,000

Interest expense 200

Total Expenses 5,700

Net Income $ 6,300




y

Worksheet

December 31, 2008

Adjusted

Trial Balance


Cash

Supplies

Equipment

Accum. depr. - Equip.

Accounts payable Interest payable

Note payable


Service revenue

Rent expense

Supplies expense


Interest expense

Totals

400200

17,000

4,000500

1,000200

23,300

2,000

200100

3,0006,000

12,000

23,300


Statement of Owner's Equity

For the Year Ended December 31, 2008

S. Byrd, Capital, Jan. 1,2008

$ 6,000

Add: Net Income 6,300

S. Byrd, Capital, Dec. 31,2008

$12,300




Worksheet

December 31, 2005

Adjusted

Trial Balance

Account Title Dr. Cr. Cash

Supplies

Equipment

Accum. depr. - Equip.

Accounts payable

Interest payable

Note payable


Service revenue

Rent expense

Supplies expense


Interest expense

Totals

400200

17,000

4,000500

1,000200

23,300

2,000

200

1003,0006,000

12,000

23,300

Balance Sheet

Accounts

Scissors Hair Stylists Balance Sheet

December 31, 2008 Assets Liabilities

Cash

$ 400 Accounts payable

$ 200Supplies 200 Interest payable 100

Equipment $17,000 Note payable 3,000Less:

AccumulatedDepreciation 2,000 15,000

Total Liabilities $ 3,300

Owner's Equity S. Byrd, Capital 12,300

Total Assets $15,600 $ 15,600



Closing the Accounts

Refers to the end-period step that

prepares the accounts for recording the

transactions of the next period.

Consists of journalizing and posting theclosing entries.

Sets the balances of the revenue and

expense accounts (nominal accounts)back to zero.

Owner’s withdrawal account is also

considered nominal account, hence also

closed.



Closing the Accounts

The asset, liability and owner’s capital

(permanent or real accounts) are not

closed at the end of the period because

their balances are not sued to measureincome.

Balances are carried over to become the

beginning balances of the next period.



Reversing Entries

Posted after the books have been closed

and the post-closing trial balance has

proved the equality of the debits and

credits in the ledger. Recorded at the beginning of next

accounting period.

For convenience and consistency inhandling accrued and deferred items.



Reversing Entries

The reversing entries are made for the

following adjusting entries.

Accrual of Expenses

Accrual of Revenues Unearned Income, if the Income Method is

used

Prepaid Expenses, if the Expense Method is

used.

Recording – reverse the adjusting entries

recorded in prior year.