Chapter 5: The Adjustment Process PDF

CHAPTER 5 THE ADJUSTMENT PROCESS The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU C...

CHAPTER 5 THE ADJUSTMENT PROCESS The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Jesus knew disappointment: “O Jerusalem, Jerusalem…how often I have longed to gather your children together, as a hen gathers her chicks,…but you were not willing” (Luke 13:34). Jesus knew rejection: “From this time many of his disciples turned back and no longer followed him” (John 6:66). Jesus knew sorrow: “My soul is overwhelmed with sorrow to the point of death” (Matthew 26:38). Jesus knew loneliness: “My God, my God, why have you forsaken me?” (Matthew 27:46).  Chapter 5 The Adjustment Process Learning Objectives 1.Define adjusting entries. 2.Explain the importance of adjusting entries. 3. Identify the accounts that need to be adjusted at the end of the accounting period. 4. Prepare adjusting entries. Ch5 The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Adjusting the Accounts At the end of the accounting period, when the journalizing and the posting processes have been completed and the trial balance has been prepared, accounts are examined to determine whether their balances reflect their true values or not. Generally, a majority of the account balances may already be presented in the financial statements. However, there are accounts that need to be updated or corrected. The accounts must be adjusted to determine the correct amount at which they may be presented in the financial statements of the business enterprise. The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  THE ADJUSTMENT PROCESS Overview Types of Common Adjustments Prepaid Expenses (Insurance, Rent, Supplies) Depreciation (PPE) Rent Income Interest Income/Receivable Accrual (Salaries, Interest, Benefits) Allowance for Doubtful Accounts/ Bad Debts The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  THE ADJUSTMENT PROCESS Reporting Revenue and Expense TWO METHODS Deferral Basis Accrual Basis The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Deferral Basis 1. There are costs recorded that must be apportioned between two or more accounting periods. Examples are the cost of the building, prepaid insurance, and supplies. 2. There are revenues recorded that must be apportioned between two or more accounting periods. Example is commissions collected in advance for services to be rendered in later periods. The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Adjustments – Deferrals and Accruals Revenues Current Period Future Period Deferrals Cash Received Revenue Recorded Accruals Revenue Recorded Cash Received Expenses Current Period Future Period Deferrals Cash Paid Expense Recorded Accruals Expense Recorded Cash Paid The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Prepaid Expenses Prepaid expenses are expenses paid in advance. They are not yet incurred but already paid. Insurance There are two methods of recording prepaid expenses: (a) the asset method, and (b) the Rent expense method. Under the asset method, an asset account is debited for the advance payment Supplies of expenses. Under the expense method, an expense account is used. The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Adjustments – Insurance June 1 – Dec 31 = 7 months On June 1, 2023, the company paid P30,000 for a two-year insurance premium. P30,000 x 7 months/ 24 mos = P8,750 adjustment Example 1– Purchase initially recorded as an asset. Adjustment 1 – Record Cash insurance used From June 1 - 6/1 30,000 December 31, P8,750 Prepaid Insurance Assets 6/1 30,000 12/31 8,750 A1 Insurance Expense A1 12/31 8,750 Expenses The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Adjustments – Insurance On June 1, 2023, the company paid P30,000 for a two-year insurance premium. Example 1– Purchase initially recorded as an expense Adjustment 2 – Record Cash insurance unused as of 6/1 30,000 December 31, P21,250 Prepaid Insurance Assets 12/31 21,250 A2 Insurance Expense 6/1 30,000 12/31 21,250 Expenses The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  On June 1, 2023, the company paid P30,000 for a two-year insurance premium. Summary Example 1– Purchase initially recorded as an asset. Adjustment 1 – Record insurance used From June 1 - December 31, P8,750 Date Description Debit Credit Description Debit Credit 2023 ASSET METHOD EXPENSE METHOD June 1 Prepaid Insurance 30,000 Insurance Expense 30,000 Cash 30,000 Cash 30,000 Dec 31 Insurance Expense 8,750 Prepaid Insurance 21,250 Prepaid Insurance 8,750 Insurance Expense 21,250 The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Adjustments – Rent July 2 - July 31 = 1 month On July 2, 2023, the company paid three months P6,000 x 1rent in month/ advance worth P9,000. 2 mos = P3,000 adjustment Example 2– Payment initially recorded as an asset. Cash Adjustment 3 – Record the rent expired July 31, P3,000 7/2 9,000 Prepaid Rent Assets 7/2 9,000 7/31 3.000 A3 Rent Expense A3 7/31 3,000 Expenses The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Adjustments – Rent On July 2, 2023, the company paid three months rent in advance worth P9,000. Example 2– Payment initially recorded as an expense Adjustment 4 – Record the Cash unexpired rent as of July 31, 7/2 9,000 P6,000 Prepaid Rent Assets 731 6,000 A4 Rent Expense 7/2 9,000 7/31 6,000 Expenses The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  On July 2, 2023, the company paid three months rent in advance worth P9,000. Summary Example 2– Payment initially recorded as an asset. Adjustment 3 – Record the rent expired July 31, P3,000 Date Description Debit Credit Description Debit Credit 2023 ASSET METHOD EXPENSE METHOD July 2 Prepaid Rent 9,000 Rent Expense 9,000 Cash 9,000 Cash 9,000 July 31 Rent Expense 3,000 Prepaid Rent 6,000 Prepaid Rent 3,000 Rent Expense 6,000 Accounting: Its Development and Basic Concept Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Adjustments – Sewing Supplies 8,000 asset July 2, 2023, the company purchasedMinus sewing 3,500supplies on hand = 4,500 worth P5,000 and on July 5 the company purchased used sewing again supplies worth 3,000. The inventory showed that sewing supplies costing P3,500 are still on hand. Example 3– Purchase initially recorded as an asset. Cash Adjustment 5 – Record the used 7/2 5,000 sewing supplies July 31, P4,500 7/5 3,000 Sewing Supplies Assets 7/2 5,000 7/31 4.500 7/5 3,000 A5 Sewing Supplies ExpenseA5 7/31 4,500 Expenses Accounting: Its Development and Basic Concept Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Summary July 2, 2023, the company purchased sewing supplies worth P5,000 and on July 5 the company purchased again sewing supplies worth 3,000. The inventory showed that sewing supplies costing P3,500 are still on hand. Example 3– Purchase Date Description Debit Credit initially recorded as an 2023 ASSET METHOD asset. July 2 Sewing Supplies 5,000 Cash 5,000 Adjustment 5 – Record the used sewing supplies July 31, P4,500 5 Sewing Supplies 3,000 Cash 3,000 July 31 Sewing Supplies Expense 4,500 Sewing Supplies 4,500  Adjustments – Sewing Supplies July 2, 2023, the company purchased sewing supplies worth P5,000 and on July 5 the company purchased again sewing supplies worth 3,000. The inventory showed that sewing supplies costing P3,500 are still on hand. Example 3– Purchase initially recorded as an expense Cash Adjustment 6– Record the 7/2 5,000 unused sewing supplies July 31, 7/5 3,000 P3,500 Sewing Supplies Assets 7/31 3.500 A6 A6 Sewing Supplies Expense 7/2 5,000 7/31 3,500 Expenses 7/5 3,000 The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  July 1 - July 31 = Depreciation of Property, Plant and 1Equipment month On July 1 D’ Fashionista purchased sewing machine and xestimates P120,000 1 that will last for ten years (120 months) and will be worthless atmos month/ 120 the=end of that time. P1,000 adjustment Cash Adjustment 7 –To record the depreciation as of July 31, 7/1 120,000 P1,000 Sewing Machine 7/1 120,000 Plant and Equipment: Depreciation Expense- Sewing Sewing Machine P120,000 Machine Less: Accum. Depreciation 1,000 7/31 1,000 Net Book Value P119,000 Accumulated Depreciation - A7 Sewing Machine 7/ 31 1,000 The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Payment for revenue received in advance is termed as unearned revenue or deferred revenue, a liability account. Upon delivery of the goods or performance of services, the advance payment is considered earned. Therefore, an adjusting journal entry is needed to transfer unearned revenue account to an earned There are two methods of recording revenue account. unearned revenue: (a) the liability method, and (b) the revenue method. Under the liability method, a liability account is used to record the amount received in advance. Under the revenue method, a revenue account is used. The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Adjustments - Rent Received in Advance March 1 - December On March 1, 2023, the company received P48,000 as 31 = 10months advance payment for a two-year rental of an office space. P48,000 x 10 mos/ 24 mos = P20,000 Example 5– Rent received in advance Initially recorded adjustment as a liability Adjustment 8 – Record the Cash earned rent as of December 3/1 48,000 31, P20,000 Unearned Rent Income 12/31 3/1 48,000 20,000 A8 Rental Income 12/31 20,000 Liability The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Summary Date Description Debit Credit Description Debit Credit 2023 LIABILITY INCOME METHOD METHOD Mar 1 Cash 48,000 Cash 48,000 Unearned Rent 48,000 Rental Income 48,000 Dec 31 Unearned Rent 20,000 Rental Income 28,000 Rental Income 20,000 Unearned Rent 28,000 The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Interest Receivable On December 1, 2023, the company received a 90-day, 6% note in the amount of P90,000. The adjusting entry on December 31, 2023 would be as follows: (Interest = P90,000 x 6% x 30/360 = P450) Dec 31 Interest Receivable 450.00 Interest Income 450.00 The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Accrued Salaries July 2023 SUN MON TUE WED THU FRI SAT 1 2 3 4 5 6 7 8 9 10 11 12 13 5,400 14 15 16 17 18 19 20 21 22 23 24 25 26 27 6,000 28 29 30 31 Given: P200.00/day per employee Salaries paid biweekly Three Employees Working days Monday - Friday except holiday The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Accrued Salaries July 2023 SUN MON TUE WED THU FRI SAT 1 2 3 4 5 6 7 8 9 10 11 12 13 5,400 14 15 16 17 18 19 20 21 22 23 24 25 26 27 6,000 28 29 30 31 July 29, 30 and 31 = P 200 x 3 days x 3 employees = 1,800 accrued salaries on July 31, 2023 July 31 Wages Expense 1,800 Wages Payable 1,800 The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Provision for Doubtful Accounts Estimating Bad Debts Using a Certain Percentage of Accounts Receivable A. Per general ledger, Accounts Receivable has a balance of P80,000. Based on past experience, 5% is estimated to be uncollectible. 5% x P80,000 = P4,000 Dec 31 Bad Debts Expense 4,000.00 Allowance for Bad Debts 4,000.00  Provision for Doubtful Accounts Estimating Bad Debts Using a Certain Percentage of Accounts Receivable B. Using the same illustration, assume that per general ledger, Allowance for Bad Debts has an existing credit balance of P1,000. Dec 31 Bad Debts Expense 3,000.00 Allowance for Bad Debts 3,000.00 Required balance (5% x P80,000) …...... P4,000 Existing balance ….................................... 1,000 Amount of adjustment ………………… P3,000 The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy  Presentation in the Statement of Financial Position Accounts Receivable ………………….. P80,000 Less: Allowance for Bad Debts ……….. 4,000 Net realizable value …................... P76,000 The Adjustment Process Financial Accounting & Reporting 1 (2023 Edition) Prepared by: Jet R. Nillos, CPA,MBA Baldevarona, Grande, & Munar CPU College of Business and Accountancy