(MODULE 4 – The Adjusting Process)

Subject Overview
 No business could operate very long without knowing how
much it was earning and how much it was spending.
 Accounting provides the business with these information,
that’s why accountants are called the scorekeepers of
business.
 Without accounting, a business couldn’t function optimally; it
wouldn’t know where it stands financially, whether it’s making
a profit or not, and it wouldn’t know its financial situation.
 Also, a sound understanding of this language will bring about
a better management of the financial aspects of living.
 Personal financial planning, education expenses, car
amortization, business loans, income taxes and investments
are based on the information system that we call
Accounting.
Objectives
 After this module, the students should be able to:
 Understand the different types of adjustments prepared at the
end of each accounting period.
 Prepare the adjusting entries and understand fully well the
importance of the adjusting entries on the company's
financial statements.
 Compare the accrual and cash basis of accounting.

 Explain Revenue Recognition Principle, Period of time

Principle and the Matching Principle.
 Distinguish deferrals from accruals.

 Know the two methods of recording prepayments (the asset

method and the expense method).
 Learn the two methods of recording income received in
advance.
CASH BASIS OF ACCOUNTING
 The cash basis of accounting recognizes revenue when cash is
received; and recognizes expenses when cash is paid.
For example, under the cash basis, services rendered in year 2019
amounting to P50,000, for which cash is collected in 2020 would be treated as
revenue in year 2020. Similarly, under the cash basis, expenses of P30,000
incurred in 2019 for which cash is disbursed in 2020 are treated as 2020 expense.
Because of these improper assignments of revenues and expenses,
the cash basis of accounting is generally considered unacceptable. There are no
needs for adjusting entries under the cash basis of accounting.

 Income Statement Report

2019 2020
Revenue 0 50,000
Expenses 0 30,000
Net Income 0 20,000
ACCRUAL BASIS OF ACCOUNTING
 The accrual basis of accounting, already discussed in
chapter one, recognizes revenues when sales are made or
services are performed, regardless of when cash is received.
It also recognizes expenses as incurred, whether or not cash
is paid out.
For instance, when services are performed for a customer on account
for P50,000 in 2019, the revenue is recorded at that time even though cash has
not been received. In 2020, when the company received cash no revenue is
recorded because it has already been recorded. Similarly, under the accrual
basis, expenses of P30,000 incurred in 2019 for which cash is disbursed in 2020
are treated as 2019 expense.
Under the accrual basis, adjusting entries are prepared to bring the
accounts up-to-date for economic activities that have taken place but have not
been recorded.

 Income Statement Report

2019 2020
Revenue 50,000 0
Expenses 30,000 0
Net Income 20,000 0
 Accounting period is the period of time, normally one month,
one quarter, or one year into which an entity's life is arbitrarily
divided for financial statement purposes.
 The length of the company's accounting period depends upon how
frequent managers, investors, and other interested people require
information about the company's performance.
 Every business prepares annual financial statements.

 THE ADJUSTING PROCESS

 After the preparation of the trial balance, the next step in the accounting
cycle is the compilation of data for adjustments.
 Compiling adjusting data is the process of gathering and putting
together data necessary to update the balances of some accounts.

 THE NEED FOR ADJUSTING ENTRIES

 Adjusting Entries are entries prepared at the end of an accounting
period to update or adjust the balances of accounts. It is very
important that adjustments be recorded correctly so that the
company's profit for the period be measured properly and its related
assets and liabilities be brought to correct balances for financial
statements.
 All adjusting entries affect at least one income statement account and
one balance sheet account. Thus, an adjusting entry will always
 involve a revenue or an expense account and an asset or a liability
account. Adjusting entries ensure the application of the accrual basis
of accounting and the matching principle.

TYPES OF ADJUSTING ENTRIES

Adjusting entries are generally prepared for the following

items:
1. Accrued Expenses
2. Accrued Revenue
3. Prepaid Expenses or Deferred Expenses
4. Unearned Revenues or Deferred Revenues
5. Depreciation of Property, Plant and Equipment
6. Uncollectible accounts or Bad debts
7. Merchandise Inventory
 Adjusting Entries for Accrued Expenses or
Accrued Liabilities
 Accrued Expenses (a liability account) - are expenses already incurred but not yet
paid. These are also called accrued liabilities or accrued payable.

 Examples of accrued expenses are as follows:

Taxes Payable Interest Payable Utilities Payable Salaries/Wages Payable

Rent Payable Advertising Payable ILLUSTRATION:

Failure to prepare the adjusting entry above, will result to taxes expense for the month of
September to be understated, resulting to an overstatement in the net income for the month of
September. On the other hand, the taxes payable will not be reflected in the balance sheet
thereby understating the total liabilities of the company at September 30, 2015.
Adjusting Entries for Accrued Expenses or
Accrued Liabilities
Since the three days
accrued salaries as of March 31,
pertains to salaries for the month of
March, it has to be included in the
salaries expense for the month of
March by preparing an adjusting entry.
The income statement
prepared by the company for the month
of March would show Salaries Expense
of P 230,000, the salaries which had
been paid amounting to P 200,000 as
shown in the T-account plus the
accrued salaries of P 30,000.

Note: The adjusting entry for an accrued

expense always involves a debit to the
appropriate expense account and a credit
to a liability account.
Adjusting Entries for Accrued Expenses or
Accrued Liabilities

Adjusting Entries for Accrued Revenue or

Accrued Assets
Accrued Revenue (an asset account) -- is revenue already earned by
the business but not yet received or collected at the end of the accounting period.
Normally, accrued revenue is not recorded yet since it has not been received.
Deferred Expenses
 Prepaid Expenses are expenses paid in advance. Since the benefits will be
received in the future, prepaid expenses are treated as asset.
 They are expected to become expenses through the passage of time or through
use and consumption.
 Prepaid expense is the exact opposite of accrued expense.
 Examples of prepaid expense include Supplies, Prepaid Rent, Prepaid Insurance,
and Prepaid Interest.

The adjusting entries for prepaid expenses depend upon the method used to record
the prepayment. The two methods of recording prepaid expenses are the Asset
Method and the Expense Method.

Asset Method - Under this method, the account debited upon payment is an asset
account. Upon adjustment, an expense account is debited with a corresponding credit
to an asset account.

Expense Method - the account debited upon payment is an expense account. Upon
adjustment, an asset account is debited and an expense account is credited.

A company may use either of the two methods, since they are both acceptable.
However, there must be consistency in using the method chosen.
Deferred Expenses
Adjusting Entries for Prepaid Expense or
Deferred Expenses
Adjusting Entries for Prepaid Expense or
Deferred Expenses
Adjusting Entries for Prepaid Expense or
Adjusting Entries for Unearned Revenues or

Deferred Revenues
 Unearned revenues or Deferred Revenues (a liability account) – are revenues
collected or received in advance by the business.
 These revenues are not yet earned but already collected or received by the
business.

The adjusting entries for Unearned Revenues depend upon the method used in
recording the advance collection. The two methods of recording unearned
revenue are as follows:

Liability Method - Under this method, the account credited upon receipt of
cash is a liability account. Upon adjustment, such liability account will be debited and
a revenue account is credited.

Revenue Method or Income Method - the account credited at the date of

collection is a revenue or income account. Upon adjustment, a revenue account is
debited and a liability account is credited.

A company may use any of the two methods since they are both acceptable.
However, the company must be consistent in using the method chosen.
Adjusting Entries for Unearned Revenues or
Adjusting Entries for Unearned Revenues or

Deferred Revenues
Adjusting Entries for Unearned Revenues or

Deferred Revenues

Deferred Revenues
 Failure to adjust the account Unearned Rent Revenue at the end of an
accounting period will cause misstatement of the following items:
Adjusting Entries for Unearned Revenues or
 Unearned Rent Revenue, will be overstated
 Total liabilities, overstated
 Rent Revenue, understated
 Net Income, understated
 If the Unearned Rent Revenue is not adjusted, rent revenue will be understated
because the earned portion of the unearned rent will not be taken up as revenue.
 On the other hand, failure to adjust the account Rent Revenue at the end of an
accounting period will cause misstatement of the following items:
 Rent Revenue, will be overstated
 Net Income, overstated
 Unearned Rent Revenue, understated
 Total Liabilities, understated
 Unearned Rent Revenue will be understated because it has been taken up as
Rent Revenue.
 Rent revenue will be overstated resulting to overstatement of net income.
Deferrals and Accruals Compared
 Deferrals – refers to the postponement of the recognition of
revenue which the company has received or collected in
advance and the postponement of the recognition of expense
which has been paid in advance.
 Thus, under the concept of deferrals income received in
advance should be taken up as liability and expense paid in
advance be taken up as asset.
 Deferrals include prepaid expenses (deferred expenses) and
unearned revenues (deferred revenues).

 Accruals – refer to the recognition of expense already

incurred though not yet paid, and the recognition of revenue
already earned though not yet received.
 Generally Accepted Accounting Principles requires that
adjustments be made for accrued items such as accrued
revenues and accrued expenses.
Adjusting Entries to take up Depreciation of

Adjusting Entries to take up Depreciation

of Property, Plant and Equipment
 Physical resources that are owned and used by a business which are
relatively fixed or permanent in nature that have a long useful life are called
Property, Plant and Equipment.
 They are sometimes called fixed assets or plant assets. Examples include
land, building, equipment, furniture and fixtures and transportation vehicles.
 These assets help generate income for the business. Therefore, it is
important and proper that a portion of the asset cost be recorded as expense
in each accounting period.
 Since fixed assets are expected to be useful for a longer time, it is not
recorded as expense in the year it is acquired but rather it is recorded as an
asset.
 The matching principle requires that a portion of the cost of plant assets be
recorded as expense in each period of usefulness.
 The process of allocating the depreciable cost of a fixed asset over its
estimated useful life is called Depreciation Accounting.
 The accumulated amount of depreciation expense from the year of
recognition to the latest balance sheet date is referred to as accumulated
depreciation.

Property, Plant and Equipment

 The pro-forma adjusting entry to take up depreciation of fixed asset follows:
Depreciation Expense (name of asset) -------------XXX
Accumulated Depreciation (name of asset) -------XXX

 The amount debited to Depreciation Expense is that portion of fixed asset cost
that is charged to expense. Accumulated Depreciation is a contra-asset account.
The credit is not made directly to the fixed asset account in order to preserve
the original cost of the fixed asset.
Factors to be considered in computing depreciation (using the straight line
method):
1. Asset Cost. This includes its purchase price plus other direct costs incurred
in acquiring and bringing the asset to its intended use. Examples of these
other costs are freight cost and installation cost.
2. Estimated Residual Value. This is the estimated amount the fixed asset can
be sold at the end of its useful life. Other terms used are salvage value,
scrap value, or trade in value.
3. Estimated useful life. This may be expressed in years or number of units,
or hours that the asset can be used.
Adjusting Entries to take up Depreciation of
There are several methods of computing depreciation, the most common are:
1. Straight-line method 3. Declining balance method
2. Sum-of-the years digit method 4. Units of production method
Adjusting Entries to take up Depreciation of

Property, Plant and Equipment

Property, Plant and Equipment
Adjusting Entries to take up Depreciation of

Property, Plant and Equipment

Video Links
 Watch: Prepayments & Accruals https://youtu.be/H0N7tvXuJlU?
list=RDCMUCYJLdSmyKoXCbndpklMn5Q
 Watch: Accrued Expense Broken Down https://youtu.be/9aZ6CCj-
ies
 Watch: Accrued Revenue Made Easy https://youtu.be/7ibN25VCvFg
 Watch: How Prepaid Expenses Work
https://youtu.be/RE7wrflFOGA
 Watch: Deferred Revenue Explained
https://youtu.be/F1zNQ1wga7o
 Watch: Straight-line Method of Depreciation in 3 Easy Steps
https://youtu.be/iruD9KTNnNc?
list=RDCMUCYJLdSmyKoXCbndpklMn5Q
 Watch: Depreciation Basics! With Journals
https://youtu.be/_pas1ETbrj8
 Video Lectures by your professor on the Problem Illustrations
of this module will be uploaded in Youtube and will be posted
in Google Classroom and Messenger Group Chat.
ASSIGNMENTS/QUIZZES:
GENERAL INSTRUCTIONS:
 Answers on assigned exercises in this module should be
submitted in Google Classroom.
 Click the posted assignment in Google Classroom then attach
your answers.
 It can be a picture of the answers written on a sheet of paper or
you may type your answers on the spreadsheet provided.
 Once your answers are attached, do not forget to click the TURN
IN button.
 Once turned in, your work will be graded and you may view your
grade in the Google Classroom.
 You may submit your work on or before the due date and time as
stated in our schedule and in the posted assignment in the
Classroom.
 Quizzes will be posted in Google Classroom, to be conducted
through Google Forms, with time limit. Follow the further
instructions and schedules posted in Google Classroom.
M4 -
M4 -
M4
REFERENCES:

 A. Baguio, M. Balbarino, E. Dela Cruz, M. Doquenia, L. Espino, J. Fonte,

M. Hernane, M. Orfiano, L. Pilapil, & C. Vedasto. Principles of
Accounting. 2014 Edition
 W. Ballada & S. Ballada. Basic Accounting Made Easy. 17th Edition 
Pictures were taken or copied from Google Images.
 Video links were taken/copied from Youtube channel Accounting Stuff.