Module 5 – Adjusting the Accounts

Learning Outcomes:

• Differentiate Accrual and Cash Accounting.

• Discuss the concept of Accrual Accounting and analyze how it improves the financial statements.
• Identify and Analyze the types of adjustments and their purposes.
• Illustrate how accounting adjustments link to the financial statement.
• Journalize and Post adjusting entries.
• Create an Adjusted Trial Balance.
• Discuss the alternative methods of recording deferrals.

Core Value/Biblical Principles:

When you make an adjusting entry, you’re making sure the activities of your business are recorded accurately in
time. If you don’t make adjusting entries, your books will show you paying for expenses before they’re actually
incurred, or collecting unearned revenue before you can actually use the money. We can infer how important the
time is. It is vital to make the adjusting entries on time, otherwise it will be useless. Hence, before we formally
start the lesson, I want you to reflect on these couple of bible verses:

Ecclesiastes 3: 1-8

1 There is a time for everything, and a season for every activity under the heavens: 2 a time to be born
and a time to die, a time to plant and a time to uproot, 3 a time to kill and a time to heal, a time to
tear down and a time to build, 4 a time to weep and a time to laugh, a time to mourn and a time to
dance, 5 a time to scatter stones and a time to gather them, a time to embrace and a time to refrain
from embracing, 6 a time to search and a time to give up, a time to keep and a time to throw away, 7 a
time to tear and a time to mend, a time to be silent and a time to speak, 8 a time to love and a time to
hate, a time for war and a time for peace.

Learning Activity (Stop and Think):

 Most of us think in terms of cash. Did our bank balance go up or down? This is in essence what the cash basis
measures—changes in the cash balance. But consider your job (if you already have one) or the job of your
parents. When do you/they actually earn your/their salary— when you/they go to work or when you/they get
paid? When you/they go to work, you/they earn. That is when you/they accrue revenue under the accrual
basis—not when you/they get paid by your/their employer.

Introduction:

In the previous modules, I introduced the accounting equation, recording business transactions and financial
statements. But have you captured all the transactions for a particular period? Not yet. In this module, we’ll
continue our exploration of the accounting cycle by learning how to update the accounts at the end of the period.
This process is called adjusting the books, and it requires special journal entries called adjusting journal entries.
For example, you’ll see how at the end of a particular period, you must determine how many supplies you have used
and how much you owe your employees and make adjusting entries to account for these amounts. These are just
some of the adjusting entries you need to make before you can see the complete picture of how well your company
performed—and determine commissions for salespeople and drawings for the owner.

Body:

ACCRUAL VS. CASH BASIS ACCOUNTING

There are two ways to do accounting:

Accrual accounting records the effect of each transaction as it occurs—that is, revenues are recorded when earned
and expenses are recorded when incurred. Most businesses use the accrual basis as covered in this book.

The financial statements, except for the cash flow statement, are prepared on the accrual basis of accounting in
order to meet their objectives. Under the accrual basis, the effects of transactions and other events are recognized
when they occur and not as cash is received or paid. This means that the accountant records revenues as they are
earned and expenses as they are incurred. The timing of cash flows is relatively immaterial for determining when to
recognize revenues and expenses.

Financial statements prepared on the accrual basis inform users not only of past transactions involving the payment
and receipt of cash, but also of obligations to pay cash in the future, and of resources that represent cash to be
received in the future. Generally accepted accounting principles require that a business use the accrual basis.

Cash-basis accounting records only cash receipts and cash payments. It ignores receivables, payables, and
depreciation. Only very small businesses use the cash basis of accounting.

Illustration:

Mr. Bakasyonista paid the Sunset Beach Resort and Hotel in Siargao P7,000 on April 8, 2019 for a one-day super
deluxe accommodation on May 13, 2019.

Under accrual accounting, the receipt of P7,000 will be considered as revenues once they already rendered its
services on May 13.

In contrast, if cash basis is used, the hotel will recognize the revenue on April 8. Expenses related to this revenue
transaction will be incurred on May 13. Suppose a financial report is prepared at the end of April, under accrual no
revenue or expense will be reported; Under cash basis, revenues of will be reported but the expenses will be
recognized when incurred on May 13. Observe that the accrual basis provided a better measure of the results of
transactions.
PERIODICITY CONCEPT

The only way to know how successfully a business has operated is to close its doors, all its assets, pay the
liabilities and return any excess cash to the owners. This process of going out of business is called liquidation.
This, however, is not a practical way of measuring business performance.

Accounting information is valued when it is communicated early enough to be used for economic decision-making.
To provide timely information, accountants have divided the economic life of a business into artificial time periods.
This assumption is referred to as the periodicity concept.

Accounting periods are generally a month, a quarter or a year. The most basic accounting period is one year.
Entities differ in their choice of the accounting year— fiscal, calendar or natural. A fiscal year is a period of any
twelve consecutive months. A calendar year is an annual period ending on December 31. A natural business year
is a twelve-month period that ends when business activities are at their lowest level of the annual cycle. A period
of less than a year is an interim period. Some even adopt an annual reporting period of 52 weeks.

Businesses need periodic reports to assess their financial condition and performance. The periodicity concept
ensures that accounting information is reported at regular intervals. It interacts with the recognition and
derecognition principles to underlie the se of accruals. To measure profit in a fair manner, entities update the
income and expense accounts immediately before the end of the period.

RECOGNITION AND DERECOGNITION

Per 2018 Conceptual Framework, recognition is the process of capturing for inclusion in the statement of financial
position or the statement(s) of financial performance an item that meets the definition of an asset, a liability,
equity, income or expenses. The amount at which an asset, a liability or equity is recognized in the statement of
financial position is referred to as its "carrying amount".

The statement of financial position and statement(s) of financial performance depict an entity's recognized assets,
liabilities, equity, income and expenses in structured summaries that are designed to make financial information
comparable and understandable.

Recognition links the elements, the statement of financial position and the statement(s) of financial performance.
The statements are linked because the recognition of one item (or a change in its carrying amount) requires the
recognition or derecognition of one or more other items (or changes in the carrying amount of one or more other
items). For example:

(a) The recognition of income occurs at the same time as:

(i) the initial recognition of an asset, or an increase in the carrying amount of an asset; or
(ii) the derecognition of a liability, or a decrease in the carrying amount of a liability.

(b) the recognition of expenses occurs at the same time as:

(i) the initial recognition of a liability, or an increase in the carrying amount o! a liability; or
(ii) the derecognition of an asset, or a decrease in the carrying amount of an asset.
The initial recognition of assets or liabilities arising from transactions or other events may result in the
simultaneous recognition of both income and related expenses. For example, the sale of goods for cash results
in the recognition of both income (from the recognition of one asset—the cash) and an expense (from the
derecognition of another asset—the goods sold). The simultaneous recognition of income and related expenses
is sometimes referred to as the matching of costs with income.

Recognition is appropriate if it results in both relevant information about assets, liabilities, equity, income and
expenses and a faithful representation of those items, because the aim is to provide information that is useful
to investors, lenders and other creditors.

Derecognition is the removal of all or part of a recognized asset or liability from an entity's statement of
financial position. Derecognition normally occurs when that item no longer meets the definition of an asset or
of a liability:

(a) for an asset, derecognition normally occurs when the entity loses control of all or part of the recognized
asset; and
(b) for a liability, derecognition normally occurs when the entity no longer has a present obligation for all
or part of the recognized liability.

THE NEED FOR ADJUSTMENTS

Accountants make adjusting entries to reflect in the accounts information on economic activities that have
occurred but have not yet been recorded. Adjusting entries assign revenues to the period in which they are
earned, and expenses to the period in which they are incurred. These entries are needed to measure properly
the profit for the period, and to bring related asset and liability accounts to correct balances for the financial
statements.

In short, adjustments are needed to ensure that the recognition and derecognition principles are followed thus
resulting to financial statements reporting the effects of all transactions at the end of the period.

Adjusting entries involve changing account balances at the end of the period from what is the current balance
of the account to what is the correct balance for proper financial reporting. Without adjusting entries, financial
statements may not fairly show the solvency of the entity in the balance sheet and the profitability in the
income statement.

Note that making adjusting entries is a way to stick to the matching principle—a principle in accounting that
says expenses should be recorded in the same accounting period as revenue related to that expense. To make
an adjusting entry, you don’t literally go back and change a journal entry—there’s no eraser or delete key
involved. Instead, you make a new entry amending the old one.
DEFERRALS AND ACCRUALS

Accountants use adjusting entries to apply accrual accounting to transactions that cover more than one accounting
period. There are two general types of adjustments made at the end of the accounting period—deferrals and
accruals.

Each adjusting entry affects a balance sheet account (an asset or a liability account) and an income statement
account (income or expense account).

Deferral is the postponement of the recognition of "an expense already paid but not yet incurred," or of "revenue
already collected but not yet earned".

- This adjustment deals with an amount already recorded in a balance sheet account; the entry, in effect,
decreases the balance sheet account and increases an income statement account. Deferrals would be
needed in two cases:
1. Allocating assets to expense to reflect expenses incurred during the accounting period (e.g.
prepaid insurance, supplies and depreciation).
2. Allocating revenues received in advance to revenue to reflect revenues earned during the
accounting period (e.g. subscriptions).

Accrual is the recognition of "an expense already incurred but unpaid", or “Revenue earned but uncollected". This
adjustment deals with an amount unrecorded in any account; the entry, in effect, increases both a balance sheet
and an income statement account. Accruals would be required in two cases:

1. Accruing expenses to reflect expenses incurred during the accounting period that are unpaid and
unrecorded.
2. Accruing revenues to reflect revenues earned during the accounting period that are uncollected and
unrecorded.

Illustration: (Adjusting Entries)

The Weddings "R" Us case is continued to illustrate the adjustment process. The letters A, L, OE, OE:I and OE:E
are still used to ensure a better understanding Of the nature of the accounts affected.

ADJUSTMENTS FOR DEFERRALS (step 5)

Allocating Assets to Expenses

Entities often make expenditures that benefit more than one period. These expenditures are generally debited to
an asset account. At the end of each accounting period, the estimated amount that has expired during the period
or that has benefited the period is transferred from the asset account to an expense account. Two of the more
important kinds of adjustments are prepaid expenses, and depreciation of property and equipment.

Prepaid Expenses

Some expenses are customarily paid in advance. These expenditures (e.g. supplies, rent and insurance) are called
prepaid expenses. Prepaid expenses are assets, not expenses. At the end of an accounting period, a portion or all
of these prepayments may have expired. The portion of an asset that has expired becomes an expense. Prepaid
expenses expire either with the passage of time or through use and consumption. The flow of costs from the
balance sheet to the income statement is illustrated below:
 Balance Sheet Income Statement
Assets Revenues and Expenses
Prepaid Rent Rent Expense
Prepaid Insurance Insurance Expense
Supplies Supplies Expense

If adjustments for prepaid expenses are not made at the end of the period, both the balance sheet and the
income statement will be misstated. First, the assets of the entity will be overstated; second, the expenses of
the company will be understated. For this reason, owner's equity in the balance sheet and profit in the income
statement will both be overstated. Besides prepaid rent, Weddings "R" Us has prepaid expenses for supplies
and insurance, both accounts need adjusting entries.

Prepaid Rent (Adjustment a). On May 1, Weddings "R" Us paid P8,000 for two months' rent in advance. This
expenditure resulted to an asset consisting of the right to occupy the office for two months. A portion of the
asset expires and becomes an expense each day. By May 31, one-half of the asset had expired, and should be
treated as an expense. The analysis of this economic event is shown below:

Transaction: Expiration of one month's rent.

Analysis: Assets decreased. Owner's equity decreased.

Rules: Decreases in assets are recorded by credits. Decreases in owner's equity are recorded by debits.

Entries: Decrease in owner's equity is recorded by a debit to rent expense. Decrease in assets is recorded by a
credit to prepaid rent.

Dr. Cr.

Rent Expense (OE: E) 4,000

Prepaid Rent (A) 4,000

After adjustments, the prepaid rent account has a balance of P4,000 (May 1 prepayment of 8,000 less the
P4,000 expired portion); the rent expense account reflects the P4,000 expense for the month.

Prepaid Insurance (Adj; b). Weddings "R" Us acquired a one-year comprehensive insurance coverage on the
service vehicle and paid P14,400 premiums. In a manner similar to prepaid rent, prepaid insurance offers
protection that expires daily. The adjustment is analyzed and recorded as shown below:

Transaction: Expiration of one month's insurance.

Analysis: Assets decreased. Owner's equity decreased.

Rules: Decreases in assets are recorded by credits. Decreases in owner's equity are recorded by debits.
Entries: Decrease in owner's equity 'is recorded by a debit to insurance expense; decrease in assets as a credit
to prepaid insurance.

Dr. Cr.

Insurance Expense (OE: E) 1,200

Prepaid Insurance (A) 1,200

The prepaid insurance account has a balance of P13,200 (May 4 prepayment of P14,40 less PI,200) and insurance
expense reflects the expired cost of PI,200 for the month. As a matter of company policy, the period May 4 to 31
is considered a month.

Supplies (Adjustment c). On May 8, Weddings the "R" process Us purchased of performing supplies, services
P 18,000 for During the month, the entity used supplies in clients. There is no need to account for these supplies
every day since the financial statements will not be prepared until the end of the month. At the end of the
accounting period, Perez-Manalo makes a careful physical inventory of the supplies. The inventory of the supplies.
The inventory count showed that supplies costing P15,000 are still on hand. This transaction is analyzed and
recorded as follows:

Transaction: Consumption of supplies.

Analysis: Assets decreased. Owner's equity decreased,

Rules: Decreases in assets are recorded by credits. Decreases in owner's equity are recorded by debits.

Entries: Decrease in owner's equity is recorded by a debit to supplies expense. Decrease in assets is recorded by
a credit to supplies.

Dr. Cr.

Supplies Expense (OE: E) 3,000

Supplies (A) 3,000

The asset account supplies now reflect the adjusted amount of P15,000 (P18,000 less P3,000). In addition, the
amount of supplies expensed during the accounting period is reflected as P3,000.

Depreciation of Property and Equipment

When an entity acquires long-lived assets such as buildings, service vehicles, computers or office furniture, it is
basically buying or prepaying for the usefulness of that asset. These assets help generate income for the entity.
Therefore, a portion of the cost of the assets should be reported as expense in each accounting period. Proper
accounting requires the allocation of the cost of the asset over its estimated useful life. The estimated amount
allocated to any one accounting period is called depreciation or depreciation expense. Three factors are involved
in computing depreciation expense:
 1. Asset cost is the amount an entity paid to acquire the depreciable asset.
2. Estimated salvage value is the amount that the asset can probably be sold for at the end of its
estimated useful life.
3. Estimated useful life is the estimated number of periods that an entity can make use of the asset.
Useful life is an estimate, not an exact measurement.

Balance Sheet Income Statement

Asset Revenues and Expenses
Service Vehicle Depreciation Expense
Office Equipment

Accountants estimate periodic depreciation. They have developed a number of methods for estimating
depreciation. The simplest procedure is called the straight-line method. The formula for determining the
amount of depreciation expense for each period using this method is:

Asset Cost xx
Less: Estimated Salvage Value xx
Depreciable Cost xx
Divided by: Estimated Useful Life xx
Depreciation Expense for each time period xx

The asset account is not directly reduced when recording depreciation expense. Instead, the reduction is
recorded in a contra account called accumulated depreciation. A contra account is used to record reductions
in a related account and its normal balance is opposite that of the related account. Use of the contra account—
accumulated depreciation—allows the disclosure of the original cost of the related asset in the balance sheet.
The balance of the contra account is deducted from the cost to obtain the book value of the property and
equipment.

Service Vehicle and Office Equipment (Adjs. d and e). Suppose that Weddings "R" Us estimated that the
service vehicle, which was bought on May 4, will last for seven years (eighty-four months) and with a salvage
value of P84,000. The office equipment that was acquired on May 5 will have a useful life of five years (sixty
months) and will be worthless at that time. Substitution of the pertinent amounts into the basic formula will
yield depreciation for service vehicle and office equipment for the month as P4,000 [(P420,000-84,000)/84
months] and P1,000 (P60,000/60 months), respectively. These amounts represent the cost allocated to the
month, thus reducing the asset accounts and increasing the expense accounts. As a matter of company policy,
the period May 4 to 31 is considered a month. The analysis follows:

Transaction: Recording depreciation expense.

Analysis: Assets decreased, Owner's equity decreased.

Rules: Decreases in assets are recorded by credits. Decreases in owner's equity are recorded by debits.
Entries Owner's equity is decreased by debits to depreciation expense- service vehicle and depreciation
expense-office equipment. Assets are decreased by credits to contra-asset accounts accumulated depreciation-
service vehicle and accumulated depreciation-office equipment.

Dr. Cr.

Depreciation Expense-Service Vehicle (OE: E) 4,000

Accumulated Depreciation-Serv. Vehicle (A) 4,000

Depreciation Expense-Office Equipt. (OE: E) 1,000

Accumulated Depreciation-Off. Equipt. (A) 1,000

After adjustments, the property and equipment section of the balance sheet for Weddings "R" Us will be:

Weddings “R” Us
Partial Trial Balance
May 31, 2019

Property and Equipment (Net):

Service Vehicle P420,000

Less: Accumulated Depreciation 4,000 P416,000

Office Equipment P60,000

Less: Accumulated Depreciation 1,000 P59,000
P475,000

Allocating Revenues Received in Advance to Revenues

There are times when an entity receives cash for services or goods even before service is rendered or goods
are delivered. When such is received in advance, the entity has an obligation to perform services or deliver
goods. The liability referred to is unearned revenues.

For example, publishing companies usually receive payments for magazine subscriptions in advance. These
payments must be recorded in a liability account. If the company fails to deliver the magazines for the
subscription period, subscribers are entitled to a refund. As the company delivers each issue of the magazine,
it earns a part of the advance payments. This earned portion must be transferred from the unearned
subscription revenues account to the subscription revenues account.
 Balance Sheet Income Statement
Liabilities Revenues and Expenses
Unearned Revenue Revenues From _______

Unearned Referral Revenues (Adj. f). On May 15, Weddings "R" Us received P10,00 as an advance
payment for referrals made. Assume that by the end of the month, one of the three couples referred has
already taken their marriage vows and as a result the amount of P4,000 pertaining to the referred event has
been realized. This transaction is analyzed as follows:

Transaction: Recognition of income where cash is received in advance.

Analysis: Liabilities decreased. Owner's equity increased.

Rules: Decreases in liabilities are recorded by debits. Increases in owner's equity are recorded by credits.

Entries: Decrease in liabilities is recorded by a debit to unearned referral revenues. Increase in owner's equity
is recorded by a credit to referral revenues.

Dr. Cr.

Unearned Referral Revenues (L) P4,000

Referral Revenues (OE: I) 4,000

The liability account unearned referral revenues reflect the referral revenues still to be earned, P6,000. The
referral revenues account reflects the amount of referrals already completed and considered as revenues
during the month, P4,000.

ADJUSTMENTS FOR ACCRUALS (step 5)

Accrued Expenses

An entity often incurs expenses before paying for them. Cash payments are usually made at regular intervals
of time such as weekly, monthly, quarterly or annually. If t accounting period ends on a date that does not
coincide with the scheduled ca payment date, an adjusting entry is needed to reflect the expense incurred
since the la payment. This adjustment helps the entity avoid the impractical preparation of hour or daily
journal entries just to accrue expenses. Salaries, interest, utilities (e. electricity, telecommunications and
water) and taxes are examples of expenses that incurred before payment is made.

Accrued Salaries (Adj. g). Entities pay their employees at regular intervals. It can be weekly, semi-monthly
or monthly. Weekly payrolls are usually made on Fridays (for five-day workweek) or Saturdays (for a six-day
workweek). Weddings "R" Us pays salaries every two Saturdays. Assume that the calendar for May appears
as follows:
 MAY
Su M T W Th F Sa
1 2 3 4 5 6
7 8 9 10 11 12 13
14 15 16 17 18 19 20
21 22 23 24 25 26 27
28 29 30 31

The office assistant and the account executive were paid salaries on May 13 and 27. At month-end, the employees
have worked for three days (May 29, 30 and 31) beyond the last pay period. The employees have earned the
salary for these days, but it is not due to be paid until the regular payday in April. The salary for these three
days is rightfully an expense for May, and the liabilities should reflect that the entity owes the employees’ salaries
for those days.

Each of the employee's salary rate is P7,800 per month or P300 per day (P7,800/26 working days). The expense
to be accrued is PI,800 (P300 x 3 days x 2 employees). This accrued expense can be analyzed as shown:

Transaction: Accrual of unrecorded expense.

Analysis: Liabilities increased. Owner's equity decreased.

Rules: Increases in liabilities are recorded by credits. Decreases in owner's equity are recorded by debits.

Entries: Decrease in owner's equity is recorded by a debit to salaries expense. Increase in liabilities is recorded
by a credit to salaries payable.

Dr. Cr.

Salaries Expense (OE: E) 1,800

Salaries Payable (L) 1,800

The liability of P1,800 is now correctly reflected in the salaries payable account. The actual expense incurred for
salaries during the month is P 15,600.
Accrued Interest (Adj. h). On May 2, Perez-Manalo borrowed P210,000 from Metrobank. She issued a
promissory note that carried a 20% interest per annum. Both the interest and principal will be payable in one
year. The note issued to the bank accrues interest at 20% annually. At the end Of May, Perez-Manalo owed
the bank P3,500 (see computation below) for interest in addition to the P210,000 loan. Interest is a charge
for the use of money over time. Interest expense is matched to a particular period during which the benefit—
the use of borrowed money—is received. The interest is a fixed obligation and accrues regardless of the
results of the entity's operations.

Interest rates are expressed at annual rates, so if interest is being calculated for less than a year, the
calculation must express time as a portion of a year. Thus, the interest expense (simple) incurred on this
note during the month is determined by the following formula:

Interest = Principal x Interest Rate x Length of Time

= P210,000 x 20% x 1/12 of a year
= P210,000 x .20 x 1/12
= P3,500
The adjusting entry to record the interest expense incurred in May is as follows:

Transaction: Accrual of unrecorded expense.

Analysis: Liabilities increased. Owner's equity decreased.

Rules: Increases in liabilities are recorded by credits. Decreases in owner's equity are recorded by debits.

Entries: Decrease in owner's equity is recorded by a debit to interest expense; increase in liabilities as credit
to interest payable.

Dr. Cr.

Interest Expense (OE: E) 3,500

Interest Payable (L) 3,500

Accrued Revenues

An entity may provide services during the period that are neither paid for by clients nor billed at the end of
the period. The value of these services represents revenue earned by the entity. Any revenue that has been
earned but not recorded during the accounting period calls for an adjusting entry that debits an asset account
and credits an income account.

Accrued Consulting Revenues (Adj. i). Suppose that Weddings "R" Us agreed to arrange a rush but simple
civil wedding for a madly-in-love couple in the afternoon of May 31. The entity intended to charge fees of
P5,300 for the services, which is earned but Unbilled. This should be recorded as shown below:

Transaction: Accrual of unrecorded revenuer

Analysis: Assets increased. Owner's equity increased.
Rules: Increase in assets are recorded by debits, increases in owner's equity are recorded by credits.
Entries: Increase in asset is recorded by a debit to accounts receivable. Increase in owner's equity as a credit
to consulting revenues.

Dr. Cr.

Accounts Receivable (A) 5,300

Consulting Revenues (OE: l) 5,300

A total of P67,700 in consulting revenues was earned by the entity during the month.

The Weddings "R" Us illustration did not tackle entries related to uncollectible accounts Hence, the ensuing
discussion on the accrual of uncollectible accounts is not in any related to the Weddings "R" Us illustration.
This is to complete the illustrations on adjustments for accruals.

ACCRUAL FOR UNCOLLECTIBLE ACCOUNTS

Entities often allow clients to purchase goods or avail of services on credit. Some of these accounts will never
be collected; hence, there is a need to reflect these as charges against income. In practice, an expense is
recognized for the estimated Uncollectible accounts in the current period, rather than when specific accounts
actually become uncollectible. This practice produces a better matching of income and expenses. Estimates
of uncollectible accounts may be based on credit sales for the period or on the accounts receivable balance.

Assume that an entity made credit sales of in 2019 and prior experience indicates an expected 1% average
uncollectible accounts rate based on credit sales. The contra account—Allowance for Uncollectible Accounts
has a normal credit balance and is shown in the balance sheet as a deduction from Accounts Receivable. The
allowance account needs to be increased by P11,000 (P1,100,000 x 1%) because accounts receivable in that
amount is doubtful of collection. The adjustment will be:

Dr. Cr.

Uncollectible Accounts Expense (OE: E) 11,000

Allowance for Uncollectible Accounts (A) 11,000

Throughout the accounting period, when there is positive evidence that a specific account is definitely
uncollectible, the appropriate amount is written off against the contra account. For example, if a P1,500
receivable was considered uncollectible, that amount would be written off as follows:

Dr. Cr.

Allowance for Uncollectible Accounts (A) 1,500

Accounts Receivable (A) 1,500

No entry is made to Uncollectible Accounts Expense, since the adjusting entry has already provided for an
estimated expense based on previous experience for all receivables.
EFFECTS OF OMITTING ADJUSTMENTS

When an accountant failed to include the proper adjusting entries, the resulting financial statements will not
accurately reflect the financial position and the performance of the entity. Inaccuracies in one accounting
period can cause further inaccuracies in the statements of subsequent periods.

Illustration. On July 1, 2019, Cabuyao Manpower Services owned by Warlito Blanche borrowed P100,000 by
signing an 18-month note at 16% interest per annum. The principal and interest are to be repaid when the
note matures on Dec. 31, 2020.

As at Dec. 31, 2019, the entity has incurred interest expense of P8,000 (P100,000 x 16% x 6/12). The
accountant did not record the adjustment for the accrued interest. The entry should have been a debit to
Interest Expense and a credit to Interest Payable for 8,000.

The effects of the omission in the 2019 financial statements are as follows:

 In the 2019 income statement, interest expense is understated by P8,000 and, therefore, profit is
overstated by P8,000.
 In the Dec. 31, 2019 balance sheet, owner's equity is overstated by P8,000 because of the
overstatement in profit. Total liabilities are understated because of the omission of the P8,000 interest
payable.

On Dec. 31, 2020, the maturity date, the note is paid together with interest. Since there was no adjusting
entry made to accrue interest in 2019, the entire interest of P24,000 (P100,000 x 16% x 18/12) was
erroneously charged against 2020 profit. The correct interest expense for 2020 should have been P16,000
(P100,000 x 16% x 12/12).

The effects of the omissions in the 2020 financial statements are as follows:

 In the 2020 income statement, interest expense is overstated by P8,000 and, therefore, profit is
understated by P8,000.
 The Dec. 31, 2020 balance sheet is correctly stated since the note along with its interest has been
settled by year-end. The effect of the omission has counterbalanced by the end of the second
accounting period.

In summary, the omission has produced two erroneous income statements and erroneous balance sheet. If
the entity should have reported a correct profit Of P500,000 in the 2019- and 2020-income statements. As a
result of the Omission proprietorship's profit in 2019 is P508,000 and in 2020, P492,000.
Conclusion:

A business needs to record the true and fair values of its expenses, revenues, assets, and liabilities. Adjusting
entries follows the accrual principle of accounting and make necessary adjustments which are not recorded during
the previous accounting year. The adjusting journal entry generally takes place on the last day of the accounting
year and majorly adjusts revenues and expenses.

Adjusting Entries are made after trial balances but before the preparation of annual financial statements. Thus,
these entries are very important towards the representation of accurate financial health of the company.

References:

Basic Financial Accounting and Reporting 22nd Edition, Win Ballada,2019

Accounting 9th Edition by Charles T. Horngren, Walter T. Harrison Jr., and M. Suzanne Oliver
https://bench.co/blog/bookkeeping/adjusting-entries/
https://theskillcollective.com/blog/coronavirus-new-normal