ADJUSTING THE

ACCOUNTS
 Accrual Basis

• The effects and other transactions and other events

are recognized when they occur and not as cash is
received or paid.
• The timing of cash flows is relatively immaterial
for determining when to recognize revenues and
expenses.
 Accrual Basis

• Revenue is recognized when earned and not when

collected and expenses are recognized when
incurred and not when paid.
 Cash Basis

• The accountant does not record a transaction until

cash is received or paid.
• Cash receipts are treated as revenues and cash
payments as expenses.
• Cash basis income is the difference between
operating cash receipts and disbursements.
 Illustration

• A client paid the Sea Wind Resort in Boracay

Island P7,000 on April 8, 2016 for a one-day super
deluxe accommodation on May 13, 2016.
 Periodicity concept

• The only way to know how successfully a business

has operated is to close its doors, sell all its assets,
pay the liabilities and return any excess cash to the
owners.
• To provide timely information, accountants have
divided the economic life of a business into
artificial time periods.
 Periodicity concept

• Fiscal year –period of any twelve consecutive

months
• Calendar year – annual period ending on December
31
• Natural business year – a twelve-month period that
ends when business activities are their lowest level
of the annual cycle
 Periodicity concept

• Interim period – a period of less than a year

 Revenue Recognition Principle

• PAS 18, Revenue states that “revenue is recognized

when it is probable that future economic benefits
will flow to the enterprise and these economic
benefits can be measured reliably.”
 Expense Recognition Principle

• Per the Framework, expenses are recognized in the

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

• Direct association
• Systematic and rational allocation
• Immediate recognition
 The Need for Adjustments

• Accountants make adjusting entries to reflect in the

accounts information on economic activities that
have occurred but have not yet been recorded.
• Adjusting entries assign revenues to the period in
which they are earned, and expenses to the period
in which they are incurred.
 The Need for Adjustments

• 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 proper financial reporting.
 The Need for Adjustments

• Each adjusting entry affects a balance sheet

account (an asset or a liability account) and an
income statement account (income and expense
account).
 Deferrals

• Deferral is the postponement of the recognition of

“an expense already paid but not yet incurred,” or
of a “revenue already collected but not yet earned”.
• This adjustment deals with an amount already
recorded in a balance sheet account.
 Deferrals

• The entry, in effect, decreases the balance sheet

account and increases an income statement
account.
• Deferrals would be needed in two cases:
• Allocating assets to expense to reflect expenses
incurred during the accounting period
• Allocating revenues received in advance to revenue to
reflect revenues earned during the accounting period
 Accruals

• Accrual is the recognition of “an expense already

incurred but unpaid,” or revenue earned but
uncollected”.
• This adjustment deals with an amount unrecorded
in any account.
• The entry, in effect, increases both a balance
sheet and an income statement account.
 Adjustment for deferrals

• 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.
 Adjustment for deferrals

• Two of the more important kind of

adjustments are prepaid expenses (rent,
insurance and supplies) and
depreciation of property and
equipment.
 Illustration

• On May 1, Weddings “R” Us paid P8,000 for two

months’ rent in advance.
• Weddings “R” Us acquired a one-year
comprehensive insurance coverage on the service
vehicle and paid P14,400 premiums.
• On May 8, Weddings “R” Us purchased supplies,
P18,000. The inventory count on hand showed that
supplies costing P15,000 are still on hand.
 Depreciation of Property and
Equipment
• Cost – the amount an entity paid to acquire the
depreciable asset.
• Salvage value – amount that the asset can probably
be sold for at the end of its estimated useful life.
• Useful life – estimated number of periods that an
entity can make use of the asset.
 Depreciation of Property and
Equipment
Asset cost xxx
Less: Estimated salvage value (xxx)
Depreciable cost xxx
Divided by: Estimated useful life xxx
Depreciation Expense for each time period xxx
 Illustration

• Suppose that Wedding “R” Us estimated that the

service vehicle, which was bought on May 4
costing P420,000, will last for seven years and with
a salvage value of P84,000. The office equipment
that was acquired on May 5 costing P60,000 will
have a useful life of five years and will be
worthless at that time.
 Allocating Revenues Received
in Advance to Revenue
• On May 15, Weddings “R” Us received
P10,000 as an advance payment for
referrals made. Assume that by the end of
the month, one of the three couples
referred has already taken their marriage
vows and as a result the amount of P4,000
pertaining to the referred event has been
realized.
 Accrued Expenses

• On May 2, Gevera borrowed P210,000 from

Metrobank. She issued a promissory note that
carried a 20% interest per annum. Both the interest
and principal will be payable in one year.
 Accrued Revenues

• Suppose that Weddings “R” Us agreed to arrange a

rush but simple civil wedding for a madly in love
couple in the afternoon of May 31. The entity
intended to charge fees of P5,300 for the services,
which is earned but unbilled.
 Accrual for Uncollectible
Accounts
• Assume that the entity made credit sales of
P1,100,000 in 2016 and prior experience indicates
an expected 1% average uncollectible accounts rate
based on credit sales.
 Alternative methods of
recording deferrals
• On October 1, 2016, Sunglao Company acquired a
3-year insurance policy for P36,000 paid in
advance.
 Alternative methods of
recording deferrals
• On July 1, 2016, Bacani Company received a
P48,000 check for 2 years’ rent paid in advance.
 Summary
Account Balance Adjusting Entry
Before Adjustment
Balance Income
Type of Sheet Statement Account Account
Adjustment Account Account Debited Credited
Prepaid
Expense
Depreciation
Unearned
Revenues
Accrued
Expenses
Accrued
Revenues
 SUMMARY
Account Balance Before Adjusting Entry
Adjustment
Balance Income
Type of Adjustment Sheet Statement Account Account
Account Account Debited Credited
Prepaid Expense Asset (O) Expense (U) Expense Prepaid Expense
Depreciation Asset (O) Expense (U) Expense Contra Asset
Unearned Revenues Liability Income (U) Unearned Revenue
(O) Revenue
Accrued Expenses Liability Expense (U) Expense Liability
(U)
Accrued Revenues Asset (U) Income (U) Receivable Revenue