FAR Chapt. 7
FAR Chapt. 7
FAR Chapt. 7
“Note: We cannot proceed to prepare the worksheet for the adjustments if the accounting
period is not yet done”
Adjusting the Accounts
Timing Issue
- Time Period Assumption
- The economic life of a business is divided into time periods (monthly, quarterly or
yearly)
- EG.
- A one-year insurance paid in advance on March 1, 2020, should be
expensed only for ten months in 2020 (March to December) and for
two months in 2021 (January to February).
- A consultancy firm received an advance fee of P30,000 good for three
months starting December 1, 2020. Only one month revenue of
P10,000 should be recognized in 2020 and the remaining P20,000 in
2021.
The basics of adjusting entries
Adjusting entries are entries prepared at the end of the accounting period to update some
accounts and ensure their accuracy before preparing the financial statements
Types of adjusting entries
- Accrued income
- Income already earned but not yet collected
- Accrued expense
- Expense already expired but not yet paid
- Unearned income
- Advance collection recorded as a liability, portion of which has been already
been earned.
- A service that is not yet rendered.
- Prepaid expense
- Advance payment is recorded as an asset, portion of which has been used up
- Bad Debts
- Clients' accounts that may not be collected anymore or are doubtful of
collection
- Depreciation expense
- Declining utility value of asset cost that should be expensed
Adjusting entries for accruals
Accrual Basis Accounting
- Also otherwise known as the Revenue Recognition Principle and the Expense
recognition principle
- Transactions recorded in the period in which the events occur
- Accrued Revenues
- Revenues are recognized when earned, rather than when cash
is received
- Adjust the unearned revenue to decrease the liability account and recognize
an income for the earned portion. The unexpired balance is shown as a
current liability in the financial statement of financial position while the earned
portion is shown in the income statement.
Bad debts
- Losses from uncollectible accounts are considered part of the risk the entity assumes and
should therefore be considered part of operating expense.
- Sometimes occurs for customers’ accounts that are doubtful of collection. Give rise to a
contra asset account (credit) with a credit to allowance for bad debts and a debit to a bad
debt expense account.
Direct write-off method
- Recognizes bad debt expense only when it is certain that the company will not be
able to collect the account anymore.
- The bad debt expense will be shown in the operating expense
- Credits the account receivable to decrease it directly
Depreciation
- Often occurs for fixed assets such as furniture and fixtures and equipment when their costs
are often adjusted from new to use.
- Gives rise to a contra asset account credited to accumulated depreciation and a debit to
depreciation expense account.
- Recognizing part of the asset as an expense because of its decreasing utility value