PURPOSE OF AUDITING ENTRIES

The purpose of adjusting entries is to match costs against revenues. The

expenses incurred during the period, whether paid or not, are matched against
the revenue earned for the same period, whether collected or not, for the correct
determination of the profit for the period.
Adjusting entries are recorded at the end of an accounting period.
Most common transactions requiring adjusting entries:
1. Depreciation of property, plant and equipment
2. Allowance for uncollectible accounts
3. Accrued and prepaid expenses
4. Accrued and unearned revenues
5. Other adjustments, like
 Unused or unsold Inventory at the end of the period

DEPRECIATION
Depreciation is the decrease in value of a property due to usage, passage of
time, action of natural elements, or decay. As it is difficult to measure the actual
decrease in value of the property, the accounting of depreciation is done through
a systematic basis. The cost of a depreciable asset is systematically allocated
over its estimated useful life. The estimated scrap value at the end of the life of
the asset is not included in the amount expensed over the periods of
depreciation.
The simplest method of depreciation is the straight-line method. Under this
method, the depreciation expense is calculated by allocating the depreciable
amount equally over the estimated useful life in years of the property.
The formula for the computation of depreciation using the straight-line
method is as follows:
Depreciation Expense =
Depreciable Value
Estimated Useful Life
The depreciable value of the
asset is the difference between its cost and estimated residual value at
the end of its useful life. The cost of the asset is the amount paid to purchase the
asset, including the incidental costs in bringing the asset to the location and
condition intended for its use. The residual value, sometime called scrap or
salvage value, is the amount estimated to be recovered at the end of the useful
life of the property.
The estimated useful life is the estimated length of time, normally in years,
when the property is expected to be used.
EXERCISES:
Exercise 1: A machine was purchased by the company for P120,000. It is
expected to be sold as scrap for P20,000 after its estimated useful life of 10
years. Present the journal entry to record the annual depreciation.

120 000−20 000

Depreciation Expense =
10 years
100 000
=
10 years
= 10 000
Answer: Depreciation Expense 10 000
Accumulated Depreciation – Machinery 10 000

Exercise 2: A computer equipment was purchased for P65,000. The equipment

will be sold for P5,000 after its useful life of 5 years. Present the depreciation
table for 5 years.
Answer:
Yea Cost Depreciatio Accumulated Net Book
r n Depreciation Value
1 65 000 12 000 12 000 53,000
2 65 000 12 000 24,000 41,000
3 65 000 12 000 36,000 29,000
4 65 000 12 000 48,000 17,000
5 65 000 12 000 60,000 5.000

Exercise 3: Compute the depreciation of the following properties and present

the journal entry to record the depreciation for one month:

Asset Cost Salvage Useful Annual Monthly

Value Life Depreciati Depreciati
(Years) on on
Building 6 400 100 000 20 315,000 26 250
000
Machinery 1 500 60 000 10 144,000 12 000
000
Equipment 480 000 0 4 120,000 10 000
48 250

Answer: Depreciation Expense 48 250

Accumulated Depreciation 48 250
UNCOLLECTIBLE ACCOUNTS

Methods of accounting for bad debts:

a. Direct write-off
b. Allowance method
1. Percent of sales
2. Percent of receivables
3. Aging of accounts

Direct Write-Off
When an account is proven to be uncollectible and worthless, it is written-off. The
write-off is recorded by crediting the receivables and debiting an expense
account, such as bad debts expenses, uncollectible accounts expense, etc.

The pro forma entry to record the write-off is as follows:

Bad Debts Expense xxx
Accounts Receivable xxx

Allowance Method
The allowance method of recognizing uncollectible accounts expenses is
recommended for the better matching of costs against revenues. This method
requires recording of the bad debts expense if the accounts are doubtful of
collection.

The pro forma entry to record the recognition of bad debts is as follows:
Bad Debts Expense xxx
Allowance for Bad Debts xxx

The “Allowance for Bad Debts” account is a deduction from the accounts
receivable account.
Illustration:
Jun 30, 2024 Sold on account to a customer merchandise for P20,000.
Sep 30, 2024 The customer paid P12,000.
Nov 30, 2024 The account balance is considered doubtful of collection.
Jan 31, 2025 The account balance is proved to be uncollectible.

Journal Entries
Direct Write-Off Method
2024
June 30 Accounts Receivable 20 000
Sales 20 000

Sept 30 Cash 12 000

Accounts Receivable 12 000

Nov 30 NO ENTRY

Jan 31 Bad Debts Expense 8 000

Allowance for Bad Debts 8 000

Allowance Method
2024
June 30 Accounts Receivable 20 000
Sales 20 000

Sept 30 Cash 12 000

Accounts Receivable 12 000

Nov 30 Bad Debts Expense 8 000

Allowance for Bad Debts 8 000

Jan 31 Allowance for Bad Debts 8 000

Accounts Receivable 8 000

EXERCISES:
Exercise 4: During its first year of operations, the company had sales of
P6,000,000. Collection from customers amounted to P4,000,000.

Required:
Prepare the adjusting journal entries to provide for doubtful accounts under the
each of the following independent assumptions:
a. The company believes one percent of sales may prove uncollectible.
b. The company policy is to maintain an allowance for doubtful accounts
equal to 10% of the outstanding accounts receivable

Answer:
a. Doubtful Accounts Expense 60 000
Allowance for Doubtful Accounts 60 000

b. Doubtful Accounts Expense 200 000

Allowance for Doubtful Accounts 200 000

6 000 000 x 1% = 60 000

6 000 000 – 4 000 000 = 2 000 000 x 10%
= 200 000
Exercise 5: At the beginning of the year, Outwork Everyone Company has an
Accounts Receivable of P3 million and an Allowance for Uncollectible Accounts of
P120,000.

During January, it sold goods to customers amounting to P300,000 and collected

P200,000. A receivable accounting amounting to P50,000 has proven to be
uncollectible and was written off.

During February, it sold goods to customers amounting to P900,000 and

collected P300,000. A receivable previously written off amounting to P5,000 has
been collected.

The company estimates that 2% of Accounts Receivable is uncollectible.

Required:
Prepare the adjusting entries for January and February.

Answer:

Accounts Receivable
 Beg
3M
Jan
Sales
300k
Collection 200k
Write Off 50k
3.3 250k
00k
(25 Allowance for Uncollectible Accounts
0k) Beg 120k
3.
050k Jan
x Write-Off
2% 50k
61 120k
000 (50k)
70k
Feb (61k)
Sales 9k
900k Feb
Collection 300k 5k
Recovery 5k 66k
5k (73k)
Feb Balance 7k
3.650k
X
2%
73
000

January: Allowance for Uncollectible Accounts 9,000

Uncollectible Accounts Expense 9,000

February: Uncollectible Accounts Expense 7,000

Allowance for Uncollectible Accounts 7,000
ACCRUED AND PREPAID EXPENSES

Accrued Expenses
Accrued expenses are expenses already incurred but not yet paid. These
expenses create an obligation to pay in the future.

The pro forma entry to record an accrued expense is as follows:

Expense xxx
Accounts Payable or Accrued expense payable xxx

Common examples of accrued expenses are salaries, utilities and interest

expenses. Employee services that have been rendered to the company but not
yet paid are accrued salaries expenses. Electricity, water and telephone services
that have been consumed but not yet paid are also accrued expenses.

Illustration:
The company borrowed P300,000 from a bank. It issued a 90-day 10%
promissory note on November 30, 2024.

Journal entries related to the promissory note are as follows:

2024
Nov 30 Cash 300,000
Notes Payable 300,000

Dec 31 Interest Expense 2,500

Interest Payable 2,500

Jan 31 Interest Expense 2,500

Interest Payable 2,500

Feb 28 Interest Expense 2,500

Interest Payable 2,500

Notes Payable 300,000

Interest Payable 7,500
Cash 307,500
Prepaid Expenses
Prepaid expenses are expenses already paid but not yet incurred. During the
accounting period, the portion that is already consumed is recorded as expense.

There are two methods in accounting prepaid expenses: the asset method and
the expense method.

Illustration:
On October 31, 2024, a company paid P120,000 as rent payment for 3 months.

The entries related to the rent payment are as follows:

Asset Method:
2024
Oct 31 Prepaid Rent 120,000
Cash 120,000
To record the payment of rent for 3 months.

Nov 30 Rent Expense 40,000

Prepaid Rent 40,000
To record the expiration of the rent for 1 month.

Dec 31 Rent Expense 40,000

Prepaid Rent 40,000
To record the expiration of the rent for 1 month.

2025
Jan 31 Rent Expense 40,000
Prepaid Rent 40,000
To record the expiration of the rent for 1 month.

Expense Method:
2024
Oct 31 Rent Expense 120,000
Cash 120,000
To record the payment of rent for 3 months.

Dec 31 Prepaid Rent 40,000

Rent Expense 40,000
To record the unexpired portion of rent.

2025
Jan 31 Rent Expense 40,000
Prepaid Rent 40,000
To record the expiration of the rent for 1 month.
Exercise 6: Believe You Can Corporation has the following information during
the month of December:

Total purchases for office supplies during the year amounted to P240,000. A
year-end physical count revealed that only 20,000 worth of supplies were on
hand.

Fees for security services provided to the company, amounting to P45,000 per
month, are scheduled to be paid on the 5th day of the following month.

On December 31, the company received the following utility bills which were
paid on the following month:
Liwanag Electric Company 40 000
Doon Dito Telecom 20 000
Clear Water District 5 000

Prepare the necessary adjusting journal entries.

Answer:
Office Supplies Expense 220,000
Office Supplies Inventory 220,000

Security Services Expense 45,000

Accrued Security Services Expense 45,000

Electricity Expenses 40,000

Telecommunication Expenses 20,000
Water Expenses 5,000
Accrued Utility Expenses 65,000