LEARNING MODULE IN ACCOUNTING 1 S.Y.

2020 – 2021 (First Semester)

MODULE 4: THE ADJUSTING PROCESS

After reading this module, the students should be able to:

a) Understand the different types of adjustments to be prepared at the end of each accounting period
b) Prepare the adjusting entries and understand fully the importance of the adjusting entries on the company’s
financial statements
c) Compare the accrual and cash basis of accounting.
d) Distinguish deferrals from accruals
e) Know the two methods of recording prepayments (the asset method and the expense method)
f) Learn the two methods of recording income received in advance.

Allotted time: 12 hours (2 weeks)

CASH VERSUS ACCRUAL BASIS

 The cash basis of accounting recognizes revenue when cash is received; and recognizes expenses when cash is
paid. There are no needs for adjusting entries under the cash basis of accounting.
 The accrual basis of accounting 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. 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.

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.
 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.

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

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:
o Taxes Payable
o Interest Payable
o Utilities Payable
 o Salaries/Wages Payable
o Rent Payable
o Advertising Payable
Illustration:
Assume that on September 30, 2019, the company has unpaid taxes amounting to P10,000. The tax pertains to the month
of September but it will be paid in October. Under the accrual basis of accounting, the tax expense must be recorded in
September. Because it remains unpaid as of September 30, the company must record the liability for the unpaid tax.
The adjusting entry on September 30, 2019, for the accrued tax is:
Taxes Expense . . . . . . . . . . . . . . . . . 10,000
Taxes Payable . . . . . . . . . . . . . . . . . . . 10,000
To take up accrued taxes as of Sept. 30
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, 2019.

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 Revenues and Accrued Assets

 Accrued Revenue (an asset account) – is a 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.

Illustration:
Tiktok Apartelle is in the business of renting apartments. The company prepares income statement on a monthly basis. As
of August 31, 2019, a tenant has not paid the August rent amounting to P8,000. Tiktok Apartelle must have to prepare an
adjusting entry on August 31, 2019, in order to take up the revenue which is already earned but not yet received.

The adjusting entry to take up the accrued rent revenue is:

Rent Receivable . . . . . . . . . . . . . . . . . 10,000
Rent Revenue . . . . . . . . . . . . . . . . . . . 10,000
To take up accrued rent revenue as of August 31, 2019.

Note: The adjusting entry for accrued revenue always involves a debit to the appropriate asset account and a credit to a
revenue account.

 Accounting for accruals requires that accrued expenses be recognized as expense though it has not been paid yet
and accrued revenues be recorded as income though payment has not been received by the company yet.

Adjusting Entries for Prepaid Expenses or 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 the use and consumption.
 Prepaid expense is the exact opposite of accrued expense.
 Examples are Supplies, Prepaid Rent, Prepaid Interest and Prepaid Insurance.
The adjusting entries for prepaid expenses depend upon the method used to record the prepayment.
1. 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 on an asset account.

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

Illustration:
Eastern Union Money Transfer started business on January 2, 2019. On Jan. 3, the company purchased office supplies
amounting to P8,000. The entry to record the purchase of the office supplies under the asset and expense methods are:

Upon prepayment/purchase:
Asset Method Expense Method
Jan. 3 Office Supplies . . . . . . . . . 8, 000 Office Supplies Expense . . . . . . . . . 8,000
Cash . . . . . . . . .. . . . . . . . . . . 8,000 Cash . . . . . . . . . . . . . . . . . . . . . . . 8,000
To record the purchase of office supplies

If during the month, the company used office supplies amounting to P6,000, we record the adjusting entries on January 31
as follows:

Upon adjustment:
Asset Method (used portion) Expense Method (unused portion)
Jan.31 Office Supplies Expense . . . . . . . . . 6, 000 Office Supplies . . . . . . . . . 2,000
Office Supplies . . . . . . . . .. . . . . . . 6,000
Office Supplies Expense. . . . . .. . . . . 2,000
To take up the office supplies used and To take up the unused office supplies
to adjust the Office Supplies account. used and to adjust the Office
Supplies Expense account.
 After posting the adjusting entry, the account Office Supplies will show adjusted balance of P2,000 under both
asset and expense method. The account Office Supplies Expense will show adjusted balance of P6,000 under both
methods.

Adjusting Entries for Unearned Revenue or Deferred Revenue

 Unearned Revenue or Deferred Revenue (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.

1. 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.

2.Revenue Method or Income Method- Under this method, the account credited upon receipt of cash is a revenue or
income account. Upon adjustment, a revenue account will be debited and a liability account is credited.

Illustration:
On October 1, 2019, Tiktok Company received P120,000 from IG Company, a tenant occupying an office space in their
building. The amount is for one year rental beginning month of October paid in advance by IG.
The entries to record the cash collection and the adjustment of Tiktok Company on December 31, 2019 under both
methods are:

Upon collection/receipt:
Liability Method Revenue Method
Oct. 1 Cash . . . . . . . . . . . 120, 000 Cash . . . . . . . . . 120,000
Unearned Rent Revenue . . . . . . 120,000 Rent Revenue . . . . . . . . . . . . . . . 120,000
To record receipt of cash payment.

Upon adjustment:
Liability Method (earned) Revenue Method (unearned)
Dec.31 Unearned Rent Revenue . . . . . . . . . 30, 000 Rent Revenue . . . . . . . . . 90,000
Rent Revenue . . . . . . . . .. . . . . . . 30,000 Unearned Rent Revenue . . . . . .. . . . . 90,000
To take up the income portion of the To take up the unearned portion
Unearned Rent. of the Rent Revenue.

Computation of the earned portion as of Dec. 31:

P120,000 rent received in advance divided by 12 months (amount given is for one year rental) = P10,000
*P10,000 is the monthly rental x 3 months (October, November, December) = P30,000 (earned portion of the rent
received in advance)
P120,000 – P30,000 = P90,000 (unearned portion)

 Whichever method is used, the unearned portion of P90,000 should be the amount reported as Unearned Rent
Revenue as of December 32 and the earned portion of P30,000 should be the amount of Rent Revenue to be
recognized for the year 2019.

ACTIVITY (Week 1)
Classify the following items as (a) deferred expense or prepaid expense, (b) deferred revenue or unearned revenue, (c)
accrued expense or accrued liability, (d) accrued revenue or accrued asset.
________1. A three year premium paid on a fire insurance policy.
________2. Utilities owed but not yet paid
________3. Supplies on hand
________4. Salary owed but not yet paid
________5. Interest owed but payable in the following period
________6. Subscriptions received in advance by a newspaper publisher
________7. Professional fees received but not yet earned
________8. Professional fees earned but not yet received
________9. Interest paid in advance from a bank loan
________10. Ren collected in advance
________11. Services rendered but uncollected
________12. Advertising paid in advance for 3 months
________13. Income collected but not yet earned
________14. Rent paid in advance
________15. Interest collected in advance by the creditor
ACTIVITY (Week 2)

1. On August 1, 2019, Gym Paredes Fitness Center paid an advance rental on a space of a building it is occupying in the
amount of P120, 000. The amount covers one year rent paid in advance beginning month of August.

Under the Asset Method

a. The entry on August 1, 2019 to record the advance payment of rental is:
__________________________________________________________________________________________________
__________________________________________________________________________________________________
__________________________________________________________________________________________________
______________________________

b. How much of the P120,000 advance rental will expire at the end of each month? _______________________
c. How many months will cover the expense portion at December 31, 2019? ___________________________
d. How much of the P120,000 will be considered as Expense on December 31, 2019, the end of the company’s
accounting period? ______________________________________
e. How much of the P120,000 will be considered as asset on December 31, 2019? ______________________
f. Prepare the adjusting entry on December 31, 2019.
__________________________________________________________________________________________________
__________________________________________________________________________________________________
__________________________________________________________________________________________________
______________________________

2. On October 1, 2019, TM Company paid P24,000. The amount represent 1 year insurance beginning month of October.

Under the Expense Method

a. The entry to record the advance payment of Insurance Premium on October 1, 2019 is:
__________________________________________________________________________________________________
__________________________________________________________________________________________________
__________________________________________________________________________________________________
______________________________

b. How much of the P24,000 insurance premium will expire at the end of each month? _______________
c. How many months will cover the expense portion at December 31, 2019? _______________________
d. How much of the P24,000 will be considered as Expense on December 31, 2019, the end of the company’s accounting
period? ______________________________________
e. How much of the P120,000 will be considered as asset on December 31, 2019?_____________________
f. Prepare the adjusting entry on December 31, 2019.
____________________________________________________________________________________________________________
____________________________________________________________________________________________________________
____________________________________________________________________________________________________________
\
3. Yellow Cab Transport Services purchased office supplies amounting to P35,000 on January 3, 2019.

a. Prepare the entry to record the above transaction under:

Asset Method Expense Method
______________________________________________ ______________________________________________
______________________________________________ ______________________________________________
______________________________________________ ______________________________________________
b. Assuming the office supplies used during the year 2011 amounts to P30,000, the adjusting entry under both methods
are:

Asset Method Expense Method

______________________________________________ ______________________________________________
______________________________________________ ______________________________________________
______________________________________________ ______________________________________________

4. On September 1, 2019, Manila Apartelle received P120,000 from a tenant. The amount represents one year-rental
beginning month of September. Prepare the entries to be prepared on September 1 and the adjusting entry on Dec. 31,
2019 under both the liability and the revenue method.
September 1 entry:
Liability Method Revenue Method
______________________________________________ ______________________________________________
______________________________________________ ______________________________________________
______________________________________________ ______________________________________________

December 31, adjusting entry:

Asset Method Expense Method
______________________________________________ ______________________________________________
______________________________________________ ______________________________________________
______________________________________________ ______________________________________________