In accounting, adjusting entries are needed in order to present in the financial statements the balances of

the accounts in adherence to the accrual principle.

*In adherence to this principle, revenues should be recognized in the period in which they are earned
without regard to when they are collected by the business. Similarly, expenses should be recognized in
the period in which they are incurred without regard to when they are paid by the business.

*Furthermore, understanding the accrual-basis accounting is easier if contrasted with the cash-basis
accounting as shown below:

Items Concerned Accrual-basis Cash-basis

1.Revenue is recognized in the period When earned When received
2. Expenses is recognized in the period When incurred When paid

In line with this, business are expected to prepare adjusting journal entries at the end of the accounting
period to ensure that revenues are recognized in the period in which they are earned and that expenses
are recognized in the period in which they incurred.

TYPES OF ADJUSTMENTS

Two major classification of adjusting entries are ACCRUALS and DEFERRALS.

Accrual classification:

1. Accrued Revenues - are revenues that have been earned but not yet collected. Adhering to
accrual principle, these revenues should have been properly included in the revenues that have
to be presented in the financial statements.

2. Accrued Expenses – are expenses that have been incurred but not yet paid. Adhering to accrual
principle, these expenses should have been properly included in the expenses that have to be
presented in the financial statements.

Deferral classification:

1. Unearned Revenues – are revenues that have been collected but not yet earned. Unearned
revenues are treated as liabilities.

2. Prepaid Expenses – are revenues that have been collected but not yet incurred. “Not yet earned”
simply means not yet used up or consumed”. Prepaid expenses are treated as assets of the
business.

*Unlike accruals, deferrals require an initial journal entry, that is, a journal entry referring to the
date when cash was collected or paid.
Ex. Accrued revenues

To illustrate, assume that as of July, 2015, the end of the accounting period, JM Photocopying Center
rendered P7,500 worth of photocopying services that have not been recorded. The following adjusting
entry will be made on July 31, 2015:

General Journal

Date Particulars Ref. Debit Credit

July 31 Accrued Revenue ( or Accounts Receivable) 7,500
Photocopying Revenues 7,500
To record revenue for services rendered

After this adjusting entry is posted, Accounts Receivable and Photocopying Revenues ledger balances both
increases. Though not yet collected, the photocopying services have already been rendered and thus
earned. Applying the accrual principles, this is already considered as earned revenue and therefore should
be recognized as revenue in the income statement for the period ended July 31, 2015.

Another example is that an interest-bearing promissory note with a principal amount (or face value) of
P5,500 which should be paid 60 days after July 16, 2015 which is on September 14, 2015 (maturity date).
The maker is Andres Cruz and the payee is JM Photocopying Center. On September 14, 2015, JM
Photocopying Center will receive total payment P5,610 (maturity value). This is the sum of the principal
amount of P5,500 and of interest of P110. This is the sum of principal amount of P5,500 and of interest
of P110 (P5,500 x 12% x 60 days/360 days. The use of 360 days is in adherence to the banker’s rule.

The journal entry on July 16, 2015 would be

GENERAL JOURNAL

Date Particulars Ref. Debit Credit

July 16 Notes Receivable 5,500
Photocopying Revenues 5,500
To record note receivable for services rendered al

On September 14, 2015, the maturity date, the journal entry for the collection of the note and interest
would be:

Date Particulars Ref. Debit Credit

Sep 14 Cash 5,610
Notes Receivable 5,500
Interest Income 110

To record collection of the note plus interest

However, using the same assumption that July 31, 2015 is the end of the accounting period, JM
Photocopying Center has to prepare financial statements dated July 31, 2015. As of that date, 15 days
would have passed and accrual principle dictates that JM Photocopying Center has already earned 15days
worth of interest income amounting to P27.50 (P5,500 x 12% x 15 days/360 days.

Adjusting entry is needed to recognized the earned interest as follows:

GENERAL JOURNAL
Date Particulars Ref. Debit Credit
July 31 Accrued Interest Income (or Interest Receivable 27.50
Interest Income 27.50
To record interest earned

Ex. Accrued Expenses

To illustrate, assume that on July 21, 2015, JM Photocopying Center issued a 30-day promissory note with
a principal amount of P5,000 and interest rate of 12% for the purchase of office tables (Furniture and
Fixture). In this example, JM Photocopying Center would be the maker and therefore, this would have
been recorded as:

GENERAL JOURNAL
Date Particulars Ref. Debit Credit
July 21 Furniture and Fixtures 5,000
Notes Payable 5,000
To record purchase of office tables and issuance of the note

On August 20, 2015, the maturity date, the journal entry for the payment of the note and interest would
be:

GENERAL JOURNAL
Date Particulars Ref. Debit Credit
Aug 20 Notes Payable 5,000
Interest Expense 50
Cash 5,050
To record payment of the note plus interest

Using the same assumption that July 31, 2015 is the end of the accounting period, JM Photocopying Center
has to prepare financial statements dated July 31, 2015. As of that date, ten days would have passed and
accrual principle dictates that JM Photocopying Center has already incurred ten days worth of interest
expense amounting to P16.67 (P5,000 x 12% x 10 days/360 days). As such, an adjusting entry is needed
to recognize the incurred interest as follows:
 GENERAL JOURNAL
Date Particulars Ref. Debit Credit
July 31 Interest Expense 16.67
Accrued Interest Expense (or Interest Payable) 16.67
To record interest incurred

Applying the accrual principle, this is already considered as incurred expense and therefore should be
recognized as expense in the income statement for the period ended July 31, 2015. Since no cash had
been paid yet, Accrued Interest Expense of Interest Payable should be recognized in the statement of
financial position as of July 31, 2015.

Ex. UNEARNED REVENUES

For unearned revenues, the receipt of cash can be recorded either through a liability method or a revenue
method. For JM Photocopying Center, the liability method uses the account Unearned Photocopying
Revenues (a liability account) while the revenue method uses the account Photocopying Revenues (a
revenue account).

To illustrate, assume that on July 20, 2015, JM Photocopying Center received P3,000 from a client for a
photocopying service which is expected to be completely rendered on August 5, 2015. The journal entry
to record the receipt of cash under the liability method would be:

Date Particular Ref. Debit Credit

July 20 Cash 3,000
Unearned Photocopying Revenues 3,000
To record receipt of cash for services still to be rendered

The journal entry to record the receipt of cash under the revenue method would be:

Date Particular Ref. Debit Credit

July 20 Cash 3,000
Photocopying Revenue 3,000
To record receipt of cash for services still to be rendered

Assume further that as of July 31, 2015, 40% of the service had already been completed and thus had
already been earned. With respect to this transaction only, the amount of P1,200 (P3,000 x 40%) should
have already been earned in the current accounting period.

Apparently, for the liability method, if there would be no adjusting entry, revenue would be understated
by P1,200. On the other hand, for the revenue method , if there would be no adjusting entry, revenue
would be overstated by P1,800 (difference between P3,000 and P1,200. In either method, there is a need
for an adjusting entry to adhere to the accrual principle which states that revenues should be recognized
in the period they are earned without regard as to when the collection is made. As such, an adjusting
entry under the liability method would be:

Date Particulars Ref. Debit Credit

July 31 Unearned Photocopying Revenue 1,200
Photocopying Revenues 1,200
To recognize earned portion of unearned photocopying
revenues

Adjusting entry under the revenue method would be:

Date Particulars Ref Debit Credit

July 31 Photocopying Revenues 1,800
Unearned Photocopying Revenues 1,800
To recognized unearned portion of earned photocopying
revenues

By debiting Photocopying Revenues account, recorded revenue is decreased by P1,800 because its normal
balance is a credit and by crediting Unearned Photocopying Revenues account, liability is increased by
P1,800 because its normal balance is a credit.

PREPAID EXPENSES

In asset method, the entry would be:

Prepaid Expenses xxx

Cash xxx

Adjusting entry under the expense method would be:

Prepaid Rent xxx

Rent Expense xxx

DEPRECIATION

Adjusting entry for depreciation:

Depreciation Expense xxx

Accumulated Depreciation xxx
The simplest and frequently used method of depreciation is called the straight line method. The formula
is:

Cost - Salvage Value or Scrap Value if any = Depreciation per year

Number of years

Ex. Assuming that the salvage value and useful life were determined to be P3,000 and five years,
respectively, the depreciable cost would be P27,000 (P30,000 – P3,000) and the annual depreciation
would be P5,400 (27,000/5 years). For the month of July 2015, the depreciation expense would be P450
(P5,400/12 months).

Entry:
Depreciation Expense 450
Accumulated Depreciation – Photocopying Equipment 450

DOUBTFUL ACCOUNTS

Adjusting entry:
Doubtful Accounts Expense xxx
Allowance for Doubtful Accounts xxx

Ex. Assuming the ledger balance of accounts receivable would be P7,500, JM Photocopying Center is using
the percentage of accounts receivable in estimating doubtful accounts and has determined that 2% of the
accounts receivable are doubtful of being collected as of July 31, 2015. The required allowance for
doubtful accounts as of July 31, 2015 should be P150 (P 7,500 x 2%)

Adjusting entry:

Doubtful Accounts Expense 150

Allowance for Doubtful Accounts 150