Basic Financial Accounting & Reporting Adjusting the Accounts Learning Objectives: After studying this chapter, you should be able to: Explain accrual accounting and state how it improves financial statements. Explain the importance of periodic reporting and time period assumption. Explain the recognition and derecognition process. Explain the five-step process for revenue recognition. Identify the types of adjustments and their purposes. Illustrate how accounting adjustments link to financial statements. Use the same steps learned in analyzing transactions. Prepare and explain the adjusting entries. Interpret the effects of omitting adjustments on the financial statements. 0. Develop skills in preparing adjusting entries using T-Accounts. 11. Summarize the adjustment process showing the type of adjustment, the effect of omitting the adjusting entry on the financial statements and the adjusting entry. 12. Prepare an adjusted trial balance. 13. Explain the alternative methods of recording deferrals. BE PITAL eeNE ACCRUAL BASIS 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.170 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada In cash basis accounting, however, the accountant does not record a transaction until cash is received or paid. Generally, cash receipts are treated as revenues and cash payments as expenses. Cash basis income is the difference between operating cash receipts and disbursements. These cash flows necessarily exclude investments by and distributions to the owner in the computation of income. Illustration. A client paid the Sea Wind Resort in Boracay Island P7,000 on April 8, 2022 for a one-day super deluxe accommodation on May 13, 2022. Under accrual basis of accounting, the receipt of P7,000 will be considered as revenues when the business has rendered its services on May 13. In contrast, if cash basis is used, the hotel will recognize revenues 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 basis, no revenue or expense will be reported; under cash basis, revenues of P7,000 will be reported but the related 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, sell 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 -use of accruals. To measure profit in a fair manner, entities update the income and expense accounts immediately before the end of the period.Adjusting the Accounts | 171 cn iinarcnitemeeinnenteeratneenheettne Se 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 of a li (ii) the derecognition of an asset, or a decrease in the carrying amount of an asset. lity; or The initial recognition of assets or liabilities arising froin 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. )172. | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada REVENUE FROM CONTRACTS WITH CUSTOMERS (PFRS 15) This standard adopts an asset-liability approach as the basis for revenue recognition, The asset-liability approach recognizes and measures revenue based on changes in assets and liabilities. Entities analyze contracts with customers because contracts initiate revenue transactions. Contracts indicate the terms of the transactions, provide the measurement of the consideration, and specify the promises that must be met by each party. The core principle is that an entity will recognize revenue at an amount that reflects the consideration to which the entity expects to be entitled in exchange for transferring goods or services to a customer. The five-step process for revenue recognition: Identify the contract with customers. Identify the performance obligations in the contract. Determine the transaction price. Allocate the transaction price to the performance obligations in the contract. Recognize revenue when each performance is satisfied. oP ye A contract is an agreement between two or more parties that creates enforceable rights and obligations. PERS 15 defines performance obligation as a promise in a contract with customer to transfer to the customer either (a) a good or service (or a bundle of goods or services) that is distinct; or (b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. Simply put, performance obligation is a promise in a contract,to provide a product or service to a Customer. %. : Transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. Hf more than one performance obligation exists, allocate the transaction price based on relative fair values. The best measure of fair value is what the good or service could be sold for on a stand-alone basis or the stand-alone selling price. An entity satisfies its performance obligation when the customer obtains control of the good or service, A performance obligation could either be satisfied over time or at a point in time. Details of this standard in another book, Conceptual Framework and Accounting Standards 2022 Edition by Prof. WIN Ballada.Adjusting the Accounts | 173 enteral ‘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. End of the period—adjusting entries recorded in the General Journal The General Journal Posting to the Ledger Unearned Revenues174 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada Adjusted ; ; Trial Balance Adjusted Trial Balance is prepared Assets Liabilities Owner's Equity Revenues Expenses 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 peri uncollected and unrecorded. 18 Period that areAdjusting the Accounts | 175 ee 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: Cost of As insurance : Balance Sheet Income Statement irenranee were policies expire and policies an supplies used supplies —>|( Assets Fr Revenues ae ee that will benefit Prepaid Expenses future | Insurance Insurance Expense periods 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.176 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada 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 P8,000 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 P14,400 less P1,200) and insurance expense reflects the expired cost of P1,200 for the month. ‘As a matter of company policy, the period May 4 to 31 is considered a month.Adjusting the Accounts | 177 Supplies (Adjustment c). On May 8, Weddings “R” Us purchased supplies, P18,000. During the month, the entity used supplies in the process of performing services for 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, Besario makes a careful physical 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:€) 3,000 Supplies (A) 3,000 The asset account supplies now reflect the adjusted amount of P15,000 (P18,000 less 3,000). 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 furnitures, 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.178 | Basic Financial Acco As the asset's Balance Sheet useful life Income Statement Cost of a expires depreciable —> | Assets Revenues asset Service Vehicle mearaiaanar aaa Expenses Office Equipment Depreciation 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 x 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 - P84,000)/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.Adjusting the Accounts | 179 RR 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:£) 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 Balance Sheet May 31, 2022 Property and Equipment (Net): Service Vehicle 420,000 . Less: Accumulated Depreciation 4,000 P416,000 Office Equipment P 60,000 Less: Accumulated Depreciation 1,000 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.inting and Reporting 2023 Edition by Prof. WIN Ballada \s the goods bic a Balance Sheet =a sondehs Income Statement services are provided tobe Fr a edaiates Revenues provided in Unearned m Revenues from Revenues future periods Unearned Referral Revenues (Adj. f). On May 15, Weddings “R” Us received P10,000 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. Or. Cr. Unearned Referral Revenues (L) 4,000 Referral Revenues (OE:!) 4,000 The liability account unearned referral revenues reflects 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 the accounting period ends on a date that does not coincide with the scheduled cash payment date, an adjusting entry is needed to reflect the expense incurred since the last Payment. This adjustment helps the entity avoid the impractical preparation of hourly or daily journal entries just to accrue expenses. Salaries, interest, utilities (e.8-, electricity, telecommunications and water) and taxes are examples of expenses that are incurred before payment is made.Adjusting the Accounts | 181 ET 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 a 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 mM id w Th F sa 1 2 3 4 5 6 7 8 9 10 Boy 12 B mw 15 16 7 18 19 20 2 2 23 24 25 26 7 23 (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 P1,800 (P00 x 3 days x 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 P15,600. Fe182_| Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada Accrued Interest (Adj. h). On May 2, Besario 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, Besario owed the bank P3,S00 (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 210,000 x 20% per year x 1/12 of ayear P210,000 x .20 x 1/12 = 3,500 " 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 i; 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 revenue. Analysis Assets increased, Owner's equity increased. Rules Increases in assets are recorded by debits. Increases in owner's equity are recorded by credits. Entries Increase in assets is recorded by a debit to accounts receivable. Increase in owner's equity as a credit to consulting revenues. Or. rs Accounts Receivable (A) 5,300 Consulting Revenues (OE:!) 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 way 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 P1,100,000 in 2022 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 need 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 were considered uncollectible, that amount would be written off as follows:by Prof. WIN Ballada Or. 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. A more detailed discussion of this topic is found in Part Four of this book. 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, 2022, 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, 2023. As at Dec. 31, 2022, 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 2022 financial statements are as follows: > In the 2022 income statement, interest expense is understated by P8,000 and, therefore, profit is overstated by P8,000. > Inthe Dec. 31,2022 balance sheet, owner's equity is overstated by P8,000 because of the overstatement in profit. Total liabilities is understated because of the omission of the 8,000 interest payable, On Dec. 31, 2023, the maturity date, the note is paid together with interest. Since there was no adjusting entry made to accrue interest in 2022, the entire interest of P24,000 (P100,000 x 16% x 18/12) was erroneously charged against 2023 profit. The correct interest expense for 2023 should have been P16,000 (P100,000 x 16% x 12/12). The effects of the omissions in the 2023 financial statements are as follows: » In the 2023 income statement, interest expense is overstated by P8,000 and, therefore, profit is understated by P8,000, » The Dec. 31, 2023 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.Adjusting the Accounts | 185 ee See In summary, the omission has produced two erroneous income statements and one erroneous balance sheet. If the entity should have reported a correct profit of P500,000 in the 2022 and 2023 income statements. As a result of the omission, the proprietorship’s profit in 2022 is P508,000 and in 2023, P492,000. ANALYSIS USING T-ACCOUNTS To recapitulate, each adjusting entry affects a balance sheet account (an asset or a liability account) and an income statement account (an income or an expense account). Almost every revenue or expense account on the income statement has one or more related accounts on the statement of financial position. For instance, rent expense is related to prepaid rent, supplies expense to supplies, service revenues to unearned service revenues and salaries expense to salaries payable. Having been apprised of these relationships, transactions affecting particular accounts can now be analyzed using T-accounts. This learning will be of use in reconstructing accounts to derive details like cash inflows, cash outflows, revenues recognized for the period or expenses charged for the period. To illustrate, Eco-Tours, established by Galicano Del Mundo at the start of the month, reported at month-end the following related accounts and account balances: Supplies, P36,600 and Supplies Expense, P15,400. Looking at the foregoing, Del Mundo wants to know how much cash was paid out to purchase supplies. Start by placing the relevant information in a T-account. Input the beginning balance on the normal balance of the account. In this case, Supplies is debit. There is no beginning balance since the company just started operations this month. As a technique, the ending balance of an account, here, Supplies for P36,600, is placed opposite its normal balance. In adjusting for supplies expense, the entry made was debit Supplies Expense, P15,400 and credit Supplies, P15,400. Total both debit and credit sides. The cash paid out for supplies can now be derived; it’s P52,000 (P52,000 — zero), the plug figure. |f there was a beginning balance of P2,000, then cash paid out would have been P50,000 (P52,000 — P2,000). Supplies Credit ) 15,400 Expense for the Month 36,600__ Ending Balance 52,000_ Total Debit (+) Beginning Balance 0- Cash Paid for Supplies Plug figure Total186 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada SS Assume instead that the P36,600 ending balance for Supplies and the P52,000 cash paid for supplies were given, using the T-account, supplies expense is P15,400 (P52,000 ~ P36,600): Supplies Debit Credit 0 Plug figure Expense for the Month 36,600 _ Ending Balance 52,000 _ Total Beginning Balance Cash Paid for Supplies Total — To illustrate further, a company reported at month-end the following related accounts and account balances: Prepaid Insurance, End, P67,000; Insurance Expense, P12,000 and Prepaid Insurance, beginning, P48,000, How much cash was used to pay for insurance this period? Answer: P31,000 Prepaid Insurance Debit Credit (+) Q Beginning Balance 48,000 12,000 _ Expense for the Month Cash Paid for Insurance Plug figure 67,000__ Ending Balance Total 79,000 Total Ge To have an ending balance of P67,000, there must have been a P31,000 debit to the Prepaid Insurance account. Since a debit to this account is normally offset by a credit to Cash, the analysis confirms that cash outflows for insurance was P31,000. 7Adjusting the Accounts | 187 sanuanay (v) aigenaoay payeysiapun awoou | —_payerssapun syassy sanuanay pansnoy (1) ajqedeg asuadxg | parersiapun sasuadxg | parersiopun sanmqen sasuadg pannoy () senuanay paweaun anuanay | —payeisiang sanuanay | pareysiapun sanmqen poysew auzoau, senuanay | (1) senuanay pawesun paversiopun awoau) | — parersiang sanuigen pourew Agen :sanuanay paweaun, yassy enu03 asuadxg | pareysiapun sasuadxg payeisiang siassy vonenaidag asuadg (y) asuadeg predaig | payeysiang sasuadg pareisiepun siassy powjas asuadeg (vy) esuadsg predaig asuadg | pareysiapun sasuadyg pareisiang siassy poyaw assy ssasuadxg piedaug qunoaay, qunoaay eee erate quawiarers ewo>U} yeays aouejes Aa Bupsnipy quaunsn{py 370Jog sesuejeg yunos9y quawysnipy jo adAy ‘S3IYLN3 ONILSNfay 40 ANVINWNS188 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada APPENDIX ALTERNATIVE METHODS OF RECORDING DEFERRALS In the discussions, all the transactions that required adjustments are initially recorded in balance sheet accounts. A prepaid expense is initially recorded in a prepaid asset account. Likewise, revenue received in advance is initially recorded in a liability account—unearned revenues. In the case of a prepaid expense, an adjusting entry is made at the end of the period to transfer the portion of the expired asset to an expense account. Similarly, an adjusting entry is made to transfer earned revenues from the liability account to an income account. Entities may initially account for deferrals using income and expense accounts. The alternative approach is illustrated in this appendix. Prepaid Expenses On Oct. 1, 2022, Calaguas Company acquired a 3-year insurance policy for P36,000 paid in advance. Calaguas may record this transaction depending on which of the two accounting policies it follows. The P36,000 payment may initially be recorded either as an asset or as an expense. Initial entry is recorded as: 1. Anasset 2022 Oct.10 Prepaid Insurance (A) 36,000 Cash 36,000 2. An expense 2022 Oct.10 Insurance Expense (OE:E) 36,000 Cash 36,000 At the end of the year, an adjusting entry is needed to establish the proper balances in the prepaid insurance and insurance expense accounts. On Dec. 31, 2022, three months' insurance has been consumed, or insurance expense is equal to P3,000 (P36,000/36 months x 3 months). Prepaid insurance equivalent to P33,000 (P36,000 - P3,000) remain. The appropriate adjustment depends on how the initial transaction was recorded.Adjusting the Accounts | 189 SST Adjusting entry required if initial entry is recorded as: 1. Anasset 2022 Dec. 31 Insurance Expense (O! 3,000 Prepaid Insurance (A) 3,000 2. Anexpense 2022 Dec. 31 Prepaid Insurance (A) 33,000 Insurance Expense (OE:E) 33,000 The effect of the adjusting entries on the ledger accounts after posting is the same regardless of the initial debits as shown below: Asan Asset ‘Asan Expense Dec. 31 balances: Dec. 31 balances: Prepaid Insurance 33,000 debit Prepaid Insurance 33,000 debit Insurance Expense 3,000 debit —_ Insurance Expense 3,000 debit —————————————— Unearned Revenues On July 1, 2022, Marasigan Company received a P48,000 check for 2 years’ rent paid in advance. On this date, Marasigan may record a credit in that amount either as unearned rental revenue or rental revenue, depending on its accounting policy. Initial entry is recorded as: 1. Aliability 2022 July1 Cash 48,000 Unearned Rent Revenues (L) 48,000 2. Arevenue 2022 ; July1 Cash 48,000 Rent Revenues (OE:!) 48,000190 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada At the end of the year, an adjusting entry is needed to establish the proper balances in the rent revenue and unearned rent revenue accounts. On Dec. 31, 2022, six months' rent has been earned, or rent revenue is equal to P12,000 (P48,000/24 months x 6 months). Unearned rent revenues equivalent to P36,000 (P48,000 - P12,000) remain. The appropriate adjustment depends on how the initial transaction was recorded. Adjusting entry required if initial entry is recorded as: 1. Aliability 2022 Dec. 31 Unearned Rent Revenues (L) 12,000 Rent Revenues (OE:I) 12,000 2. Arevenue 2022 Dec. 31 Rent Revenues (OE:I) 36,000 Unearned Rent Revenues (L) 36,000 The effect of the adjusting entries on the ledger accounts after posting is the same regardless of the initial credits as shown below: Asa Liability As an Income Dec. 31 balances: Dec, 31 balances: Unearned Rent Revenues 36,000 credit © Unearned Rent Revenues 36,000 credit Rent Revenues 12,000 credit Rent Revenues 12,000 creditAdjusting the Accounts | 191 DISCUSSION QUESTIONS 1. What is meant by the periodicity concept? 2. Differentiate fiscal, calendar and natural business year. 3. What are adjusting entries? Why are adjusting entries necessary? 4, Cite the differences between deferrals and accruals. 5, Adjusting entries are needed when deferrals and accruals exist. Enumerate the two principal situations under each that require adjusting entries. 6. Accounts receivable that is doubtful of collection should be provided an allowance. What entry should the accountant make? 7. Whatis a contra account? Give examples'of contra accounts. 8. Illustrate how the adjusting entries would differ if the payment of a two-year insurance policy is initially recorded as an asset or as an expense. 9. Illustrate how the adjusting entries would differ if the receipt of a three-year rental revenue is initially recorded as a liability or as revenue. 10. Discuss the concept of depreciation. What are the factors to be considered in computing for depreciation expense? 11. If the accountant failed to record accrued interest on notes payable, what is the effect of this omission on the financial statements? 12. If the accountant failed to record the acquisition of computer equipment, what is the effect of this omission on the financial statements? 13. If an entity failed to make an adjusting entry, will the trial balance be in balance?192 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada NAME: SCORE: SECTION: PROFESSOR: Fill in the Blanks 1. The financial year of a business is from Jan. 1 to Dec. 31. In Jan. 2021, it provided goods worth P125,000 to a customer. This amount should be recorded in the year . In Dec. 2021, it paid P240,000 for the rent for Jan. 2022. This expense should be recorded in the year 2. There are two main accounting theories'that determine how income and expenses are accounted for. They are the concept and the concept. 3. A business prepares an income statement for a financial year. The business collected P260,000 for 13 months of rental income, but only recorded P240,000 as rent income in the income statement. This practice complies with the concept. 4. Ina business with a 12-month financial year starting from Jan. 1, the last month of the financial year is . For another business with a 12-month financial year starting from Mar. 1, the last month of the financial year is 5. There are certain rules dictating the financial period that income and expenses are to be recorded in. Income is recognized and recorded when it is ; and expenses are recorded when they are 6. The financial year of a business is from Jan, 1 to Dec. 31. In preparing the income. statement for the year ended Dec. 31, 2022, the business includes the income and expenses from Jan. to Dec. 2022 only. This practice follows the concept. An income earned in Jan. 2021 which was collected in, Dec. 2020 is recorded in 2021. This second practice follows the concept. 7. Atrial balance lists all the names of ledger accounts in the and their__________as at a particular date. The total from accounts with balances should tally with the total from accounts with balances,Adjusting the Accounts | 193 NAME: SCORE: SECTION: PROFESSOR: True or False 10. 11. 12. 13. 14. The adjusting entry to recognize an expense which is unrecorded and unpaid will cause total assets to increase, The adjusting entry to allocate part of the cost of a one-year fire insurance policy to expense will cause total assets to increase. Every adjusting entry must change both an income statement account and a balance sheet account. Failure to record the adjusting entry for depreciation results in assets and owner's equity being overstated on the balance sheet. A fiscal period must begin on January 1. Revenue cannot be recognized unless delivery of goods has occurred or services have been rendered. Adjusting entries are useful in apportioning costs among two or more accounting periods. Recording incurred but unpaid expenses is an example of an accrual. Revenue is equal to the cash received by a company during an accounting period. ‘Acompany's fiscal year must correspond to the calendar year. In recording the adjusting entries for depreciation, both accounts involved are increased. The amount of accrued revenues is récorded by debiting an asset account and crediting an income account. Accrued revenue is a term used to describe revenue that has been received but not yet earned. Book value is the original cost of a building less depreciation for the year.15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27, 28, zs. 194 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada The adjusting entry to recognize earned revenues which was received in advance will cause total liabilities to decrease. If all transactions were originally recorded in conformity with GAAP, there would be- no need for adjusting entries at the end of the period. The adjustment to record depreciation of property and equipment consists of a debit to depreciation expense‘and a credit to accumulated depreciation. When services are not paid for until after they have been performed, the accrued expense is recorded by an adjusting entry at the end of the accounting period. The adjusting entry to recognize earned commission revenues not previously recorded or billed will cause total assets to increase. When the reduction in prepaid expenses is not properly recorded, this causes the asset accounts and expense accounts to be understated. Applying accrual accounting results in a more accurate measurement of profit for the period than does the cash basis of accounting. Not all increases to cash represent revenues. Adjusting entries affect cash flows in the current period. Accrual accounting recognizes revenues and expenses at the point that cash changes hands. A deferral is the recognition of an expense that has arisen but has not yet been recorded, Assets become liabilities when they expire, When there is no direct connection between revenues and costs, the costs are systematically allocated among the periods benefited. Revenue results from collection of accounts receivable. Accumulated depreciation accounts may be referred to as contra-asset accounts.30. 31. 32. 33. 34. 35. 36. 37. 38. 39, 40. 41. 42. 43. ing the Accounts | 195 Accounts that are partly income statement amounts and partly balance sheet amounts are called mixed accounts. An asset's book value represents the true market value of the asset. If the adjustment for accrued salaries is omitted, liabilities and expenses will be understated. A decrease in an expense account is the equivalent of a decrease in owner's equity. Failure to record the adjusting entry.for accrued salaries results in the current year's profit being overstated, ‘As equipment is depreciated, its book value increases and its accumulated depreciation increases: An adjusting entry includes at least one balance sheet account and at least one income statement account. All decreases in owner's equity are a result of expenses. Accounting periods should be of equal length to facilitate comparisons between periods. Failure to record the adjusting entry for depreciation will overstate assets on the balance sheet. In recording the adjusting entry for accrued salaries, all the accounts involved are decreased. The owner's personal withdrawals for the year cause a decrease in profit. The expiration of usefulness of equipment during an accounting period is called depreciation. Acquiring a computer for cash is just exchanging one asset for another and will not result in an expense even in future periods.196 | Basic Financial Accounting and Reporting 2023 Edition by Pro} NAME: SCORE: SECTION: PROFESSOR: Matching Type Below are terms pertinent to adjusting entries. Match each definition with its related term. There are two answers for each term. Terms 1, Accrued Expense 2. Deferred Expense 3. Accrued Revenue 4, Deferred Revenue Matching Type : Definitions a. Revenue not yet earned; collected in advance. b. Office supplies on hand; used next accounting period. ¢. Rent revenue collected; not yet earned. d. Rent not yet collected; already earned. e. Anexpense incurred; not yet paid or recorded. f.- Revenue earned; not yet collected. g. Anexpense not yet incurred; paid in advance. h. Property taxes incurred; not yet paid. Match each transaction with its related term: Terms 1. Deferred Revenue 2. Accrued Revenue 3. Deferred Expense 4, Accrued Expense Transactions At the end of the year, salaries payable of P3,600 had not been recorded or paid. Supplies for office use were purchased during the year for P500, and P100 of the office supplies remained on hand (unused) at year-end, Interest of P250 on a note receivable was earned at year-end, although collection of the interest is not due until the following year. At the end of the year, service revenues of P2,000 was collected in cash but was not yet earned,Adjusting the Accounts | 197 NAME: SCORE: SECTION: PROFESSOR: Matching Type Re i. aa Rw ~ Property and Equipment Accrued Expense General Ledger Worksheet Closing Entries Accrual Basis Cash Basis Adjusting Entries Deferral Depreciation Contra-account Book value of the asset anmonep creo equired: ‘An accounting method in which revenues are reported in the period in which they are earned, and expenses are reported in the period in which they are incurred. The entry required at the end of an accounting period to bring the accounts up to date and to ensure the proper matching of income and expenses. The allocation of the cost of property and equipment to expense over its useful life. An account which is "offset against" another account. An expense that is unpaid and unrecorded. A postponement of the recognition of an expense already paid, or of revenues already received in advance. Aworking paper often used by accountants to summarize adjusting entries. The difference between the accumulated depreciation account and the related property and equipment account. It is used to classify and summarize transactions, and to prepare data for financial statements,198 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada NAME: ‘SCORE: SECTION: PROFESSOR: Multiple Choice 1. Which of the following events would be associated with an end-of-period adjustment? a. The decision to start a second production shift. b, The payment of salaries and wages. c. The recording of depreciation on equipment. d. The transfer of staff to another department. 2. Deferred revenues should be reported as a. contributed capital on the balance sheet. b. expenses on the income statement. ¢. income on the income statement. d. liabilities on the balance sheet. 3. Accrued revenues should be reported as assets on the balance sheet. expenses on the income statement. liabilities on the balance sheet. revenues on the income statement. ao 4. Adeferred expense should be recorded when a. an expense is incurred as cash is paid. b.. anon-cash resource is consumed after cash is paid. c. aservice is rendered before payment of cash. d. cash s paid before an expense has been incurred. 5, An accrued expense should be recorded by a buyer when a service is received on payment of cash, bya seller when a service is rendered before payment of cash. when an expense is incurred as cash is paid. when an expense is incurred before cash is paid. goose 6. Anaccrued revenue should be recorded by a° a. buyer when a service is received on payment of cash. b. seller when a customer pays for a service before the service is rendered. c. seller when a service is rendered before receipt of cash. d._ seller when a service Is rendered on receipt of cash.10.. 11. 12. Adjusting the Accounts | 199 Deferred expenses should be reported as a. . assets on the balance sheet. b. expenses on the income statement. c. income on the income statement. d. liabilities on the balance sheet. Accrued expenses should be reported as a. assets on the balance sheet. b. expenses on the income statement. c. liabilities on the balance sheet. d. revenues on the income statement. ‘An end-of-period adjustment involves a._achange in an account balance that is neither an accrual or a deferral. b. a recognition of the extra cash flows related to the year-end delivery of goods and services. c. anadjustment that results in revenues or expenses being reported in a different time period from the associated cash flows. d. an exchange of resources between two departments in an organization. A deferred revenue should be recorded by a buyer when a service is received on payment of cash. seller when a customer pays for a service before the service is rendered. seller when a service is rendered before receipt of cash. seller when a service is rendered on receipt of cash. i pose Salaries and wages that are recorded as expenses at year end but remain unpaid are an example of a. adeferred expense. b. adeferred revenue. c. anaccrued expense. d. an accrued revenue. The purchase of a prepaid insurance policy would initially be recorded as . a deferred expense. . adeferred revenue. an accrued expense. an accrued revenue. aos200 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada NAME: SCORE: SECTION: PROFESSOR: Multiple Choice 1. If a P2,500 adjustment for depreciation is omitted, which of the following financial statement errors will occur? a. assets will be understated b. expenses will be overstated c. owner's equity will be overstated d. profit will be understated The Supplies account had a P2,800 debit balance at the end of the accounting period before adjustment for supplies used, and an inventory of P600 worth of unused supplies was on hand. Which of the following is the required adjusting entry? a. Debit Supplies Expense P600 and credit Supplies P600. b. Debit Supplies P600 and credit Supplies Expense P600. c. Debit Supplies 2,200 and credit Supplies Expense P2,200. d. Debit Supplies Expense P2,200 and credit Supplies P2,200. A law firm began November with office supplies of P16,000. During the month, the firm purchased supplies of P29,000. On November 30, supplies on hand totaled P21,000. Supplies expense for the period is a. P24,000. b. P29,000. cc. P45,000. d. P21,000. 4. On Nov. 15, 2022, cash Is received in advance of rendering services. Assuming that ro the services have been performed by Dec. 31, 2022, the adjusting entry would be a debit to a. Cash and a credit to Service Revenues. b. Service Revenues and a credit to Accounts Receivable. ¢. Unearned Revenues and a credit to Cash. d, Unearned Revenues and a credit to Service Revenues, An entity's weekly payroll of P5,000 is paid on Fridays. Assume that the last day of the month falls on Wednesday. Which of the following is the required adjusting entry? a. Debit Salaries Expense P3,000 and credit Salaries Payable P3,000 b, Debit Salaries Expense P2,000 and credit Salaries Payable P2,000Adjusting the Accounts | 201 c. Debit Salaries Payable P3,000 and credit Salaries Expense P3,000 d. Debit Unpaid Salaries P3,000 and credit Salaries Payable P3,000 A business received cash of P30,000 in advance for revenue that will be earned later. The cash receipt entry debited cash and credited unearned revenues for P30,000. At the end of the period, P11,000 is still unearned. The adjusting entry for this situation will a. debit revenues and credit unearned revenues for P19,000. b. debit revenues and credit unearned revenues for P11,000. c. debit unearned revenues and credit revenues for P19,000. d. debit unearned revenues and credit revenues for P11,000. Which of the following accounts could not be credited in an adjusting entry? Interest Receivable Office Supplies Prepaid Rent Service Revenues ange At the beginning of 2022, an entity purchased a fire insurance policy covering a property for a period of two years. The P5,600 cost of the policy was paid in cash. At the end of 2022, the company will reduce Prepaid Insurance for this policy by a. PO. b. P467. cc. P5,600. d. P2,800. ‘An entity has P1,500 of supplies on hand at the end of 2022. During 2023, P2,750 of supplies were purchased, A count of supplies on hand at the end of 2023 found an inventory of P875. What was the amount of supplies expense for 2023? P1,875. PS,125. 3,375. 4,250. aooeNAME: SCORE: SECTION: PROFESSOR: Multiple Choice 1. Which of the following transactions will not result in an increase in revenues? Accumulation of interest in bank account. An investment in the business by the owner. Sale of goods on credit. Sale of services for cash. en ee 2. Unearned Revenues was P6,000 at the end of February and P7,S00 at the end of March. Service Revenues was P42,000 for the month of March. How much cash was received for services provided during March? a, P55,500 b. P40,500 c. 28,500 d. P43,500 3. Failure to adjust for accrued Salaries at year-end will result in an overstatement of liabilities. overstatement of profit. understatement of assets. understatement of owner's equity. ar pe 4, .Salaries Payable were P3,500 at the end of September and P2,800 at the end of October. Salaries Expense for October was P18,000. How much cash was paid for salaries during October? P18,700 24,100 P17,300 P11,700 pose 5. An adjusting entry can include a debit to a(n) asset and a credit to a liability. expense and a credit to a revenue. liability and a credit to a revenue. revenue and a credit to an asset. aos10. Adjusting the Accounts | -203 The adjustment for that portion of revenue received in advance which now has been earned is to debit a. Cash and credit Unearned Revenues. b. Service Revenues and credit Unearned Revenues. c. Unearned Revenues and credit Cash. d. Unearned Revenues and credit Service Revenues. Which of the following transactions during the year would most likely not need an adjusting entry at the end of the period? Cash Withdrawal by the owner. Performance of a service that previously was paid for. Purchase of a two-year insurance policy. Purchase of office equipment. poo An adjusting entry cannot include a. debit to a(n) asset and a credit to a liability. asset and a credit to a revenue. expense and a credit to an asset. liability and a credit to a revenue. aoc An adjusting entry made to record accrued interest on a note payable due next year consists of a debit to Interest Expense and a credit to Cash. Interest Expense and a credit to Interest Payable. Interest Expense and a credit to Notes Payable. Interest Receivable and a credit to Interest Earned. aooe Failure to record depreciation at year-end will result in an overstatement of total assets. overstatement of total liabilities. understatement of profit. understatement of total liabilities, “ppore Use the following information to answer questions 11 to 15 below. The following information pertains to Esterlina Gevera Machine Shop: a. Accrued interest on a note receivable amounted to P1,000. b. A one-year insurance policy was purchased for P20,000, Three months have passed since the purchase. ¢. Depreciation on buildings is at P50,000.204 | Basic Financial Accounting and Reporting 2023 Edit 11. 12. 13. 14. 15. ion by Prof. WIN Ballada d. The company received a P36,000 advance payment during the year on services still to be performed. By the end of the year, one-fourth of the services had been performed. e. The company's Supplies account showed a beginning debit balance of P2,000 and supplies purchased of P8,000; P3,000 of supplies were on hand at year-end. The adjusting entry for Supplies would include a a. credit to Supplies for P3,000. b. credit to Supplies Expense for P8,000. c. debit to Supplies Expense for P7,000. d. debit to Supplies Expense for P8,000. The adjusting entry for depreciation on buildings would include a a. credit to Accumulated Depreciation-Buildings for P50,000. b. credit to Buildings for P50,000. c. credit to Depreciation Expense-Buildings for P50,000. d. debit to Acctimulated Depreciation-Buildings for P50,000. The adjusting entry for the insurance policy would include a a. credit to Insurance Expense for P15,000. b. credit to Prepaid Insurance for P5,000. c. debit to Insurance Expense for P15,000. d. debit to Prepaid Insurance for P5,000. The adjusting entry to record the accrued interest on the note would include a a. credit to Interest Income for P1,000. b. credit to Interest Receivable for P1,000. ‘c. debit to Interest Expense for P1,000, d. debit to Interest Payable for P1,000. The adjusting entry to record the amount of service revenues earned during the period would include a a. credit to Unearned Service Revenues for P9,000, b. debit to Service Revenues for P27,000, ¢. debit to Unearned Service Revenues for P9,000, d. debit to Unearned Service Revenues for P27,000,16. 17. 18. 19. 20. 21, Adjusting the Accounts | 205 Which of the following transactions will not result in the recognition of an expense? Acash withdrawal by the owner. Expiration of prepaid insurance. Interest accrued on a bank loan. Use of machinery during the period. aoc The’accountant may spread the cost of a building over many years primarily because of the fiscal year assumption. going concern assumption. periodicity assumption. periodicity assumption and going concern assumption. aos Which of the following accounts would probably need to be adjusted at year-end? Land Notes Payable Supplies Withdrawals aos Which of the following is an example of an accrual? Bookkeeping fees collected but not yet earned. Equipment purchased for use in the business. Interest earned but not yet received. Six months' rent paid in advance. aes Which of the following accounts would likely not need to be adjusted at year-end? land Office Supplies Prepaid Advertising Unearned Revenues aogp Which of the following is an example of a deferral? commission collected in advance. Interest earned on a bank account, Interest expense incurred but not yet paid. Medical fees earned but not yet collected. gooseby Prof. WIN Ballada Use the following information to answer questions 22 to 26 below. The trial balance for Patrocinio Abad Claims Adjuster appears as follows: Patrocinio Abad Claims Adjuster Trial Balance Dec. 31. 2023 Cash P 20,000 Accounts Receivable 50,000 Prepaid Insurance 5,000 Supplies 15,000 Office Equipment 40,000 Accumulated Depreciation- Office Equipment P 20,000 Accounts Payable 30,000 Abad, Capital 60,000 Service Revenues 50,000 Salaries Expense Rent Expense P160,000 22. If on Dec. 31. 2023, supplies on hand were P2,000, the adjusting entry would contain a 23. 24. a b. A d. credit to Supplies Expense for P13,000. credit to Supplies for P2,000. debit to Supplies Expense for P13,000. debit to Supplies for P2,000. If on Dec, 31. 2023, the insurance still unexpired amounted to P2,000, the adjusting entry would contain a aoe credit to Prepaid Insurance for P2,000. credit to Prepaid Insurance for P3,000. debit to Insurance Expense for P2,000. debit to Prepaid Insurance for P3,000. If the estimated depreciation for office equipment were P20,000, the adjusting entry would contain a a. b. c d. credit to Accumulated Depreciation-Office Equipment for P20,000. credit to Depreciation Expense-Office Equipment for P20,000. credit to Office Equipment for P20,000. debit to Accumulated Depreciation-Office Equipment for P20,000.25. 26. 27. 28. 29. Adjusting the Accounts | 207 If as of Dec. 31. 2023 the rent of P10,000 for December had not been recorded or paid, the adjusting entry would include a a. credit to Accumulated Rent for P10,000. b. credit to Cash for P10,000. c. debit to Rent Expense for P10,000. d. debit to Rent Payable for P10,000. If services totaling P12,500 had been performed but not yet billed, the adjusting entry to record this would include a credit to Service Revenues for P12,500. credit to Service Revenues for P62,500. credit to Unearned Service Revenues for P12,500. debit to Service Revenues for P12,500. aoe The recording of an expense could result in a corresponding increase in a. aliability. b. anasset. cc. owner's equity. d. revenue. Office Supplies were P9,000 at the end of January and P11,400 at the end of February.. During February, Office Supplies Expense equaled P3,000. How much cash was paid for office supplies during February? a. P2,400 b. P14,400 . P17,400 d. P5,400 : An adjusting entry would not include which of the following accounts? a Cash b. Interest Receivable ©. Property Taxes Payable d. Unearned Revenues208 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada [ NAME: SCORE: SECTION: PROFESSOR: Multiple Choice 1. WIN.com sells one-year and two-year subscriptions for its electronic book-of-the- month download business. Subscriptions are collected in advance and credited to sales. An analysis of the recorded sales activity revealed the following: 2021 2022 Sales P420,000 P500,000 Less: Cancellations 20,000 30,000 Net Sales P400,000 P470,000 Subscriptions Expirations: 2021 120,000 2022 155,000 130,000 2023 125,000 200,000 2004 anon P400,000___P470,000 In WIN.com’s Dec. 31, 2022 balance sheet, the balance for unearned subscription revenues should be a. P470,000. b. 465,000. c. 400,000. d. 340,000. 2. An analysis of Angelina Tagay Antiques,unadjusted prepaid expense account at Dec. 31, 2022 revealed the following: i, An opening balance at P15,000 for Angelina Tagay’s comprehensive insurance policy. Angelina Tagay paid an annual premium of P30,000.on July 1, 2021. ii, A P32,000 annual insurance premium payment made July 1, 2022. ili, A P20,000 advance rental payment for a warehouse leased for one year beginning Jan. 1, 2023. In its Dec, 31, 2022 balance sheet, what amount should Angelina Tagay report as prepaid expenses? 52,000 P36,000 P20,000 P16,000 poreAdjusting the Accounts | 209 3. On Nov. 1, 2022, Alevir Pido Portraits paid P36,000 to renew its insurance policy for 3 years. On Dec. 31, 2022, Alevir Pido’s unadjusted trial balance showed a balance of P900 for prepaid insurance and P44,100 for insurance expense. What amounts should be reported for prepaid insurance and insurance expense in Alevir Pido’s Dec. 31, 2022 financial statements? Prepaid insurance Insurance Expense a. P33,000 P12,000 b. P34,000 P12,000 c. P34,000 P11,000 d. P34,900 P10,100 4, Anentity that pays employees every two weeks has paid workers P375,000 in wages and salaries for work completed during 2021. In addition, the employees earned one week's salary of P7,200 at the end of December that will be paid as part of the 14,400 payroll at the end of the first week of January in 2022. How much should the company report for salaries and wages expense for 2021? a. P367,800. b. P375,000. c. P389,400. d. P382,200. 5. Roberto Orcajada Realty pays commissions to its sales staff at the rate of 3% of net sales. Sales staff are not paid salaries but are given monthly advances of P15,000. Advances are charged to commission expense, and reconciliations against commissions are prepared quarterly. Net sales for the year ended Mar. 31, 2022 were P15,000,000. The unadjusted balance in the commissions expense account on March 31, 2022 was P400,000. March advances were paid on Apr. 3, 2022. In its income statement. for the year ended Mar. 31, 2022, what amount should Roberto Orcajada report as commission expense? a. P465,000 b. P450,000 c. P415,000 d. P400,000210 | Basic Financial Accounting and Reporting 2023 Edition by Prof. WIN Ballada 6. Based on 2022 sales of music recorded by an artist under a contract with Therese IndieMusic, the artist earned P200,000 after an adjustment of P16,000 for anticipated returns. In addition, Therese paid the artist P150,000 in 2022 as a reasonable estimate of the amount recoverable from future royalties to be earned by the artists. What amount should Therese report in its 2022 income statement as royalty expense? a. P200,000 b. P216,000 c. P350,000 d. P366,000 7. How would the proceeds received from the advance sale of non-refundable tickets for a theatrical performance be reported in the seller’s financial statements before the performance? a. Revenue for the entire proceeds. b. Revenue to the extent of related costs expended. c.. Unearned revenue for the entire proceeds. d. Unearned revenue to the extent of related costs expended. 8. Under Maurice Sabio Vintage Clothing Services accounting system, all insurance premiums paid are debited to prepaid insurance. For interim financial reports, Maurice Sabio makes monthly estimated charges to insurance expenses with credits to prepaid insurance. Additional information for the year ended Dec. 31, 2022 is as follows: Prepaid insurance at Dec. 31, 2021 P110,000 Charges to insurance expense during 2022 (including a year- 437,500 end adjustment of P10,500) Prepaid insurance at Dec. 31, 2022 120,500 What was the total amount of insurance premiums paid by Maurice Sabio during 2022? a. P327,500 b. P427,000 c. P437,500 d, P448,000\ \ Adjusting the Accounts | 211 LA TT 9. Edgar Detoya Law must determine the Dec. 31, 2022 year-end accruals for advertising and rent expenses. A P5,000 advertising bill was received Jan. 7, 2023. It related to cost of P3;750 for advertisements in Dec. 2022 issues and P1,250 for advertisements in Jan. 2023 issues of the newspaper. A store lease, effective Dec. 16, 2021 calls for fixed rent of P12,000 per month, payable one month from the effective date and monthly thereafter. In addition, rent equal to 5% of net sales over P3,000,000 per calendar year is payable on Jan. 31 of the following. year. Net sales for 2022 were P5S,500,000. In its Dec. 31, 2022 balance sheet, Edgar Detoya should report accrued liabilities of a. P125,000. b, P128,750. ¢. P131,000. d. P134,750. 10. SuySan Real Estate owns an office building and leases the office under a variety of rental agreements involving rent paid in advance monthly or annually. Not all tenants make timely payments of their rent. SuySan’s balance sheets contained the following data: 2021 2022 Rental Receivable P192,000 P248,000 Unearned Rentals 640,000 480,000 During 2022, SuySan received P1,600,000 from tenants. What amount of rental revenues should SuySan record for 2022? : P1,816,000 1,708,000 P1,440,000 P1,332,000 aoe