ADJUSTING ENTRIES

Purposes of the Adjusting Entries

● To conform to the principle of “Matching Costs Against Revenue” which will result in a
more accurate measurement of the net income.
● To arrive at the correct valuation of assets and liabilities.
● To arrive at the correct determination of the owner’s equity.

Usual adjustments made at the end of accounting period

1. Unused Supplies (Supplies Inventory)

These are supplies which remain unused at end of accounting period. At the time they are
bought, Supplies Expense is debited hence, at the end of the accounting period, this account
will be overstated by the amount of unused supplies. There is a need to reduce the balance of
this account.

Note: Unused supplies - current assets

Initial Entry:
Supplies expense xx
Cash/Accounts payable xx

Adjusting Entry:
Unused supplies xx
Supplies expense xx

2. Prepaid Expenses (Deferred Expenses)

These are expenses not yet incurred but already paid. If at the end of the accounting period,
these expenses are not yet used up or the benefit has not yet been received, an adjustment is
necessary to reduce the amount of expense.
● Prepaid Rent
● Prepaid Advertisement
● Prepaid Insurance

Note: Prepaid Expense - current assets

Initial Entry:
Prepaid Rent xx
Cash xx

Adjusting Entry:
Rent Expense xx
Prepaid Rent xx
 3. Accrued Expenses
Assuming the accrued expense is not yet paid:
Utilities expense xx
Accrued utilities expense xx

Adjusting Entry:
Accrued utilities expense xx
Cash xx

These are expenses already incurred but not yet paid. Considering that an item of expense is
not yet paid, hence not yet recorded, there is a need to recognize the expense and the liability
in the books.
● Accrued utilities expense (Utilities payable)
● Accrued salaries expense (Salaries payable)

Note: Accrued Expenses - current liabilities

4. Unearned Income (Deferred Income)

Initial Entry:
Cash xx
Unearned service revenue xx

Adjusting Entry:
Unearned service revenue xx
Service Revenue xx

This is an income not yet earned but already collected.

● Unearned service revenue/income

Note: Unearned Income/Revenue - current liability

5. Accrued Income
This is an income already earned but not yet collected. Considering that this item of
income is not collected, hence it is not yet recorded in the books.
● Accrued interest income (Interest Receivable)
● Accrued rent income (Rental Receivable)

Note: The term Accrued can either mean unpaid if it is an expense or uncollected if it is
an income.

Adjusting Entry:
Accrued Interest Income xx
Interest Income xx
 6. Bad Debts (Impairment Loss)
This refers to the estimated receivables which may not be collected. This being the case, the
bad debts will be considered as an additional expense and should be recognized as such.

Note: The Allowance for Impairment Loss (contra asset) will be shown in the Balance
Sheet as a deduction from Accounts Receivable to arrive at the Net Realizable Value

Adjusting Entry:
Impairment Loss xx
Allowance for Impairment Loss xx

7. Depreciation
Refers to the decrease in the value of a non-current asset due to ordinary wear and
tear or passage of time.

Note: The Accumulated Depreciation account (contra asset) will be shown in the Balance
Sheet as a deduction from the asset being depreciated to arrive at the Carrying Amount.

Adjusting Entry:
Depreciation - Machinery xx
Accumulated Depreciation xx
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Bad debts
How to compute estimated Bad Debts?
● A fixed percentage of sales
● A fixed percentage of the accounts receivables
● Aging of receivables

Example
The following selected accounts appear in the preliminary trial balance as at December 31,
200G:

Sales 180,000
Accounts Receivables 30,000
Allowance for Impairment Loss 1,200

1. Fixed percentage of sales

Bad debts are estimated at 1% of sales.

Adjusting Entry:
Impairment Loss (1% x P180,000) 1,800
Allowance for Impairment Loss 1,800
To record provision for bad debts

Note: The net realizable value (NRV) of the accounts receivable after the above entry is:
Accounts receivable P30,000

2. Fixed Percentage of the accounts receivable

Bad debts are estimated at 9% of Accounts Receivable

Adjusting Entry:
Impairment Loss (9%xP30,000=2,700-1,200) 1,500
Allowance for Impairment Loss 1,500

To record provision for bad debts

Note: The net realizable value (NRV) of the accounts receivable after the above entry is:
Accounts receivable P30,000
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Depreciation
How to compute estimated Depreciation?

Cost - Salvage or Scrap Value (at the end of the life) X Number of months Life

EXAMPLE 1
A machinery costing P250,000 is acquired on August 1 of the current year. It is estimated to
have a salvage value of P20,000 at the end of its 10-year useful life.Computation of the
depreciation on December 31, the end of the accounting period.

P260,000 - 20,000/ 10 = P24,000 x 5/12 = P10,000

Adjusting entry:
Depreciation - Machinery 10,000
Accumulated Depreciation - Machinery 10,000

Provision for 5 months depreciation

EXAMPLE 2
Assume that the machinery is depreciated at the rate 4% per annum. The life of the machine
therefore is 25 years computed as follows:
Let x = life
1/x = .04
X = 1/.04
x = 25 years
P260,000 - 20,000/25 = P9,600 x 5/12 = P4,000
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Accrued Interest
How to compute Accrued Interest?

EXAMPLE 1
Assume an 8%, 60-day promissory note for P24,000 received or issued on December 1, 200C

a. If it is a note receivable, the adjusting entry on Dec. 31 is:

Interest receivable 160

Interest income 160

b. If it is a note payable, the adjusting entry on Dec. 31 is:

Interest expense 160

Interest payable 160

Computation: (8% x 24,000 x 30/60) = P160

Nature of Merchandising Business

Merchandising Business
A merchandising or trading business is engaged in the buying of merchandise or goods which
will be sold (in their original form) at a price higher than the purchase cost.

Purchases - used to record the acquisition of merchandise

Sales - used to record revenue/sold merchandise
Merchandise Inventory - unsold merchandise at the end of the accounting period
Cost of Goods Sold - Purchases less ending inventory

Simple Computation for Net Profit/Net Income

Sales 120,000
Less: Cost of Goods Sold
Purchases 80,000
Ending Inventory 15,000 65,000
Gross Profit 55,000
Less: Expenses 35,000
Net Profit/ Income 20,000

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Accounting for Purchases of Merchandise
When merchandise is purchased, the following are the usual terms:

Cash or COD (Cash on Delivery) - the purchase of merchandise is payable in cash.

On credit or On account - the purchase of merchandise is payable at some future time.
Credit term or Credit period - the time within the payment should be made

○ Example of Credit terms:

● n/30 - payable within 30 days from the date of the invoice.
● n/EOM - payable at the end of the month when the purchase is made.
● 10/EOM - payable up to 10 days after the end of the month of the purchase.

Trade Discount - is a special discount given to the buyer for buying in large quantity.
The discount is an outright deduction from the list price hence the amount to be
recorded is the net amount.

Purchase Discount - is a discount given to the buyer for paying within the specified period of
time which is earlier than the credit period.

NOTE: The difference between a trade discount and purchase discount is that trade
discount is deducted on the date of purchased while the purchase discount is deducted
on the date of payment.

Discount Period - is the period of time within which to pay to be entitled to a discount.
○ Examples of Credit terms with discounts offered:
● 2/10, n/30
● 2/10, 1/15, n/30
● 3/EOM, n/60
● 2/10EOM, n/60

Cost of Delivering or Transporting the Goods

Freight In - the costs incurred by the buyer for transporting the goods from the seller’s place to
the buyer’s place.

Purchase Returns and Allowances

The buyer may return the merchandise purchased for any of the following reasons:

● Defective merchandise or they are not in good or satisfactory condition.

● Merchandise may have been damaged while in transit.
● Merchandise arrived too late.
● Merchandise received is not what is ordered.
● The term may not be what has been agreed upon.

Recording the Purchase Merchandise (Periodic Inventory Method)

Example
Jan. 1 - Bought merchandise from Abby Trading, P10,000 terms 2/10, n/30.
Purchases 10,000
Accounts payable 10,000

Jan. 1 - Paid freight on the above purchases, P600.

Freight In 600
Cash 600

Jan. 2 - Returned P2,000 worth of merchandise to Abby Trading

Accounts payable 2,000
Purchase Returns & Allow. 2,000

Jan. 5 - Made a partial payment to Abby Trading, P3,000

Accounts payable 3,000
Cash 3,000

Jan. 10 - Paid Abby Trading in full

Accounts payable 5,000
Purchase discount 160
Cash 4,840

Jan. 14 - Bought merchandise from Barbi Trading with a list price of P10,000 terms COD
with trade discount of 10%
Purchases 9,000
Cash 9,000

Purchases 10,000
Less: (10%x10,000) 1,000

Net Purchases: 9,000

Jan. 15 - Bought merchandise from Corvex Trading with a list price of P20,000 terms 2/10,
n/30 with trade discount of 10% and 5%

Purchases 17,100
Accounts payable 17,100

Purchases
20,000
Less:(10%x20,000) 2,000
(5%x18,000) 900

18,000 - 900 = 17,100

Accounting for Sales of Merchandise

SALES INVOICE - is a document that the seller gives to the buyer listing the items ordered or
sold together.
DELIVERY RECEIPT - is a document issued by the seller and signed by the customer
evidencing receipt of the goods ordered or sold as per the sales invoice
CREDIT MEMO - is a business form used by the seller to notify the buyer that his account is
credited for returns made.

FREIGHT OUT - this is an expense incurred by the seller to transport the goods to the buyer’s
place.

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Recording Sales of Merchandise and Related Transactions
TRANSACTIONS
1. Sales of Merchandise

DEBIT (Value received or Paid for)

Cash
Accounts receivable
Note receivable

CREDIT (Value parted with)

Sales
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Recording Sales of Merchandise and Related Transactions
TRANSACTIONS
2. Sales Returns

DEBIT (Value received or Paid for)

Sales Returns and Allowances

CREDIT (Value parted with)

Cash
Accounts receivable
~~~~~
Recording Sales of Merchandise and Related Transactions
TRANSACTIONS
3. Payment of freight
DEBIT (Value received or Paid for)
Freight Out
CREDIT (Value parted with)
Cash
~~~~~
Recording Sales of Merchandise and Related Transactions
TRANSACTIONS
4. Collection without discount

DEBIT (Value received or Paid for)

Cash

CREDIT (Value parted with)

Accounts Receivable
~~~~~
Recording Sales of Merchandise and Related Transactions
TRANSACTIONS
5. Collection with discount

DEBIT (Value received or Paid for)

Cash
Sales discount

CREDIT (Value parted with)

Accounts Receivable
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Journal Entries - Sales of Merchandise

Jan. 2 - Sold merchandise to Cortez P20,000 terms 2/10, n/30.

Accounts Receivable 20,000
Sales 20,000

Jan. 2 - Paid freight on the above sales, P1,500.

Freight Out 1,500
Cash 1,500

Jan. 3 - Cortez returned P2,000 worth of merchandise.

Sales returns and allowance 2,000
Accounts receivable 2,000

Jan. 4 - Cortez made a partial payment of P10,000.

Cash 10,000
Accounts receivable 10,000

Jan. 12 - Cortez paid his account in full.

Cash 7,640
Sales discount 360
Accounts receivable 8,000
Jan. 15 - Sold merchandise from Cruz P8,000 terms COD with trade discount of 10%
Cash 7,200
Sales 7,200

Jan. 18 - Sold merchandise to Reyes with a list price of P30,000 terms 1/10, n/30 with TD
of 10% and 6%
Accounts receivable 25,380
Sales 25,380