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MODULE 4 PACKET
AE 111 – FINANCIAL ACCOUNTING & REPORTING
MODULE 4 OVERVIEW:

Welcome to Module 4 – ADJUSTING ENTRIES, WORKSHEET & FINANCIAL STATEMENTS

In this module, we will discuss how to prepare the adjusting entries, worksheet, and financial
statements such as the income statement, statement of changes in equity and statement of
financial position.

CONSULTATION HOURS:
Phone or Messenger: 5-6 PM Wednesday
Virtual time: 7-8PM Monday and Thursday

MODULE 4 LEARNING OBJECTIVES:

By the end of this module, the students will be able to:
1. Explain accrual accounting, the periodicity concept, and the revenue and expense
recognition principles
2. Prepare adjusting entries for deferrals and accruals.
3. Explain the effects of omitting adjustments in financial statements.
4. Prepare an adjusted trial balance.
5. Prepare in good form a ten-column worksheet.
6. Prepare financial statements from completed worksheet.
7. Explain how the financial statements are interrelated.
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COURSE CONTENT FOR MODULE 4:
ADJUSTING ENTRIES, WORKSHEET & FINANCIAL STATEMENTS
ACTIVITY DESCRIPTION TIME TO COMPLETE
Lecture discussions The Need for Adjustments 30 minutes
Adjustments for Deferrals and Accruals 1 hour
Preparing the Worksheet 1 hour
Preparing the Financial Statements 30 minutes
Activity Giving instructions for the activity: 15 minutes

LECTURE DISCUSSIONS ACCRUAL BASIS

The financial statements except for the cash flow statement, are prepared on the accrual basis
of accounting. Under the accrual basis, the effects of transactions and other events are
recognized when they occur and not as cash is received or paid. This means that the accountant
records revenues as they are earned and expenses as they are incurred. The timing of cash
flows is immaterial for determining when to recognize revenues and expenses. Generally
accepted accounting principles require that a business use the accrual basis.

PERIODICITY CONCEPT
To provide timely information, accountants have divided the economic life of a business into
artificial time periods. This assumption is referred to as the periodicity concept.

Accounting periods are generally a month, a quarter or a year. The most basic accounting period
is one year. Entities differ in their choice of the accounting year – fiscal, calendar or natural. A
fiscal year is a period of any twelve consecutive months (ex. August 1, 2020-July 31, 2021). A
calendar year is an annual period that starts on January 1 and ending on December 31. A
natural business year is a twelve-month period that ends when business activities are at their
lowest level of the annual cycle. A period of less than one year is an interim period.

The periodicity concept ensures that accounting information is reported at regular intervals. To
measure profit in a fair manner, entities update the income and expense accounts immediately
before the end of the period.

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REVENUE AND EXPENSE RECOGNITION PRINCIPLES

Revenue should be recognized when earned. Revenue is recognized when it is probable that
economic benefits will flow to the enterprise and these economic benefits can be measured
reliably.

Expenses are recognized in the income statement when it is probable that a decrease in future
economic benefits related to a decrease in asset or an increase of a liability has arisen, and that
the decrease in economic benefits can be measured reliably.

THE NEED FOR ADJUSTMENTS

PURPOSES OF ADJUSTMENTS

a. measure properly the profit for the period, and

b. bring related asset and liability accounts to correct balances

In short, adjustments are needed to ensure that the revenue and expense recognition
principles are followed thus resulting in financial statements reporting the effects of all
transactions at the end of the period

 Adjusting entries involve changing account balances at the end of the period from what is
the current balance of the account to what is the correct balance for financial reporting.

 Without adjusting entries, financial statement may not fairly show the solvency of the
entity in the balance sheet and the profitability in the income statement.

 While adjustments are made to recognize revenues and expenses in the period that these
have been earned and incurred respectively, each adjusting entry affects however, a
BALANCE SHEET ACCOUNT (AN ASSET OR A LIABILITY ACCOUNT) AND AN
INCOME STATEMENT ACCOUNT (revenue/income or expense account).

TWO (2) GENERAL TYPES OF ADJUSTMENTS:

1. Accruals

2. Deferrals
ACCRUALS:

 It is the recognition of:

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1. An expense already incurred but not yet paid or unpaid. (Accrued Expenses or
Payables)

 Example: Salaries incurred but not yet paid because payment is to be made
at the end of the covered period, electricity used but billing has not been
received from utility company.

2. Revenues already earned but payment has not yet been received or uncollected.
(Accrued Revenues or Receivables)

 Example: No billing or Statement of Account has been issued yet.

 This adjustment deals with an amount unrecorded in any account.

 The entry will have an effect of increasing BOTH a balance sheet and an income
statement account

 This would be required in two cases:

1. Accruing expenses to reflect expenses incurred during the accounting period that are
UNPAID AND UNRECORDED

(Please refer to the example next page.)

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2. Accruing revenues to reflect revenues earned during the accounting period that are
UNCOLLECTED AND UNRECORDED.

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DEFERRALS:

 It is the POSTPONEMENT of the recognition of:

1. an “expense already paid but not yet incurred” (PREPAID EXPENSES OR

PREPAYMENTS) or

2. a “revenue already collected but not yet earned” (UNEARNED REVENUES -

LIABILITY)

 This adjustment deals with an amount already RECORDED in a balance sheet account
(Prepayment-Current Asset or Unearned Revenue-Current Liability)

 The entry will have an effect of:

1. decreasing the balance sheet account (Expensing a Prepayment or Earning an

Unearned Revenue); and

2. Increasing an income statement account (increase in expense or increase in revenue):

 This will be needed in two cases:

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1. Allocating assets to expense to reflect expenses incurred during the accounting period
(e.g. prepaid insurance over the covered period, supplies when used and depreciation over
the life of the asset)

2. Allocating revenues received in advance to revenue to reflect revenues earned during the
accounting period (e.g. subscriptions, airplane fares, etc.)

ADJUSTMENTS FOR DEFERRALS:

A. ALLOCATING ASSETS TO EXPENSES

 Entities often make expenditures that benefit more than one period.

 These expenditures are generally DEBITED to an ASSET account.

 At the end of each accounting period, the estimated amount that has expired
during the period or that has benefited the period is transferred from the ASSET
account to an EXPENSE account.

 Two of the more important kinds of these adjustments are:

1. PREPAID EXPENSES

2. DEPRECIATION OF PROPERTY AND EQUIPMENT

PREPAID EXPENSES

 These are expenses paid in advance.

 These are recorded as asset and not as an expense as it benefits future period(s).

 At the end of the accounting period, a portion or all these prepayments may have
expired or already benefited the current period.

 Prepaid expenses expire either with the passage of time or through use and
consumption.

 That portion of an asset that has expired becomes expense.

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Cost of insurance INCOME

BALANCE SHEET
policies and Prepayment expires STATEMENT
supplies that will or supplies used
Assets Expenses
benefit future
periods Prepayment Insurance Expense
Supplies Supplies Expense

• If adjustments for prepaid expenses are not made at the end of the period, both the
balance sheet and income statement will be misstated.
• ASSETS WILL BE OVERSTATED & EXPENSES UNDERSTATED.
• OWNER’S EQUITY IN THE BALANCE SHEET AND REVENUES IN THE INCOME
STATEMENT WILL BE OVERSTATED.

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DEPRECIATION OF PROPERTY AND EQUIPMENT

 When an entity acquires long-lived assets such as buildings, service vehicles,

computers, or office furniture, it is basically buying or prepaying for the usefulness
of those assets.

 These assets help generate income for the entity.

 Therefore, a portion of the cost of the assets should be reported as expense in

each accounting period that those assets will derive a benefit from and for the
entity.

 Proper accounting requires the allocation of the cost of the asset over its estimated
useful life (EUL).

 The estimated amount allocated to any one accounting period is called

DEPRECIATION or DEPRECIATION EXPENSE.

 Three factors are involved in computing depreciation expense:

1. Asset Cost
- It is the amount that an entity paid to acquire the depreciable asset. -
Generally, the acquisition cost (historical cost)

2. Estimated Salvage Value

- It is the amount that the asset can probably be sold for at the end of
its estimated useful life.

3. Estimated Useful Life (EUL)

- It is the estimated number of periods that an entity can make use of
the asset (economically utilized).
- Useful life is an estimate, not an exact measurement.

 Methods of estimating depreciation include the STRAIGHT-LINE METHOD.

ASSET COST xx

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LESS: ESTIMATED SALVAGE VALUE xx

DEPRECIABLE COST xx
DIVIDED BY: ESTIMATED USEFUL LIFE xx
DEPRECIATION EXPENSE FOR EACH PERIOD xx
 The asset account is NOT directly reduced when recording depreciation expense.
 The reduction is recorded in a contra account called ACCUMULATED
DEPRECIATION.
 The balance of the contra account is deducted from the cost to obtain the BOOK
VALUE of the property and equipment.
 The book value generally also represents the carrying value of the asset in the
statement of financial position.

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B. ALLOCATING REVENUES RECEIVED IN ADVANCE TO REVENUES

 This adjustment refers to an event when CASH IS RECEIVED for services and
goods even BEFORE service is rendered or goods are delivered.
 When such is received in advance, the entity has an OBLIGATION to perform
services or deliver goods.
 The LIABILITY referred to is UNEARNED REVENUES.
 Examples include Magazine Subscription, Airplane Tickets or Airfare, Prepaid
Load Sold by Telecoms (point of view of the Telecoms), etc.

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SUMMARY OF ADJUSTING ENTRIES

Account Balances Before Adjusting Entry
Type of Adjustment Adjustment
Balance Sheet Income Statement Account Account
Account Account Debited Credited
Assets Expenses Expense Prepaid
Prepaid Expenses Overstated Understated Expense
(asset method)
Assets Expenses Depreciation Accumulated
Depreciation
Overstated Understated Expense Depreciation
Liabilities Income Unearned Revenues
Unearned Revenues Understated Revenues
Overstated
(liability method)
Liabilities Expenses Expense Payable
Accrued Expenses
Understated Understated
Assets Income Receivable Revenues
Accrued Revenues
Understated Understated

THE WORKSHEET

Accountants often use the worksheet to help transfer data from the unadjusted trial
balance to the financial statements. This multi-column document provides an efficient way to
summarize the data for financial statements. The accountant generally prepares a worksheet
when it is time to adjust the accounts and prepare the financial statements. However, it is

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possible to prepare the financial statements directly from the adjusted trial balance at the end of
the accounting period if the business has relatively few accounts.

The worksheet is not part of the ledger or the journal, nor is it a financial statement. It is a
summary device used by the accountants for his convenience.

Preparing the Worksheet

Step 1 Enter the account balances in the unadjusted trial balance columns and total the
amounts.
 The numbers, titles, and balances of the accounts at the end of the accounting
period are lifted directly from the ledger before the adjusting entries are prepared
 The accounts are listed in the worksheet in the order they appear in the ledger.
 Total debits must equal total credits

Step 2 Enter the adjusting entries in the adjustments columns and total the amounts
 As each adjustment is entered, a letter is used to identify the debit entry and the
corresponding credit entry

Step 3 Compute each account’s adjusted balance by combining the unadjusted trial balance and
the adjustment figures. Enter the adjusted amounts in the adjusted trial balance columns. The
adjusted trial balance is prepared by combining horizontally, line by line, the amount of each
account in the unadjusted trial balance columns with the corresponding amounts in the
adjustment columns. This procedure is called cross-footing.

A simple convention to observe when extending amounts from the trial balance to the adjusted
trial balance follows:
 Add when the type of adjustment (debit or credit) is the same as the unadjusted
balance.
 Subtract when the type of adjustment (debit or credit) is different from the
unadjusted balance

Step 4 Extend the asset, liability and owner’s equity amounts from the adjusted trial balance
columns to the balance sheet columns. Extend the income and expense amounts to the
income statement columns. Total the statement columns.
 Every account is either a balance sheet account or an income statement account.
Asset, liability capital, and withdrawal accounts are extended to the balance

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sheet columns. income and expense accounts are moved to the income statement
columns.
 Debits in the adjusted trial balance remain as debits in the statement columns while
credits as credits.

Step 5 Compute profit or loss as the difference between total revenues and total expenses in the
income statement. Enter profit or loss as a balancing amount in the income statement and in the
balance sheet and compute the final column totals.
 Profit or loss is the difference between the debit and credit columns of the income
statement. The profit or loss should always be the amount by which the debit and
credit columns for income statement, and the debit and credit columns for balance
sheet differ.

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ESSENCE OF FINANCIAL STATEMENTS

There are questions that the owner of the business periodically asks – How much did the
business entity earn? What is the financial condition of the business? How much is the owner’s
interest in the entity today? What happened to the cash receipts? Where did cash go? Investors,
creditors, taxing authorities and other users have their own questions about the business which
need to be answered.

The financial statements are the means by which the information accumulated and
processed in financial accounting is periodically communicated to the users. Without accounting
information embodied in financial statements, users may not be able to arrive at sound economic
decisions. The objective of financial statements is to provide information about the financial
position, financial performance, and cash flows of the entity that is useful to a wide range of
users in making economic decisions.

PREPARING THE FINANCIAL STATEMENTS (Step 6)

Once the worksheet is completed, it is easy to prepare the financial statements for the
account balances have been extended to the appropriate income and balance sheet columns.
Most of the information needed to prepare the income statement, statement of changes in equity
and balance sheet are available from the worksheet. Note that financial statements shall be
presented at least annually.

Income Statement
The income statement is a formal statement showing the performance of the enterprise
for a given period of time. It summarizes the revenues earned and expenses incurred for that
period of time. The income statement for Del Mundo Landscape Specialist (refer to Excel File) is
prepared directly from the income statement columns of the worksheet.

Del Mundo Landscape Specialist

Income Statement

For the Year Ended December 31, 2020

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Revenues

Landscaping Revenues ₱
2,500
Lawn Cutting Revenues
39,750
Total Revenues
42,250

Less: Expenses

Salaries Expense ₱
5,600
Supplies Expense
500
Rent Expense
7,000
Insurance Expenses
2,000
Gas Expense
1,500
Advertising Expense
1,750
Depreciation Expense - Vehicles
4,500
Depreciation Expense - Equipment
1,000
Interest Expense
1,400

25,250

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Profit ₱
17,000

Statement of Changes in Equity

The statement of changes in equity summarizes the changes that occurred in owner’s
equity. Changes in an enterprise’s equity between two balance sheet dates reflect the increase
or decrease in its assets during the period.

In the case of sole proprietorships, increases in owner’s equity arise from additional
investments by the owner and profit during the period. Decreases result from withdrawals by the
owner and from loss for the period.
Del Mundo Landscape Specialist
Statement of Changes in Equity
For the Year Ended December 31, 2020

Del Mundo, Capital, Beginning ₱ 450,000

Add: Additional Investments -
Net Profit 17,000
Total ₱ 467,000
Less: Withdrawals
5,000
Del Mundo, Capital, Ending
₱ 462,000

Balance Sheet
The balance sheet is a statement that shows the financial position or condition of an entity
by listing the assets, liabilities, and owner’s equity as at a specific date. This statement is also
called the statement of financial position.

Users of financial statements analyze the balance sheet to evaluate an entity’s liquidity,
its financial flexibility, and its ability to generate profits, and its solvency.

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Del Mundo Landscape Specialist

Statement of Financial Position

As of December 31, 2020

ASSETS

Current Assets

Cash ₱
182,250
Account Receivable
10,000
Supplies 500

Prepaid Rent
14,000
Prepaid Insurance ₱
22,000 228,750
Noncurrent Assets

Vehicle ₱
300,000
Less: Accumulated Depreciation 4,500 ₱ 295,500

Equipment ₱
54,000
Less: Accumulated Depreciation 1,000 53,000 348,500
TOTAL ASSETS ₱ 577,250

LIABILITIES

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Current Liabilities

Notes Payable ₱
100,000
Accounts Payable 1,000

Salaries Payable 1,600

Interest Payable 1,400

Unearned Revenues
11,250
TOTAL LIABILITIES ₱
115,250

OWNER'S EQUITY

Del Mundo, Capital, Ending

462,000
TOTAL LIABILITIES AND OWNER'S EQUITY ₱ 577,250

Statement of Cash Flows

The statement of cash flows provides information about the cash receipts and cash
payments of an entity during a period. It is a formal statement that classifies cash receipts
(inflows) and cash payments (outflows) into operating, investing, and financing activities. The
statement shows the net increase or decrease in cash during the period and the cash balance at
the end of the period. It also helps project the future net cash flows of the entity.

Cash Flows from Operating Activities

Cash flows from operating activities are generally the cash effects of transactions and other
events that enter into the determination of profit or loss

Cash Inflows
• receipts from sale of goods and performance of services
• receipts from royalties, fees, commissions, and other revenues

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Cash outflows
• payments to suppliers of goods and services
• payments to employees
• payments for taxes
• payments for interest expense
• payments for other operating expenses

Cash Flows from Investing Activities

Investing activities include making and collecting loans, acquiring, and disposing of investments
in debt or equity securities; and obtaining and selling of property and equipment and other
productive assets.

Cash Inflows
• receipts from sale of property and equipment
• receipts from sale of investments in debt and equity securities
• receipts from collections on notes receivable

Cash outflows
• payments to acquire property and equipment
• payments to acquire debt and equity securities
• payments to make loans to others generally in the form of notes receivable

Cash Flows from Financing Activities

Financing activities include obtaining resources from owners and creditors.

Cash Inflows
• receipts from investments by owners
• receipts from issuance of notes payable

Cash outflows
• payments to owners in the form of withdrawals
• payments to settle notes payable

Del Mundo Landscape Specialist

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Statement of Cash Flows

For the Year Ended December 31, 2020

Cash flows from Operating Activities

Cash received from clients ₱ 43,500

Payments to employees (4,000)

Payments for office rent (21,000)

Payments for insurance (24,000)

Payments for advertising (1,750)

Payments for other operating expenses (1,500)

Net cash provided by (used in)operating activities (8,750)

Cash flows from Investing Activities

Payments to acquire vehicle (200,000)

Payments to acquire equipment (54,000)

Net cash provided by (used in) investing activities (254,000)

Cash flows from Financing Activities

Cash received as investments by owner 450,000

Payments for withdrawals by owner (5,000)

Net cash provided by (used in)financing activities 445,000

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Net increase (decrease) in Cash ₱ 182,250

Cah balance at the beginning of the period 0

Cah balance at the end of the period ₱ 182,250

Exercise 4-1: Worksheet Extensions

Classify each account listed below as assets (A), liabilities (L), owner’s equity (OE), revenue (R),
or expenses (E). Indicate the normal debit or credit balance of each account. Indicate whether
each account will appear in the Income Statement columns (I) or the Balance Sheet columns (B)
of the worksheet.

Normal Income Statement or

Account Classification Balance Balance Sheet Columns
Example: Rent Expense E Debit I

1. Accounts Receivable

2. Depreciation Expense

3. Accounts Payable

4. Supplies

5. Computer Equipment

6. Biore, Capital

7. Accumulated Depreciation

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8. Biore, Withdrawals

9. Consulting Revenues

10. Prepaid Insurance

Exercise 4-2: Worksheet Preparation &Financial Statements

Rosalina Besario Surveyors

Trial Balance

May 31, 2020

Cash
210,000
Account Receivable
930,000

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Prepaid Advertising
360,000
Engineering Supplies
270,000
Survey Equipment
1,890,000
Accumulated Depreciation - Survey Equipt.
640,000
Accounts Payable
190,000
Unearned Survey Revenues
120,000
Notes Payable
500,000
Salaries Payable

Interest Payable

Besario, Capital
1,120,000
Besario, Withdrawals
700,000
Survey Revenues
6,510,000
Salaries Expense
3,270,000
Supplies Expense

Rent Expense
960,000
Insurance Expenses
250,000
Utilities Expense
160,000
Advertising Expense

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Depreciation Expense

Interest Expense

Miscellaneous Expense
80,000
TOTALS
9,080,000 9,080,000

The following information pertaining to the year-end adjustments is available:

a. The P360,000 prepaid advertising represents expenditure made on Nov. 1, 2019

for monthly advertising over the next 18 months.

b. A count of engineering supplies at May 31, 2020 amounted to P90,000

c. Depreciation on the surveying equipment amounted to P160,000.

d. One third of the unearned survey revenues has been earned at year-end.

e. Salaries of P140,000 have accrued.

f. Interest of P60,000 on the notes payable has accrued at year-end.

REQUIRED: 1. Prepare the adjustments on the worksheet and complete the worksheet.
2. Prepare the income statement, statement of changes in equity, and

statement of financial position.

REFERENCES:

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Aliling, Leonardo E. (2013). Fundamentals of basic

accounting. Quezon City: Rex Printing Company, Inc.

Ballada, Win Lu, Susan Ballada (2019). Basic

financial accounting & reporting. Manila, Philippines:
Made Easy & Domdane Publisher.

Cabrera, Ma. Elenita B., Cabrera, Gilbert Anthony B.

(2019) Financial accounting and reporting
fundamentals.. Manila, Philippines: GIC Enterprises
& Co., Inc.

Cabrera, Ma. Elenita B. (2018). Financial accounting

and reporting -comprehensive edition.
Manila, Philippines: GIC Enterprises & Co. Inc.
Printed Learning Resources
Mroczkwowski, Nicholas, David Flanders. (2015).
Accounting basic reports. 10th ed. Australia: Cengage
Learning Australia.

Valix, Conrado T., Christian Aris M. Valix. (2017).

Theory of accounts. Manila, Philippines: GIC
Enterprises & Co.

Weygandt, Jerry J., Paul D. Kimmek Donald E.

Kieso. (2016) Accounting principles. International
Student Version. 12th ed. Hoboken, NJ: John Wiley &
Sons.

Wild, John, et al. (2015) Principles of accounting.

International edition. New York: Mc Graw Hill.

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Adjusting Entries. Retrieved from

https://www.youtube.com/watch?v=B02hG5B38Hk
https://www.youtube.com/watch?v=WfqStMsLwis
https://www.youtube.com/watch?v=T8OWLNYd9No

Preparation of Worksheet. Retrieved from

https://www.youtube.com/channel/UC5na0U982ACiL
zHLVGKSp6Q
Web and Other Learning Resources
https://www.youtube.com/watch?v=r_o0jCvthto
https://www.youtube.com/watch?v=BTuH7C0g87o&t
=36s

https://www.youtube.com/watch?v=BTuH7C0g87o

https://www.youtube.com/watch?v=xq-RPrpw9ro

Preparation of Financial Statements. Retrieved from

https://www.youtube.com/watch?v=myNAkXT9XgY

2020-2021 Module Packets for AE 0 (Fundamentals of Accounting) | College of Commerce |

University of San Agustin, Iloilo City, 5000, Philippines Page 28 of 28