CERTIFIED ACCOUNTING TECHNICIAN LEVEL 1

MODULE 2

Adjusting the Accounts

To provide timely information, business periods are divided into artificial periods which are generally a
month, a quarter, or a year.

Businesses need periodic report to assess their financial condition or performance. During this period,
accountant usually performs recognition or derecognition of accounting transactions.

Recognition – process of capturing for inclusion in the statement of financial position. The initial
recognition of assets or liabilities arising from transactions or other events may result in the simultaneous
recognition of both income and expenses.

Derecognition – removal of all or part of a recognized assets or liability from an entity’s financial
statements. This normally occurs when that item no longer meets the definition of an asset or liability.

Adjusting Entries – are journal entries made at the end of an accounting period that is prepared for the
proper matching of revenues and expenses.

Types of Adjusting Entries Pro-forma Adjusting entries for Accruals

Accrual – recognize income earned
regardless of when it is collected and record Accrued Revenue - income already earned
expense incurred whether paid or not. but not yet collected (Asset).

Deferrals – recording advance collection of income Accounts Receivable xx

(unearned income) or recording advance payment Receivable xx
of expenses (prepaid expense).
Accrued Expense - expense already incurred
Doubtful Accounts – provision for uncollectible but not yet paid (Liability).
accounts.
Expenses xx
Depreciation – allocation of the cost of an asset to Liability xx
expense

Illustrative Problem 1 – Adjusting entries for Accruals

A building owned by Modesto Hotel Services was partly rented by Perez Company for P50,000 per
month payable every 5th day of the following month. The rental for the month of December will be paid on
January 5, 2022.

Accrued Income Accrued Expenses

Books of Modesto Books of Perez
2021 2021
Dec. 31 Rent Receivable 50,000 Dec. 31 Rent Expense 50,000
Rent Income 50,000 Rent Payable 50,000
Income earned not collected. Rent expense not paid.
Illustrative Problem 2 - Accrued Interest.

On May 1, 2021 Modesto borrowed 210,000 from Banco De Oro. She issued a promissory note
that carried 10% interest per annum. Both principal and interest will be paid on Dec. 31, 2021.
Answer the following:
(1) How much is the interest incurred on Dec. 31, 2021?
(2) Prepare adjusting entry.

Suggested Answer:
1. Interest = Principal x interest rate x length of time) that is; P210,000 x 10% x 8/12 = P 14,000.
2. Adjusting Entry:
12/31/21 - Interest expense P 14,000
Interest payable P14,000
To accrue interest expense for loan borrowed.

ADJUSTMENTS FOR DEFERRALS

Prepayments – advance payment Pre-collection – advance collection
Prepaid Expense – expenses already paid but not
Unearned income – income received not yet earned
yet incurred
Ex.: Prepaid rent, Unused supplies Ex.: Unearned service income, Unearned fees revenue

Two methods of recording prepayments Two methods of recording pre-collections

1. Expense method – upon payment, expense 1. Income method – upon collection, an income
account is debited account is credited
2. Asset method – upon payment, asset account is 2. Liability method – upon collection, a liability
debited account is credited

Illustrative Problem 3 – Prepayments

On September 1, 2021, Adam Realty paid an insurance premium covering the period from September 1, 2021
to September 1, 2022 in the amount of P3,000. The accounting period ends December 31, 2021.

Comparative Journal Entries

Expense Method Asset Method
Sept. 1, Insurance Expense 3,000 Prepaid Insurance 3,000
2021 Cash 3,000 Cash 3,000
Insurance premium paid Insurance premium paid
Prepaid Expense 2,400 Insurance Expense 1,200
Dec. 31, Insurance Expense 2,400 Cash 1,200
2021
Take up unexpired (asset) portion Take up expense portion
Illustrative Problem 4 – Precollection

On October 1, 2021 Adam Realty collected P24,000 from a tenant representing an advance collection from
building rentals for one year. The accounting period ends on December 31, 2021.

Comparative Journal Entries

Income Method Liability Method
Oct. 1, Cash 24,000 Cash 24,000
2021 Rent Income 24,000 Unearned Rent Income 24,000
Collection of advance rental Collection of advance rental
Rent Income 18,000 Unearned Rent Income 6,000
Dec. 31, Unearned Rent Income 18,000 Rent Income 6,000
2021 Unearned portion (liability) of rental collected Earned portion (income) of rental
in advance collected in advance
 FAQs

1. When do we record adjusting entries?

- Adjusting entries are journal entries recorded at the end of an accounting period to alter the
ending balances in various general ledger accounts. Before financial statements are prepared,
additional journal entries, called adjusting entries, and are made to ensure that the company's
financial records adhere to the revenue recognition and matching principles.

2. What expenses are to be accrued?

- Here are some common examples of expenses that can be accrued:
a. Interest on borrowed loans
b. Supplies received but not yet paid
c. Services received
d. Employee Salaries
e. Taxes
f. Commissions
g. Utilities
h. Rent

3. What is the difference between accrued expenses and accounts payable?

- Accrued expenses are expenses a company knows it must pay, but cannot do so because it has
not yet been billed for them. The company accounts for these costs so that the management has
a better indication of what its total liabilities really are. This will allow the company to make better
decisions on how to spend its money. Accounts payable are debts for which invoices have been
received, but have not yet been paid. Both accrued expenses and accounts payable are
accounted for under “Current Liabilities” on a company’s balance sheet. Once an accrued
expense receives an invoice, the amount is moved into accounts payable.

Constructing Worksheet and Financial Statements

Accountants often use a worksheet to help transfer data from the unadjusted trial balance to the
financial statements. An accounting worksheet is a multi-column document that is used to determine
the accuracy of the financial statements prepared by a company at the end of the accounting period. It
also assists in keeping track of the steps involved in the accounting cycle.

For this lesson, take note and be reminded about the following:

Worksheet – is a columnar sheet used as a tool or bridge connecting the Trial Balance and Financial
Statements.

Real accounts (permanent accounts) – these are the elements of financial statements found in the
statement of financial position (balance sheet), namely Assets, Liabilities and Owner’s Equity.

Nominal accounts (temporary accounts) – these are the elements of financial statements found in the
statement of financial performance (income statement), namely: Income and Expenses.

Profit – when the income earned is greater the expenses incurred during the period.

Loss – when the income earned is less than the expenses incurred during the period.

The steps in the preparation of a worksheet follow:

 Steps in the preparation of a worksheet
Step 1 Write the name of the business or proprietor if there is no trade name, the title of
the report and the period covered by the report. These are written at the center of
the uppermost portion of the columnar sheet. The period maybe for a month, a
quarter, a semi-annual accounting period or a year;
Step 2 Copy the trial balance “as it is” in the unadjusted trial balance column of the
worksheet and double rule;
Step 3 Enter the adjusting entries in the Adjustments Column; make sure that a letter
marking is used in order to identify the debit entry and the corresponding credit
entry. If the account title is not in the TB, write it below the last account title of the
TB. The debit and credit totals of the adjustments column should be equal.
Step 4 Total horizontally each account (observing the debit and credit rules) and write the
new account balance under the “adjusted trial balance” column.
Step 5 Extend the balances of the nominal accounts to the statement of financial
performance (income statement) section observing the debit and credit balances of
accounts appearing in the Adjusted Trial Balance.
Step 6 Extend the balances of the real accounts to the statement of financial position
(balance sheet) section observing the debit and credit balances of accounts
appearing in the Adjusted Trial Balance.
Step 7 Foot the debit and credit amount columns of the statement of financial
performance and statement of financial position and place the totals at the bottom
of their respective columns in the same line with the double ruled total of the trial
balance.

At this point, the following results can be observed:

1. The amounts of the debit and credit columns of both the statement of financial
performance and the statement of financial position are not equal.
2. That the amount of difference between the debit and credit money columns of
the statement of financial performance is the same amount of difference between
the debit and credit columns of statement of financial position.
3. The same amount of difference between the debit and credit totals of both the
statement of financial performance and statement of financial position represents
either the “profit” or “loss” from operations.
Step 8 Enter the amount of difference in the columns of both the statement of financial
performance and statement of financial position which showed a smaller total in
the next line following their totals and label it their “Net Income” or “Loss”.
Step 9 After the “Profit” of “Loss” is extended, total the debit and credit columns of the
statement of financial performance and statement of financial position. As they now
have equal balances, double rule the amounts.
 Lara Jean Repairs and Maintenance Service
Worksheet
For the month ended 31 June 2022
Unadjusted Adjusted Statement of Financial Statement of Financial
Adjustments
Trial Balance Trial Balance Performance Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash in Bank 743,000
Accounts Receivable 35,000
Repair Supplies 90,000
Repair Equipment 150,000
Notes Payable 100,000
Accounts Payable 30,000 Balance in the unadjusted balance is exactly the
L. Jean, Capital 850,000 same as the trial balance. The totals of debit and
L. Jean, Drawing 10,000 credit are equal.
Repair Income 80,000
Salaries Expense 10,000
Rent Expense 5,000
Utilities Expense 12,000
Taxes and Licenses 4,000
Interest Expense 1,000
Single rule the sum of each
Total 1,060,000 1,060,000 column. No peso sign was used
in this worksheet.

Adjusting Entries
Estimated Uncollectible
P 350 Depreciation Expense P 2,500
a Accounts c
Allowance for Uncollectible P 350 Accumulated Depreciation P 2,500
b Repair Supplies Expense P 20,000 d Advertising Expense P 3,000
Repair Supplies P 20,000 Accrued Advertising P 3,000
 Lara Jean Repairs and Maintenance Service
Worksheet
For the month ended 31 June 2022
Unadjusted Adjusted Statement of Financial Statement of
Adjustments
Trial Balance Trial Balance Performance Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash in Bank 743,000
Accounts Receivable 35,000
Repair Supplies 90,000 (b) 20,000
Repair Equipment 150,000
Notes Payable 100,000
Accounts Payable 30,000
L. Jean, Capital 850,000
L. Jean, Drawing 10,000 Letters were identified and
Repair Income 80,000 sequenced according to the
Salaries Expense 10,000 adjusting entries.
Rent Expense 5,000
Utilities Expense 12,000
Taxes and Licenses 4,000
Interest Expense 1,000
Total 1,060,000 1,060,000
Adjustments:
Uncollectible Account (a) 350
Est. Uncollectible Acct. (a) 350
Repair Supplies Exp. (b) 20,000
Depreciation Expense (c) 2,500
Accum. Depreciation (c) 2,500
Advertising Expense (d) 3,000
Accrued Advertising (d) 3,000
Total 25,850 25,850
 Lara Jean Repairs and Maintenance Service
Worksheet
For the month ended 31 June 2022
Unadjusted Adjusted Statement of Financial Statement of
Adjustments
Trial Balance Trial Balance Performance Financial Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash in Bank 743,000 743,000
Accounts Receivable 35,000 35,000 The amounts in the unadjusted trial balance
and adjustments are combined. If the
Repair Supplies 90,000 (b) 20,000 70,000
amounts have the same column, they are
Repair Equipment 150,000 150,000 added. If the amounts have opposite
Notes Payable 100,000 100,000 columns, say, one is in the debit and the
Accounts Payable 30,000 30,000 other one is in the credit, get their difference
L. Jean, Capital 850,000 850,000 and follow the column of the amount which
has the greater value.
L. Jean, Drawing 10,000 10,000
Repair Income 80,000 80,000
Salaries Expense 10,000 10,000
Rent Expense 5,000 5,000
Utilities Expense 12,000 12,000
Taxes and Licenses 4,000 4,000
Interest Expense 1,000 1,000
Total 1,060,000 1,060,000
Adjustments:
Uncollectible Account (a) 350 350
Est. Uncollectible Acct. (a) 350 350
Repair Supplies Exp. (b) 20,000 20,000
Depreciation Expense (c) 2,500 2,500
Accum. Depreciation (c) 2,500 2,500
Advertising Expense (d) 3,000 3,000
Accrued Advertising (d) 3,000 3,000
Total 25,850 25,850 1,065,850 1,065,850
 Lara Jean Repairs and Maintenance Service
Worksheet
For the month ended 31 June 2022
Unadjusted Adjusted Statement of Financial Statement of Financial
Adjustments
Trial Balance Trial Balance Performance Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash in Bank 743,000 743,000 743,000
Accounts Receivable 35,000 35,000 35,000
Repair Supplies 90,000 (b)20,000 70,000 70,000
Repair Equipment 150,000 150,000 150,000
Notes Payable 100,000 100,000 100,000
Accounts Payable 30,000 30,000 30,000
L. Jean, Capital 850,000 850,000 850,000
L. Jean, Drawing 10,000 10,000 10,000
Repair Income 80,000 80,000 80,000
Salaries Expense 10,000 10,000 10,000
Rent Expense 5,000 5,000 5,000
Utilities Expense 12,000 12,000 12,000
Taxes and Licenses 4,000 4,000 4,000
Interest Expense 1,000 1,000 1,000
Total 1,060,000 1,060,000
Adjustments:
Uncollectible Account (a) 350 350 350
Est. Uncollectible Acct. (a) 350 350 350
Repair Supplies Exp. (b) 20,000 20,000 20,000
Depreciation Expense (c) 2,500 2,500 2,500
Accum. Depreciation (c) 2,500 2,500 2,500
Advertising Expense (d) 3,000 3,000 3,000
Accrued Advertising (d) 3,000 3,000 3,000
Total 25,850 25,850 1,065,850 1,065,850 57,850 80,000 1,008,000 985,850
22,150 22,150
80,000 80,000 1,008,000 1,008,000
The profit or loss is balancing figure for both the income statement and the
balance sheet. The difference in statement of financial performance section and statement of financial
position section is the same.
STATEMENT OF FINANCIAL POSITION

The statement of financial position is a statement that shows the financial position or condition of an entity by
listing the assets, liabilities, and owner’s equity as at the specific date. This statement is also called the balance
sheet. The balance sheet can be presented In either the following format:

Report format – balance sheet format that lists assets, liabilities and owner’s equity in vertical sequence.
Account format – balance sheet format that lists the assets on the left side and the liabilities and owner’s equity
on the right side.

STATEMENT OF CASH FLOW

The statement of cash flows provides information about cash receipts and cash payments of an entity during the
period. This statement is presented in the following format:

Direct method – a method in preparing the statement of cash flow from operating activities by adding the
individual operating cash inflows and subtracting the individual operating cash outflows.
Indirect method – a method in preparing the statement of cash flow from operating activities by adjusting profit
for income and expense items not resulting from cash transactions.

Statement of cash flow presents cash flows from the following activities:

Operating Activities – the inflows and outflows of cash from the normal operating activities of the business.
Investing Activities – the inflows and outflows of cash from the sale or purchase of assets other than inventory.
Financing Activities – the inflows and outflows of cash from the owners and creditors of the enterprise.

Relationships Among Financial Statements:

1. The statement of financial performance reports all income and expenses during the period. The profit or loss
is the final figure in this statement.
2. The statement of changes in equity considers the profit or loss figure from the income statement as one of
the determining factors that explains the change in owner’s equity.
3. The statement of financial position reports the ending owner’s equity, taken directly from the statement of
changes in equity.
4. The statement of cash flows reports the net increase or decrease in cash during the period and ends with
cash balance reported in the balance sheet. This statement is prepared based on information from the
income statement and the balance sheet
Using the data of the illustrative problem above, the financial statements can now be prepared.

Lara Jean Repairs and Maintenance Service

Statement of Financial Performance
For the month ended 31 June 2022

Revenue:
Repair Income P80,000

Operating Expenses:
Uncollectible Accounts P350
Depreciation Expense 2,500
Salaries Expense 10,000
Rent Expense 5,000
Utilities 12,000
Repair Supplies Expense 20,000
Taxes and Licenses 4,000
Advertising Expense 3,000 56,850
Operating Income 23,150
Less: Finance Charges
Interest Expense 1,000
Profit for the month P22,150

Usually, the Statement of Financial Performance is the first statement that will be prepared because aside from
the reason that this is shown ahead of the Balance Sheet in the worksheet, it is much easier to gather the data
and the format is so simple.

Lara Jean Repairs and Maintenance Service

Statement of Changes in Owner's Equity
For the month ended 31 June 2022

L. Jean, Capital - June 1, 2022 P850,000

Add: Additional Investment P -
Profit 22,150 22,150
Total 872,150
Less: Withdrawal 10,000
L. Jean, Capital - June 31, 2022 P862,150

Note that L. Jean, Capital beginning of P850,000 was reduced by his withdrawal of P10,000 and increased by
P22,150 representing the profit for the month or a new total of P862,150. This is the present owner’s capital
and the same will appear in the Statement of Financial Position below.
 Lara Jean Repairs and Maintenance Service
Statement of Financial Position
As of June 31, 2022

ASSETS
Current Assets:
Cash in Bank P743,000
Accounts Receivable P35,000
Less: Estimated Uncollectible Accounts 350 34,650
Laundry Supplies 70,000
Total Current Assets 847,650

Non-Current Assets:
Property and Equipment
Laundry Equipment 150,000
Less: Accumulated Depreciation 2,500
Total Non-Current Assets 147,500
Total Assets P995,150
LIABILITIES
Current Liabilities:
Notes Payable P100,000
Accounts Payable 30,000
Accrued Advertising 3,000
Total Current Liabilities 133,000
OWNER'S EQUITY
Equity
L. Jean, Capital 862,150
Total Liabilities and Owner's Equity P995,150

For purposes of this illustration, the format used is report format. Note however, that the standards did not specify
the required format, hence the company can use either report format or account format.

The next statement that can be prepared is the Statement of Cash Flows, for purposes of this illustration the
direct method is used in presenting the Statement of Cash Flows.
Cash-in-Bank
December 1 – Investment P850,000 – Financing December 3 – P150,000 – Laundry Equipment – Investing
17 – Bank Loan of P100,000 – Financing 10 - P4,000 – Payment of taxes – Operating
21 – Collection of P45,000 – Operating 12 -P10,000 – Withdrawal - Financing
17 -P1,000 – Payment of Interest – Operating
25 - P60,000 – Payment of Supp. – Operating
30 - P27,000 – Payment of Rent (P5,000), Utilities
(P12,000), Salary (P10,000 )

The cash ledger is shown above to explain how the cash balance became P743,000 at the end of the period.
The debit side would give you an idea of the sources of cash and the credit side gives you an idea of the uses
of cash. The difference between sources of cash in the amount of P995,000 and the uses of cash in the
amount of P252,000 in the cash balance at the end of the period, P743,000.
 Lara Jean Repairs and Maintenance Service
Statement of Cash Flow
As of June 31, 2022

Cash Flows from Operating Activities:

Cash collections from customers P45,000
Payment of taxes and licenses (4,000)
Purchase of Repair Supplies (60,000)
Payment of Salaries (10,000)
Payment of rental (5,000)
Payment of utilities (12,000)
Payment of interest (1,000)
Net cash provided by (used in) operating activities (47,000)
Cash Flows from Operating Activities:
Purchases of repair equipment (150,000)
Net cash provided by (used in) investing activities (150,000)
Cash Flows from Financing Activities:
Cash received as an investment by owner 850,000
Cash received from bank loan 100,000
Payment for withdrawn by owner (10,000)
Net cash provided by (used in) financing activities 940,000
Net Increase (Decrease) in Cash 743,000
Add: Cash Balance at the beginning of the period -
Cash Balance at the end of the period P743,000

FAQs
1. How accounts should be classified in the Statement of Financial Position?
- The revised accounting standard, PAS 1, does not prescribed the order of format in which
an entity presents items in the Statement of Financial Position. What is required is the
current and non-current distinction for assets and liabilities.

2. What is the importance and use of financial statements?

- Users of the financial statements analyze the balance sheet to evaluate an entity’s liquidity,
its financial flexibility, and it’s ability to generate profits, and it’s solvency.

3. Why is it important to present and prepare the statement of Cash Flow?

- The statement of cash flow reports the net increase or decrease in cash during the period
ends with the cash balance reported in the balance sheet. This statement is prepared based
on the information from the income statement and the balance sheet.

Completing the Accounting Cycle

At the end of each year, the balances of temporary accounts are transferred to the capital account.
This phase of the accounting cycle is called the closing procedure. A temporary account is closed
when an entry is made to bring its balance to zero. A summary account – Income Summary is used to
close the income and expense accounts. Closing the books of accounts signals the end of the
accounting period.
Closing process involves the following process:

1. Close the income accounts

 Income accounts have credit balances before the closing entries are posted. For this reason, an
entry debiting each revenue account in the amount of its balance is needed to close the account.
The credit is made to the income summary account. The entry to close the income accounts for the
Lara Jean Repairs and Maintenance Service is as follows:

March 31 Repair Income 80,000

Income Summary 80,000

2. Close the expense accounts

Expense accounts have debit balances before the closing entries are posted. For this reason, a
compound entry is needed to credit all expense accounts and debit the income summary for the
total. These data can be found in the debit side of the income statement column of the worksheet.

Mar-31 Income Summary 57,850

Salaries Expense 10,000
Rent Expense 5,000
Utilities Expense 12,000
Taxes and licenses 4,000
Interest Expense 1,000
Uncollectible Accounts Expense 350
Repair Supplies Expense 20,000
Depreciation Expense 2,500
Advertising Expense 3,000

Close the income summary account

After posting the closing entries involving the income and expense accounts, the balance of the
income summary account will be equal to the profit or loss for the period. A profit is indicated by a
credit balance and a loss by a debit balance. The income summary account, regardless of the nature
of its balance, must be closed to the capital account. For Lara Jean Repairs and Maintenance
Service, the entry is as follows:

March 31 Income Summary 22,150

L. Jean, Capital 22,150

3. Close the withdrawal account

The withdrawal account shows the amount by which it was increased during the period by
withdrawals of cash or other assets of the business by the owner for personal use for this reason,
the debit balance of the withdrawal account must be closed to the capital account as follows:

March 31 L. Jean, Capital 10,000

L. Jean, Withdrawal 10,000

The effect of posting this closing entry is to close the withdrawal account and to transfer the balance to
the capital account.
 Statement of Financial Statement of Financial
Closing Entries
Performance Position
Account Titles Dr. Cr. Dr. Cr. Dr. Cr.
Cash in Bank 743,000
Accounts Receivable 35,000
Repair Supplies 70,000
Repair Equipment 150,000
Notes Payable 100,000
Accounts Payable 30,000
L. Jean, Capital 850,000 4 10,000 3 22,150
L. Jean, Drawing 10,000 4 10,000
Repair Income 80,000 1 80,000
Salaries Expense 10,000 2 10,000
Rent Expense 5,000 2 5,000
Utilities Expense 12,000 2 12,000
Taxes and Licenses 4,000 2 4,000
Interest Expense 1,000 2 1,000
Total
Adjustments:
Uncollectible Account 350 2 350
Est. Uncollectible Act. 350
Repair Supplies Exp. 20,000 2 20,000
Depreciation Expense 2,500 2 2,500
Accum. Depreciation 2,500
Advertising Expense 3,000 2 3,000
Accrued Advertising 3,000
Income Summary 2 57,850 1 80,000
3 22,150
Total 57,850 80,000 1,008,000 985,850 170,000 170,000
22,150 22,150
80,000 80,000 1,008,000 1,008,000

FAQs
Do closing entries has an impact in the financial statements?
- Yes. Closing entries follow period-end adjustments in the closing cycle. Missing a closing entry
causes misreporting of the current period's retained earnings, and if not corrected, it creates
errors in the current or next period's financial reports.

It is possible to commit an error in posting the adjustments and closing entries to the ledger accounts; thus, it is
necessary to test the equality of the accounts by preparing a new trial balance called post-closing trial balance.

✓ The post-closing trial balance verifies that all the debits equal the credits in the trial balance.
✓ The trial balance contains only balance sheet items such as assets, liabilities, and ending capital because
all income and expense accounts, as well as the withdrawal account, have zero balances.

Note that only the balance sheet accounts have balances because at this point, all the income statement
accounts have been closed. Preparing the post-closing trial balance may not be the last step in the accounting
cycle. Some entities elect to reverse certain end-to-period adjustments on the first day of the new period.
 Reversing entry
✓ is a journal entry which is the exact opposite of a related adjusting entry made at the end of the period.
✓ a technique to simplify the recording of regular transactions in the next accounting period.
✓ Optional
✓ made for any adjusting that increased/created an asset or liability.

Illustration. To show how reversing entries can be helpful, let’s try to revisit our previous sample case of
Lara Jean Repairs and Maintenance Service.

Adjusting Entry to record Advertising Expense:

Mar. 31 Advertising Expense 3,000

Accrued Advertising 3,000
Closing Entry

Mar. 31 Income Summary 3,000

Advertising Expense 3,000
Reversing Entry

Mar. 31 Accrued Advertising 3,000

Advertising Expense 3,000

Payment Entry

Apr. 10 Advertising Expense 12,000

Cash 12,000

These transactions had the following effects on advertising expense:

a. Adjusted advertising expense to accrue P3, 000 in the proper accounting period.
b. Closed the correct total advertising expense during the period, including the advertising expense
accrued up to March 31.
c. Established a credit balance of P3,000 on April 1 in advertising expense equal to the expense
recognized through the adjusting entry on March 31. The liability account Accrued
Advertising was reduced to zero balance.
d. Recorded the P12, 000 payment of twelve months advertising coverage in the usual manner. The
reversing entry has the effect of leaving the balance of P9,000 in the advertising expense account.
This P9,000 balance represented the nine months’ expense in the next accounting period.
FAQs
What type of adjustments should be reversed?
- The only types of adjusting entries that may be reversed are those that are prepared for the
following:
• accrued income,
• accrued expense,
• unearned revenue using the income method, and
• prepaid expense using the expense method.
Preparing the Worksheet, including Journalizing and posting adjusting and closing entries in a merchandising business

PREPARING THE WORKSHEET

The extension of the beginning and ending inventory balances requires some new procedures. First, the
beginning inventory balance is extended to the debit column of the income statement. This procedure has the
effect of adding beginning inventory to net cost of purchases; observe that the purchases account is also in the
debit column of the income statement.

Second, the ending inventory balance which is not in the trial balance is entered in the credit column of the
income statement. This procedure has the effect of subtracting the ending inventory from goods available for sale.
Note that two inventory amounts appeared in the income statement columns. This is because both the beginning
inventory and the ending inventory are needed in the computation of cost of sales.

Finally, the ending inventory is also entered in the debit column of the balance sheet

STATEMENT OF FINANCIAL PERFORMANCE FORMAT

Nature of Expenses Format

All expenses are presented under the general label of Operating Expenses in the Statement of Financial
Performance. Examples include raw materials, supplies used, employee benefits expense, depreciation and
amortization expense, transportation costs, advertising costs and other operating expenses.

Function of Expense Format

This method, also referred to as the “cost of sales” format, classifies expenses according to their function. The
expenses are presented under the following categories:
• cost of sales
• distribution /selling expense
• administrative expense
• other operating expenses
ADJUSTING ENTRIES FOR A MERCHANDISING ENTITY

Adjusting entries are generally the same for merchandising and service entries except for an entry to set up the
ending inventory under the periodic inventory system after physical count is made.

CLOSING ENTRIES

Closing entries are also similar to service entities except for some unique nominal accounts that arise from
merchandising operations. These accounts include Purchases, Freight In, Purchase Returns and Allowances,
Purchase Discount, Sales, Sales Returns and Allowances, Sales Discount and Freight Out.
Illustrative Problem
Adjusting and Closing Entries

MICB Company
Trial Balance
As of December 31, 2020

Cash 176,866
Accounts receivable 53,300
Merchandise inventory 50,000
Store supplies 10,000
Store equipment 50,000
Delivery equipment 350,000
Accounts payable 42,560
VAT Payable 846
Capital 660,000
Purchases 148,600
Freight in 3,000
Purchase returns and allowances 1,500
Purchase discount 1,542
Sales 141,250
Sales returns and allowances 1,200
Sales discount 1,140
Freight out . 2,000
_________________________
846,852 846,852

MICB COMPANY
Statement of Cost of Goods Sold
For the year ended December 31, 2021

Merchandise inventory, beginning 50,000

Add: Purchase 148,600
Freight in 30,000
Gross purchases 151,600
Less: Purchase returns 1,500
Purchase discounts 1,542 3,042 148,558
Goods Available for sale 198,558
Less: Merchandise inventory, end 98,000
Cost of goods sold 100,558

The adjusting entry is:

Date Particulars Debit Credit

Merchandise inventory 98,000

Income summary 98,000

Closing entries from the above Illustrative Problem are as follows:

Date Particulars Debit Credit

Dec Sales 141,250

Sales Returns & Allows 1,200
Sales discount 1,140
Freight out 2,000
Income summary 136,910
Dec Income summary 198,558
Purchase Returns & Allows 1,500
Purchase Discounts 1,542
Purchases 148,600
Merchandise Inventory, beg 50,000
Freight In 5,000

POST-CLOSING TRIAL BALANCE

A post-closing trial balance is a list of balances of ledger accounts prepared after closing entries have been
prepared and posted to the ledger accounts. Since the closing entries transfer the balances of temporary
accounts (i.e. expense, revenue, gain, dividend and withdrawal accounts) to the capital account, the new
balances of the temporary accounts are zero and therefore they are not listed on a post-closing trial balance.
However, all the other accounts having non-negative balances are listed including the capital account.

Illustrative Problem
ADJUSTING AND CLOSING ENTRIES

MICB Company
Trial Balance
As of December 31, 2021

Cash 176,866
Accounts receivable 53,300
Merchandise inventory 50,000
Store supplies 10,000
Store equipment 50,000
Delivery equipment 350,000
Accounts payable 42,560
VAT Payable 846
MICB, Capital 660,000
Purchases 148,600
Transportation in 3,000
Purchase return and allowances 1,500
Purchase discount 1,542
Sales 141,250
Sales returns and allowances 1,200
Sales discount 1,140
Transportation out 2,000 ________
Totals 846,852 846,852
 MICB COMPANY
Statement of Cost of Goods Sold
For the year ended December 31, 2021

Merchandise inventory, beginning 50,000

Add: Purchase 148,600
Transportation in 30,000
Gross purchases 151,600
Less: Purchase returns 1,500
Purchase discounts 1,542 3,042 148,558
Goods Available for sale 198,558
Less: Merchandise inventory, end 98,000
Cost of goods sold 100,558
The adjusting entry is:

Date Particulars Debit Credit

Dec Merchandise inventory 98,000

Income summary 98,000

Closing entries from the above Illustrative Problem are as follows:

Date Particulars Debit Credit

Dec Sales 141,250

Sales Returns & Allows 1,200
Sales discount 1,140
Freight out 2,000
Income summary 136,910

Dec Income summary 198,558

Purchase Returns & Allows 1,500
Purchase Discounts 1,542
Purchases 148,600
Merchandise Inventory, beg 50,000
Freight In 5,000

MICB COMPANY
Post-Closing Trial Balance
As of December 31, 2020

Account Title Debit Credit

Cash 176,866
Accounts receivable 53,200
Merchandise inventory 98,000
Store supplies 10,000
Store equipment 50,000
Delivery equipment 350,000
Accounts payable 42,560
VAT Payable 846
MICB, Capital 696,352
738,912 738,912
EXERCISES
E1: Direction: Practice what you understand by answering the proceeding problem.

On August 1, 2021, Peter Company insured its property with Pru Life Insurance Company and pays premium of P24,000
for one year policy contract covering the period from Aug. 1, 2021 to Aug. 1, 2022. The accounting ends on December 31,
2021.

Assuming expense method is used:

1. What is the journal entry to record the advance payment?
2. On December 31, 2021, how much is the unexpired portion of the Insurance premium paid in advance
3. What is the adjusting entry on December 31, 2021?
4. In your adjusting entry, what account will you record, Asset or Expense?
5. In your adjusting entry, are you increasing or decreasing the amount of your Insurance Expense account?
6. After posting the adjusting entry, how much is the balance of the Insurance Expense account?

Assuming asset method is used:

7. What is the journal entry to record the advance payment?
8. How much is the unexpired portion of the Insurance Expense account as of December 31, 2021?
9. What is the adjusting entry on December 31, 2021?
10. In your adjusting entry, what account will you record, Asset or Expense?
11. In your adjusting entry, are you increasing or decreasing the amount of your Prepaid Insurance account?
12. After posting the adjusting entry, how much is the balance of the Prepaid Insurance account?

E2: Direction: Practice what you understand by answering the proceeding problem.

On October 1, 2021, Adam Realty Co. collected the amount of P60,000 representing advanced rental from a tenant who
occupies a space of the building. The advanced rental will cover the period Oct. 1, 2021 to October 1, 2022. The
accounting period ends on December 31, 2021.

Assuming the income method is used:

1. What is the journal entry to record the advance collection?
2. How much is the unearned portion of the amount received in advance as of December 31, 2021?
3. What is the adjusting entry to record on December 31, 2103?
4. In your adjusting entry, what account will you record, Income or Liability?
5. In your adjusting entry, are you increasing or decreasing the amount of your Rent Income account?
6. After posting the adjusting entry, how much is the balance of the Rent Income account?

Assuming the liability method is used:

7. What is the journal entry to record the advance collection?
8. How much is the earned portion of the amount received in advance as of December 31, 2021?
9. What is the adjusting entry to record on December 31, 2103?
10. In your adjusting entry, what account will you record, Liability or Income?
11. In your adjusting entry, are you increasing or decreasing the amount of your Rent Income account?
12. After posting the adjusting entry, how much is the balance of the Unearned Rent Income account?

E3: Directions: Check what you have understood by answering the following problem.

As of December 31, 2021, Mr. Koekie Dano holds a 60-day, 10% note of P240,000 signed by Ms. Joy Ursula dated
November 1, 2021.

Answer the following questions or do what is requested.

1. Prepare the journal entry in the books of Mr. Dano upon released of the money.
2. How much interest would be earned upon maturity of the note?
3. How much is the maturity value of the note?
4. How much interest earned by Mr. Dano as of December 31, 2021?
5. Prepare adjusting entry on the books of Mr. Dano to record adjustments on December 31, 2021?
E4: Direction: Practice what you understand by answering the proceeding problem.

Presented below is the worksheet of Anna Mae Company.

Anna Mae Company

Unadjusted Trial Balance
December 31, 2022
Debit Credit
Cash 9,316
Accounts Receivable 1,690
Prepaid Insurance 1,200
Laundry Supplies 390
Laundry Equipment 4,400
Accounts Payable 3,990
Anna Mae, Drawing 800
Anna Mae, Capital 12,000
Laundry Service Revenue 300
Store Rent Expense 1,040
Utility Expense 154
Total 18,990 16,290

Adjustments:
1. Insurance Expense 100
Prepaid Insurance 100
To record the one-month expiration of prepaid insurance
2. Laundry Supplies Expense 196
Laundry Supplies 196
To record usage of repairs supplies
3. Depreciation Expense-Laundry Equipment 70
Accumulated Depreciation-Laundry Equipment 70
To record depreciation of Repair Equipment
4. Income Tax Expense 40
Income Tax Payable 40
To record provision for income tax
5. Uncollectible Accounts Expense 30
Allowance for Uncollectible Accounts 30
To record provision for uncollectible accounts
 Anna Mae Company
Worksheet
As of December 31, 2022
Unadjusted Trial Statement of Financial Statement of Financial
Adjustments Adjusted Trial Balance
Account Titles Balance Performance Position
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Cash 9,316 9,316 9,316
Accounts Receivable 1,690 1,690 1,690
Prepaid Insurance 1,200 (a) 100 1,100 1,100
Laundry Supplies 390 (b) 196 194 194
Laundry Equipment 4,400 4,400 4,400
Accounts Payable 3,990 3,990 3,990
Anna Mae, Capital 12,000 12,000 12,000
Anna Mae Withdrawal 800 800 800
Bicycle Repair Revenue 3,000 3,000 3,000
Store Rent Expense 1,040 1,040 1,040
Utility Expense 154 154 154
Total 18,990 18,990
Adjustments:
Insurance Expense (a) 100 100 100
Laundry Supplies Expense (b) 196 196 196
Depreciation Expense - Eqt (c) 70 70 70
Accumulated Dep’n - Eqpt (c) 70 70 70
Income Tax Expense (d) 40 40 40
Income Tax Payable (d) 40 40 40
Uncollectible Accts Exp. (e) 30 30 30
Allow. for Uncoll. Accts (e) 30 100 30
Total 436 436 19,130 19,130 1,630 3,000 17,500 16,130
1,370 1,370
3,000 3,000 17,500 17,500
Based on the worksheet prepared for Anna Mae Company, prepare the following financial statements. Note not to forget
the header for each statement.

1. Statement of Financial Performance

2. Statement of Changes in Owner’s Equity
3. Statement of Financial Position
4. Statement of Cash Flows
E5: Direction: Classify the accounts below as permanent or temporary.
Answer:
1. Rent Expense
2. Prepaid Insurance
3. Accounts Receivable
4. Supplies Expense
5. Accumulated Depreciation – Equipment

E6: Direction: Answer the subsequent questions using the problem below:

The following is the income summary account of Lalala Services on Dec. 31, 2021, after all revenue and expenses
have been closed to the account.

Income Summary

197,000 190,000

3. What do the figures in the account represent?

Answer:

4. What is the profit or loss?

Answer:

5. Close the Income Summary account.

Answer:
E7: Direction: Choose the letter of the correct answer and write it on the space provided before each item number.

1. Closing entries reduce the following type of accounts to a zero balance at the end of the period.
a. income and expenses
b. income summary
c. withdrawals
d. all of the above
2. The purpose of the post-closing trial balance is to
a. provide the account balances for the preparation of the balance sheet.
b. ensure that the ledger is in balance for completion of the worksheet.
c. aid the journalizing and posting of the closing entries.
d. ensure that the ledger is in balance for the start of the next period.
3. Which of the following accounts will appear on the post-closing trial balance?
a. building
b. depreciation expense – building
c. owner withdrawals
d. service revenues

E8: Direction: Some of the adjusting entries of the CPA Company on Dec. 31, 2022 is presented below. Prepare the
reversing entries.

2022
Dec. 31 Prepaid Insurance 25,000
Insurance Expense 25,000
To record unexpired insurance at year-end.

31 Interest Receivable 17,000

Interest Income 17,000
To record accrued interest at year-end

31 Office Supplies Expense 50,000

Office Supplies 50,000
To record office supplies used during the period.

31 Depreciation Expense 125,000

Accumulated Depreciation 125,000
To record depreciation for the year.

31 Salaries Expense 35,000

Salaries Payable 35,000
To record salaries accrued at year-end.

31 Rent Revenues 80,000

Unearned Rent Revenues 80,000
To record liability of unearned rent revenue at year-end.

DATE ACCOUNT DEBIT CREDIT

E9: Direction: Corazon Mendoza, tax consultant, began her practice on December 31, 2022. The transactions of the
firm are presented below. Assuming all relevant adjusting journal entries are made on December 31, 2022. Prepare the
corresponding reversing entries, at the start of the next period.

Dec. 1 Mendoza invested P150,000 in the firm.

2 Paid rent for December to Laguna Realty, P8,000.
2 Purchased supplies on account, P7,200
3 Acquired P75,000 of office equipment, paying P37,000 down with the balance due in 30 days.

8 Paid P7,200 on account for supplies purchased.

14 Paid assistant’s salaries for two weeks, P6,000.
20 Performed consulting services for cash, P20,000.
28 Paid assistant’s salaries for two weeks, P6,000.
30 Billed clients for December consulting services, P48,000.
31 Mendoza withdrew P12,000 from the business.

Chart of accounts:
Account Titles Code Account Titles Code
Cash (110) Accounts Payable (210)
Accounts Receivable (120) Salaries Payable (220)
Fees Receivable (130) Mendoza, Capital (310)
Supplies (140) Mendoza, Withdrawals (320)
Office Equipment (150) Income Summary (330)
Accumulated Depreciation (155) Consulting Revenues (410)
Supplies Expense (520) Rent Expense (530)
Depreciation Expense (540)

Additional information:
1. Supplies on hand at Dec. 31 amounted to P4,700.
2. Salaries of P1,800 accrued at month-end.
3. Depreciation is P800 for December.
4. Mendoza has spent 20 hours on a tax fraud case during December. When completed in January, her work will
be billed at P500 per hour. Note: The firm uses the account Fees Receivable to reflect the amounts earned but
not yet billed.
E10: Directions: The Unadjusted Trial Balance of Godofredo Company, prepared by a bookkeeper who was new in the
practice, is present below. Correct the Unadjusted Trial Balance below, Prepare adjusting entries, enter it to the blank
worksheet provided and complete it.

Godofredo Company
Unadjusted Trial Balance
As of December 31, 2020

Debit Credit

Cash 100,000
Accounts receivable 500,000
Merchandise inventory 700,000
Prepaid rent 300,000
Shop equipment 1,600,000
Accumulated depreciation 200,000
Accounts payable 400,000
Godofredo, Capital 1,300,000
Godofredo, Withdrawals 100,000
Sales 2,900,000
Sales discounts 100,000
Purchases 800,000
Purchase returns & Allowances 200,000
Transportation in 100,000
Salaries expense 400,000
Advertising expense 150,000
Utilities expense 100,000
Supplies expense 50,000 .
Totals 5,000,000 5,000,000

Additional information:
a. Accrued salaries at year-end amounted to P30,000.
b. Rent in the amount of P100,000 has expired during the year.
c. Depreciation on shop equipment is P200,000.
d. The Dec. 31 merchandise inventory amounted to P500,000.

DATE ACCOUNT TITLE AND EXPLANATION DR CR

 DATE ACCOUNT TITLE AND EXPLANATION DR CR

E11: Directions: Answer the following statements with true or false if you agree or disagree.

1. When preparing the worksheet for a merchandising company that uses the periodic inventory
system, the merchandise inventory amount shown on the trial balance will be carried over to the
Statement of financial position debit column.
2. On the worksheet of a merchandising company that uses the periodic inventory system, both the
purchases and purchases returns and allowances appear in the statement of financial performance
columns.
3. The purchases account is closed to the merchandise inventory account.
4. The ending inventory amount appears in both statement of financial performance columns on the
worksheet of a merchandising company that uses the periodic inventory system.
5. The worksheet of a merchandising business is the same as that of a service business except that it
has to deal with the new accounts related to merchandising transactions.