Fundamentals of Accountancy, Business and Management 1

ADJUSTING THE ACCOUNTS

LEARNING OBJECTIVES:

After a critical study of this module, you should be able to:

1. Distinguish between the cash basis and accrual basis of accounting.

2. Prepare the adjusting entries.

CASH BASIS VS ACCRUAL BASIS OF ACCOUNTING

The cash basis of accounting recognizes the revenue only when collected and
records only the expenses when paid. Uncollected revenue and unpaid expenses are not
recognized. Under the accrual basis of accounting however, revenue is recognized when
earned collected or not and expenses are recognized when incurred paid or not.

ADJUSTMENTS AND ADJUSTING ENTRIES

Most businesses use the accrual basis of accounting hence; adjustments at the end of
an accounting period are made to update the accounting records.

Adjustments – an account that is added to or subtracted from an account balance to bring

that balance up to date.

Adjusting Entries – are journal entries made at the end of an accounting period to update
the general ledger accounts.

The following are the adjustments to be made at the end of an accounting period:

1. Merchandise Inventory at the end – this refers to the unsold merchandise during the
period which will become the beginning inventory in the next period. This is applicable
only to a merchandising or manufacturing concern.
2. Impairment Loss on Receivables – (formerly bad debts expense) refers to that portion
of the receivables estimated to be uncollectible and considered as an expense.
3. Depreciation Expense – is a decrease in the value of a fixed asset due to the ordinary
wear and tear (with the passage of time) and charge to expense.

ACCRUALS AND DEFERRALS

As stated earlier, if the accrual basis of accounting is used, revenue is recorded (recognized)
when it is earned, collected or not, and expenses are recorded when they are actually
incurred, paid or not.

ACCRUALS:

4. Accrued Income – this is an income already earned but not yet recorded because it is
still uncollected (e.g. interest earned on noted receivable, unpaid rental of a tenant, etc.).
5. Accrued Expense – this is an expense already incurred but not yet recorded because it
is still unpaid (e.g. unpaid salaries, commission, interest, rent, etc.).
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DEFERRALS:

6. Unearned or Deferred Income – this is an income already collected and recorded as

such but not yet earned (e.g. advanced rental paid by the tenant, interest income
collected in advance, etc.). This is considered a liability until it is earned hence there is a
need to adjust at the end of the accounting period.
7. Prepaid or Deferred Expense – this is an expense paid in advance and recorded as
such. This is considered as an asset until the benefit is received hence there is a need to
adjust at the end of the accounting period (e.g. prepaid advertising, insurance, rent, etc.).

Example Problem:

ACCOUNT TITLE DEBIT CREDIT

Cash Php 78,400.00
Accounts Receivable 8,900.00
Office Supplies 2,500.00
Prepaid Insurance 6,000.00
Furniture and Equipment 75,000.00
Accounts Payable Php 30,000.00
Loan Payable 60,000.00
Nestor Martel, Capital 60,000.00
Nestor Martel, Drawing 12,000.00
Legal Fees Earned 44,400.00
Salary Expense 5,500.00
Advertising Expense 3,600.00
Utilities Expense 1,500.00
Miscellaneous Expense 1,000.00
Total Php 194,400.00 Php 194,400.00
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The expanded chart of accounts listed below will be used as reference:

Statement of Financial Position accounts

101 – Cash 201 – Accounts Payable

102 – Accounts Receivable 202 – Rent Payable

104 – Prepaid Advertising 203 – Interest Payable

105 – Prepaid Insurance 204 – Unearned Legal Fees

106 – Office Supplies 204 – Loan Payable

108 – Furniture and Equipment 301 – Nestor Martel, Capital

109 – Accumulated Depreciation 302 – Nestor Martel, Drawing

Statement of Comprehensive Income accounts

401 – Legal Fees Earned 505 – Insurance Expense

501 – Salary Expense 506 – Supplies Expense

502 – Rent Expense 507 – Depreciation Expense

503 – Advertising Expense 509 – Miscellaneous Expense

504 – Utilities Expense 601 – Interest Expense

Additional Information:

1. The one-year P6,000 insurance paid was effective December 1.

2. Office rental of P4,000 for the month of December was still unpaid.
3. Interest of 18% per annum on the P60,000 bank loan granted on December 11 has
accrued.
4. Advertising placement of P3,600 for three months was effective on December 1.
5. Fees of P5,000 collected in advance on December 30 will be for services to be rendered
next year.
6. Office supplies unused at the end of the month amounted to P1,600.
7. Furniture and Equipment are estimated to have a useful life of ten years. It was decided to
provide depreciation for December.

REQUIRED:

a. Prepare the necessary Adjusting Journal Entries on December 31.

b. Prepare the Adjusted Trial Balance as of December 31 of the current year.
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Solution to Example Problem a:

1 Insurance Expense Php 500.00

Prepaid Insurance Php 500.00
Computation: P6,000 / 12 = P500

2 Rent Expense 4,000.00

Rent Payable 4,000.00

3 Interest Expense 600.00

Interest Payable 600.00
Computation: P60,000 x 18% x 20/360 = P600

4 Prepaid Advertising 2,400.00

Advertising Expense 2,400.00
Computaion: P3,600 x 2/3 = P2,400

5 Legal Fees Earned 5,000.00

Unearned Legal Fees 5,000.00

6 Supplies Expense 900.00

Office Supplies 900.00
Computation: P2,500 - P1,600 = P900

7 Depreciation Expense 625.00

Accumulated Depreciation 625.00
Computation: P75,000 / 10 / 1/12 =
 Fundamentals of Accountancy, Business and Management 1

ACCOUNT TITLE DEBIT CREDIT Solution

to
Cash Php 78,400.00
Example
Accounts Receivable 8,900.00
Problem b:
Prepaid Advertising 2,400.00
Prepaid Insurance 5,500.00
Office Supplies 1,600.00
Furniture and Equipment 75,000.00
Accumulated Depreciation Php 625.00
Accounts Payable 30,000.00
Rent Payable 4,000.00
Interest Payable 600.00
Unearned Legal Fees 5,000.00
Loan Payable 60,000.00
Nestor Martel, Capital 60,000.00
Nestor Martel, Drawing 12,000.00
Legal Fees Earned 39,400.00
Salary Expense 5,500.00
Rent Expense 4,000.00
Advertising Expense 1,200.00
Utilities Expense 1,500.00
Insurance Expense 500.00
Supplies Expense 900.00
Depreciation Expense 625.00
Interest Expense 600.00
Miscellaneous Expense 1,000.00
Total Php 199,625.00 Php 199,625.00
 Fundamentals of Accountancy, Business and Management 1

PROBLEMS:

1. Selected account balances before adjustments for Lopez Realty Agency at December 31
of the current year are as follows:

Accounts Receivable P 29,250 – Unearned Fees P 26,500 –

Supplies 2,700 – Fees Earned 299,800 –

Prepaid Rent 18,000 – Salary Expense 60,000 –

Equipment 70,000 – Rent Expense 24,000 –

Accumulated Depreciation 14,000 – Supplies Expense 0–

Salary Payable 0– Depreciation Expense 0–

Additional information at December 31 is as follows:

a. The unused supplies at December 31 were 1/3 of the amount recorded.

b. Equipment is being depreciated over 10 year period without salvage.
c. Prepaid rent was paid on September 1 to cover six-month period.
d. Two-weeks salary at P2,750 per week for December was not paid.
e. Unearned fees at December 31 amounted to P5,500.
f. Fees earned but still unbilled at December 31 was P12,250.

Required:
 Fundamentals of Accountancy, Business and Management 1
1) Journalize the adjusting entries at December 31.
2) Determine the balances of the accounts affected by adjustments.

2. The following account balances appear in the P. Patron Law Office general ledger as of
December 31 of the current year:

Cash P 34,500 – Office Supplies Expense P 0–

Prepaid Advertising 4,800 – Salary Expense 76,500 –

Office Supplies 8,300 – Professional Fees 255,800 –

Salary Payable 0– Unearned Fees 10,000 –

Additional information at December 31 is as follows:

a. The office supplies on hand at December 31 are valued at P1,450.

b. Salaries for the last week of December has been earned but not paid amounted to
P13,500.
c. Advertising paid on November 1 covered a period of six months.
d. Of the record Unearned Fees, only P2,500 has been earned.

Required:

1) Journalize the adjusting entries at December 31.

2) Determine the balances of the accounts affected by adjustments.