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Adjusting the Accounts

Step 5
Learning Objectives
LO1 Define and explain what is an accrual basis accounting is
LO2 Explain periodicity concept and give the revenue and expense
recognition principles
LO3 Explain the importance and nature of adjusting entries
LO4 Explain and illustrate accruals and deferrals
LO5 Discuss the effects of omitting adjustments
ACCOUNTING CYCLE
Step 1 Identify Transactions
Step 2 Record Transactions in Journal
Step 3 Post Journal to Ledger
Step 4 Prepare Trial Balance
Step 5 Record Adjusting Entries
Step 6 Prepare Adjusted Trial Balance
Step 7 Prepare Financial Statements
Step 8 Post Closing Entries
Accrual Basis of Accounting

• Under accrual basis, the effects of transactions and other events


are recognized when they occur and not as cash is received or paid.
Revenue and Expense Recognition
Revenue recognition:
Revenue is recognized when both of the following conditions are met:
a. Revenue is earned.
b. Revenue is realized or realizable.

Expense recognition:
Expense is recognized in the period in which related revenue is recognized (Matching Principle).
-Direct association
-Systematic and rational allocation
-Immediately
Periodicity Concept

• An assumption which divides the economic life of a


business into artificial time periods or intervals, such as
months, quarters, and years.
• The usual reporting is annually (calendar year/fiscal year).
Step 5: Recording Adjusting Entries

• Any entry to record unrecognized income or expenses for the


period is called an adjusting entry.
• These entries are needed to proper measure the profit for the
period, and to bring related asset and liability accounts to correct
balances for the financial statements
• Updating of accounts
Accruals
Accrual is the recognition of “an expense already incurred but unpaid”, or
“revenue earned but uncollected.”
MONEY IS LATE
❑ Accrued expenses – expenses incurred but not yet paid (L)
• Accrued salaries
• Accrued interest
❑ Accrued revenues– revenues already earned but not yet collected (A)
• Accrued consulting
Deferrals
Deferral is the postponement of the recognition of “an expense already paid but not yet
incurred” or of “revenue already collected but not yet earned.”
MONEY IS EARLY
❑ Prepaid (deferred) expenses - expenses paid but not yet incurred (A)
• Prepaid rent
• Prepaid Insurance
• Supplies
❑ Unearned (deferred) revenues – income received but not yet earned (L)
There is an original(initial entry before adjustment) entry for the early receipt or payment of cash.
Other Adjustments
❑ Doubtful Accounts or Bad Debts, and other Allowances
Dr. Doubtful account expense xx
Cr. Allowance for DA xx

❑ Depreciation
Dr. Depreciation expense xx
Cr. Accumulated depreciation xx
Practice!
Classify the following items (PE) prepaid expense, (UR) unearned revenue, (AR) accrued revenue, or (AE) accrued expense.

Items Type of adjustment


1. A three-year premium paid on a fire insurance policy. PE
2. Fees earned but not yet received. AR
3. Fees received but not yet earned. UR
4. Salary owed but not yet paid. AE
5. Subscriptions received in advance by a magazine publisher. UR
6. Supplies on hand. PE
7. Taxes owed but payable in the following period. AE
8. Utilities owed but not yet paid. AE
9. Fees accrued but unbilled. AR
10. Wages accrued but not paid. AE
Rules on Adjusting Journal Entries
✔ Every adjustment affects one income statement account and one balance
sheet account.

✔ The income statement account is either a revenue or an expense.

✔ Adjustments are only done at the end of an accounting period.

✔ Adjusting entries will never include cash.


Pro-forma ADJUSTING ENTRIES for
ACCRUALS
❑ Accrued expenses – expenses incurred but not yet paid (EL)
(Will give rise to a liability)
Dr. Expense (IS) xx
Cr. Liability (BS) xx
❑ Accrued revenues– revenues already earned but not yet collected (AI)
(Will give rise to an asset)
Dr. Asset (BS) xx
Cr. Revenue (IS) xx
Practice!
The amount of accrued but unpaid expenses at the end
of the period is both an expense and
a. a deferral
b. a liability
c. an asset
d. an income
Practice!

Accrued revenues
a. decrease assets.
b. decrease liabilities.
c. increase assets.
d. increase liabilities.
Practice!

Accrued expenses
a. decrease assets
b. decrease liabilities.
c. increase assets.
d. increase liabilities.
Practice!
The word “accrued” implies which of the following?
a. Money has been received and the service has been provided.
b. Money has been paid but no services have been provided.
c. Money has been paid for a service to be performed during the next
period.
d. Money has not been paid or received but the service has already been
performed or rendered.
Practice
Illustration of Accrual Adjustments
On May 31, 2020, the following data were accumulated to assist the accountant in preparing the adjusting
entries for Oceanside Realty:

a. Fees accrued but unbilled at May 31 are P19,750.


DR. CR.
Accounts receivable (BS) 19,750
Fees earned (IS) 19,750
b. Wages accrued but not paid at May 31 are P2,700.
DR. CR.
Wages expense (IS) 2,700
Wages payable (BS) 2,700
Practice
Illustration of Deferral Adjustments

On May 31, 2020, the following data were accumulated to assist the accountant in preparing the adjusting
entries for Oceanside Realty:

a. The supplies account balance on May 31 is P12,300. The supplies on hand at May 31 are P4,150.
DR. CR.

b. The unearned rent (L)account balance at May 31 is P9,000, representing the receipt of an advance
payment on May 1 of three months’ rent from tenants.
DR. CR.
ADJUSTING JOURNAL ENTRIES
Use excel sheet for practice. ☺
Methods for Recording Deferrals
Prepaid expenses (Co. 5000 prepaid rent, 3 months expired, 2 months unexpired)
a. Asset method (usual) Date Description Debit Credit
Original entry (A) Prepaid rent 5,000
Cash 5,000
Adjusting entry(E) Rent expense 3,000
Prepaid rent 3,000

Date Description Debit Credit


b. Expense method Original entry (E )Rent expense
Cash
5,000
5,000
Adjusting entry(A) Prepaid rent 2,000
Rent expense 2,000
Methods for Recording Deferrals
(answer me!)
Unearned revenues (Company received 6,000, rendered ¾ services to customers.
Date Description Debit Credit
a. Liability method Original entry Cash 6,000
(L) Unearned service revenue 6,000
Adjusting entry Unearned service revenue (BS) 4,500
(I) Service revenue (IS) 4,500

Date Description Debit Credit


Original entry Cash 6,000
b. Income method (I) Service revenue 6,000
Adjusting entry Service revenue (IS) 1,500
(L) Unearned service revenue (BS) 1,500
Effects of Omitting Adjustments
Type of Adjustment BS Account IS Account
Accrued Expenses Liabilities understated Expenses understated
Accrued Revenues Assets understated Income understated
Prepaid Expenses
Asset method Assets overstated Expenses understated
Expense method Assets understated Expenses overstated
Unearned Revenues
Liability method Liability overstated Income understated
Income method Liabilities understated Income overstated
Depreciation Assets overstated Expenses understated
Thank you!

Matthew 7:7

“Ask, and it will be given to you; seek, and you will find;
knock, and it will be opened to you.

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