ADJUSTING ENTRIES

Adjusting entries are made to update the accounts in an

accounting system. Some accounts are not up-to-date
hence requiring adjustments to get them to their correct
balances

Adjusting entries are prepared at the end of the

accounting period for: accrual of income, accrual of
expenses, deferrals, prepayments, depreciation, and
allowances.
The preparation of adjusting entries is an application of the accrual
concept of accounting and the matching principle.

• The accrual concept states that income is recognized when earned

regardless of when collected and expense is recognized when
incurred regardless of when paid.
• The matching principle aims to align expenses with revenues.
Expenses should be recognized in the period when the revenues
generated by such expenses are recognized.

If adjusting entries are not prepared, some income, expense, asset,

and liability accounts may not reflect their true values when reported in
the financial statements. For this reason, adjusting entries are
necessary.
 TYPES OF ADJUSTING ENTRIES

Generally, there are 4 types of adjusting entries. Adjusting entries are prepared
for the following:
• Accrued Income – income earned but not yet received
• Accrued Expense – expenses incurred but not yet paid
• Deferred Income – income received but not yet earned
• Prepaid Expense – expenses paid but not yet incurred
Adjusting entries are also made for:
• Depreciation
• Doubtful Accounts or Bad Debts, and other allowances
 COMPOSITION OF AN ADJUSTING ENTRY

Adjusting entries affect at least one nominal account and one real account.
A nominal account is an account whose balance is measured from period to period.
Nominal accounts include all accounts in the Income Statement, plus owner's
withdrawal. They are also called temporary accounts or income statement accounts.
• Examples of nominal accounts are: Service Revenue, Salaries Expense, Rent
Expense, Utilities Expense, Mr. Gray Drawing, etc.
A real account has a balance that is measured cumulatively, rather than from period
to period. Real accounts include all accounts in the balance sheet. They are also
called permanent accounts or balance sheet accounts.
• Real accounts include: Cash, Accounts Receivable, Rent Receivable, Accounts
Payable, Mr. Gray Capital, and others.
All adjusting entries include at least a nominal account and a real account.
 ADJUSTING ENTRY FOR ACCRUED REVENUE

Accrued income (or accrued revenue) refers to income already earned but has not yet been collected.
At the end of every period, accountants should make sure that they are properly included as income,
with a corresponding receivable.

Pro-Forma Entry
The adjusting entry to record an accrued revenue is:

mmm dd Receivable account* x,xxx.xx

Income account** x,xxx.xx

*Appropriate receivable account such as Accounts Receivable, Rent Receivable, Interest Receivable, etc.
**Income account such as Service Revenue, Rent Income, Interest Income, etc.
In our previous set of transactions, assume this additional information:
• On December 31, 2019, Gray Electronic Repair Services rendered P300
worth of services to a client. However, the amount has not yet been
collected. It was agreed that the customer will pay the amount on January
15, 2020. The transaction was not recorded in the books of the company as
of 2019.
• In this case, we should make an adjusting entry in 2019 to recognize the
income since it has already been earned. The adjusting entry would be:

Dec 31 Accounts Receivable 300.00

Service Revenue 300.00

 MORE EXAMPLES: ADJUSTING ENTRIES FOR
ACCRUED INCOME

Example 1: Company ABC leases its building space to a tenant. The tenant
agreed to pay monthly rental fees of P2,000 covering a period from the 1st to the
30th or 31st of every month. On December 31, 2019, ABC Company did not
receive the rental fee for December yet and no record was made in the journal.
Under the accrual basis, the rent income above should already be recognized
because it has already been earned even if it has not yet been collected. The
adjusting journal entry would be:

Dec 31 Rent Receivable 2,000.00

Rent Income 2,000.00
Example 2: ABC Company lent P9,000 at 10% interest on December 1, 2019.
The amount will be collected after 1 year. At the end of December, no entry was
entered in the journal to take up the interest income.
Interest is earned through the passage of time. In the case above, the P9,000
principal plus a P900 interest will be collected by the company after 1 year. The
P900 interest pertains to 1 year.
However, 1 month has already passed. The company is already entitled to 1/12 of
the interest, as prorated. Therefore the adjusting entry would be to recognize P75
(i.e. P900 x 1/12 ) as interest income:

Dec 31 Interest Receivable 75.00

Interest Income 75.00
 ADJUSTING ENTRY FOR ACCRUED EXPENSES

• Accrued expenses refer to expenses that are already incurred but have not yet been paid.
• At the end of period, accountants should make sure that they are properly recorded in the books
of the company as an expense, with a corresponding payable account.
Pro-Forma Entry
The pro-forma adjusting entry to record an accrued expense is:

mmm dd Expense account* x,xxx.xx

Liability account** x,xxx.xx

*Appropriate expense account (such as Utilities Expense, Rent Expense, Interest Expense, etc.)
**Appropriate liability account (Utilities Payable, Rent Payable, Interest Payable, Accounts Payable,
etc.)
For Example

• For the month of December 2019, Gray Electronic Repair Services

used a total of P1,800 worth of electricity and water. The company
received the bills on January 10, 2020. When should the expense be
recorded, December 2019 or January 2020?
• Answer – in December 2019. According to the accrual concept of
accounting, expenses are recognized when incurred regardless of
when paid. The amount above pertains to utilities used in December.
Therefore, if no entry was made for it in December then an adjusting
entry is necessary.

Dec 31 Utilities Expense 1,800.00

Utilities Payable 1,800.00
MORE EXAMPLES: ADJUSTING ENTRIES FOR ACCRUED
EXPENSE

Example 1: VIRON Company entered into a rental agreement to use the premises of
DON's building. The agreement states that VIRON will pay monthly rentals of P1,500. The
lease started on December 1, 2019. On December 31 of the same year, the rent for the
month has not yet been paid and no record for rent expense was made.
In this case, VIRON Company already incurred (consumed/used) the expense. Even if it
has not yet been paid, it should be recorded as an expense. The necessary adjusting
entry would be:

Dec 31 Rent Expense 1,500.00

Rent Payable 1,500.00
Example 2: VIRON Company borrowed P6,000 at 12% interest on August
1, 2019. The amount will be paid after 1 year. At the end of December, the
end of the accounting period, no entry was entered in the journal to take up
the interest.
Let's analyze the above transaction.
VIRON will be paying P6,000 principal plus P720 interest after a year. The
P720 interest covers 1 year. At the end of December, a part of that is
already incurred, i.e. P720 x 5/12 or P300. That pertains to interest for 5
months, from August 1 to December 31. The adjusting entry would be:

Dec 31 Interest Expense 300.00

Interest Payable 300.00
 ADJUSTING ENTRY FOR UNEARNED REVENUE

• Unearned revenue, also known as unearned income, deferred revenue, or

deferred income, represents revenue already collected but not yet earned.
• Hence, they are also called "advances from customers".
• There are two ways of recording unearned revenue: (1) the liability method,
and (2) the income method.
Liability Method
Under the liability method, a liability account is recorded when the amount is
collected. The common accounts used are: Unearned Revenue, Deferred
Income, Advances from Customers, etc. For this illustration, let us use
Unearned Revenue.
Suppose on January 10, 2019, ABC Company made P30,000 advanced collections
from its customers. If the liability method is used, the entry would be:

Jan 10 Cash 30,000.00

Unearned Revenue 30,000.00

Now, what if at the end of the month, 20% of the unearned revenue has been
rendered? This will require an adjusting entry.

Jan 31 Unearned Revenue 6,000.00

Service Income 6,000.00
Income Method
• Under the income method, the accountant records the entire collection under
an income account. Using the same transaction above, the initial entry for the
collection would be:

Jan 10 Cash 30,000.00

Service Income 30,000.00

• If at the end of the year the company earned 20% of the entire P30,000, then the
adjusting entry would be:

Jan 31 Service Income 24,000.00

Unearned Income 24,000.00
 ANOTHER EXAMPLE

• On December 1, 2019, DRG Company collected from TRM Corp. a total of

P60,000 as rental fee for three months starting December 1.
• Under the liability method, the initial entry would be:

Dec 1 Cash 60,000.00

Unearned Rent Income 60,000.00

• On December 31, 2019, the end of the accounting period, 1/3 of the rent received
has already been earned
We should then record the income through this adjusting entry:
Dec 31 Unearned Rent Income 20,000.00
Rent Income 20,000.00
• If the company made use of the income method, the initial entry would be:

Dec 1 Cash 60,000.00

Rent Income 60,000.00

• In this case, we must decrease Rent Income by P40,000 because that part has
not yet been earned. The income account shall have a balance of P20,000. The
amount removed from income shall be transferred to liability (Unearned Rent
Income). The adjusting entry would be:

Dec 31 Rent Income 40,000.00

Unearned Rent Income 40,000.00
 ADJUSTING ENTRIES FOR PREPAID EXPENSE

• Prepaid expenses (a.k.a. prepayments) represent payments made for expenses

which have not yet been incurred.
• In other words, these are "advanced payments" by a company for supplies, rent,
utilities and others that are still to be consumed. Hence, they are included in the
company's assets.
• Expenses are recognized when they are incurred regardless of when paid. Expenses
are considered incurred when they are used, consumed, utilized or has expired.
• Prepaid expenses may need to be adjusted at the end of the accounting period. The
adjusting entry for prepaid expense depends upon the journal entry made when it
was initially recorded.
• There are two ways of recording prepayments: (1) the asset method, and (2) the
expense method.
Asset Method
• Under the asset method, a prepaid expense account (an asset) is recorded when the amount
is paid. Prepaid expense accounts include: Office Supplies, Prepaid Rent, Prepaid Insurance,
and others.

Dec 7 Service Supplies 1,500.00

Cash 1,500.00

• Suppose at the end of the month, 60% of the supplies have been used. Thus, out of the
P1,500, P900 worth of supplies have been used and P600 remain unused. The P900 must
then be recognized as expense since it has already been used.
• The adjusting entry will include: (1) recognition of expense and (2) decrease in the asset
initially recorded (since some of it has already been used). The adjusting entry would be:

Dec 31 Service Supplies Expense 900.00

Service Supplies 900.00
Expense Method
• Under the expense method, the accountant initially records the entire payment
as expense. If the expense method was used, the entry would have been:

Dec 7 Service Supplies Expense 1,500.00

Cash 1,500.00

• Take note that the entire amount was initially expensed. If 60% was used, then
the adjusting entry at the end of the month would be:

Dec 31 Service Supplies 600.00

Service Supplies Expense 600.00
 ANOTHER EXAMPLE

• GVG Company acquired a six-month insurance coverage for its properties on September 1, 2019
for a total of P6,000.
• Under the asset method, the initial entry would be:

Sep 1 Prepaid Insurance 6,000.00

Cash 6,000.00

• On December 31, 2019, the end of the accounting period, part of the prepaid insurance already has
expired (hence, expense is incurred). The expired part is the insurance from September to
December. Thus, we should make the following adjusting entry:

Dec 31 Insurance Expense 4,000.00

Prepaid Insurance 4,000.00
• If the company made use of the expense method, the initial entry would be:

Sep 1 Insurance Expense 6,000.00

Cash 6,000.00

• In this case, we must decrease Insurance Expense by P2,000 because that part has not
yet been incurred (not used/not expired). Insurance Expense shall then have a balance
of P4,000. The amount removed from the expense shall be transferred to Prepaid
Insurance. The adjusting entry would be:

Dec 31 Prepaid Insurance 2,000.00

Insurance Expense 2,000.00