Unit Two: Adjusting and journal entries

This unit to provide you the necessary information regarding the following content coverage and topics:
 Recording depreciation of non-current assets and disposal of fixed assets
 Adjusting expense accounts and revenue accounts
 Recording bad and doubtful debts
 Adjusting ledger accounts for inventories and transfer to final accounts
This guide will also assist you to attain the learning outcomes stated in the cover page. Specifically, u
completion of this learning guide, you will be able to:
 Record Depreciation of non-current assets and disposal of fixed asset
 Adjust expense account and revenue account for prepayment and accrual
 Accounting Terms and Definitions
 Accounting Periods concept, assumption and principles
 Define Basis of Accounting
 Record bad and doubtful accounts
 Adjusting Ledger accounts and transfer to final account

2.1 Recording Depreciation of non-current assets and disposal of fixed asset

2.1.1 Disposal of Plant Asset
Plant asset which are not useful may be discarded, sold or applied towards purchase of another asset.
For any reason, when plant assets are disposed, it is necessary to remove the book value of the asset
from the accounts.
2.1.2 Discarding Plant Asset
When plant assets are no longer useful to the business and have no market value, they are discarded.
If the asset has been fully depreciated; no loss is realized.
Example: - Assume that an item of equipment acquired at a cost of Br 6, 000.00 becomes fully
depreciated at December 31, the end of the preceding fiscal year. And now it is discarded as it is
worth less on March 24, 2003.
The journal entry would be:
March 24, 2003 Accumulated Depreciation- Equipment 6,000.00
Equipment 6,000.00

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But if the equipment was not fully depreciated, (i.e., the accumulated depreciation was not Br.
6,000.00), first the three-month depreciation has to be calculated and recorded. Furthermore, there
might be a possible loss in disposal.
Example:
Assume that for the previous example that the accumulated depreciation balances as of Dec. 31
2002 was Br. 4,750.00. And a straight-line depreciation of 10% of cost per annual is used. And the
equipment was disposed on March 24, 2003, the journal entry would be: -
First: record the 3-month depreciation:
March 24 Depreciation expense 150.00
Accumulated Depreciation 150.00
(Calculated: - 6,000.00 X 10%/3/12 = 150.00)
Second: journal disposal
Accumulated depreciation 4,900.00
Loss on disposal by equipment 1,100.00
Equipment 6,000.00
Note: - loss or gain on disposal on plant assets is non-operating activities and are reported as other
expense or other income respectively, in the income statement.
2.1.2 Sale of plant asset
The entries for the sale of plant asset are similar to disposal, but here we have cash or other assets
received. If the sales price exceeds the above value of the asset, the sales results in gain. But if the
sales price is less than the book value, then the transaction results in a loss.
Example: Assume equipment acquired at a cost of Br. 10,000.00 and depreciated at annual rate of
10% of cost is sold for cash on October 12, of the eighth year of its use. The accumulated
depreciation in the account of as of proceeding Dec. 31 is Br. 7,000.00.
1st The entry to record the depreciation for nine month of the current year is:-
Oct 12 Depreciation expense- equipment 750
Accumulated depreciation–equip. 750
(Calculation: - 7,000*10%*9/12=750)
After the current depreciation's recorded; the book value of the asset is Br. 2,250.00
The Journal entry to record the sales under different assumptions as to selling price
are as follows:
Assumption 1 Sales value Br 2,250.00, at book value
Oct 12 Cash 2,250.00
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 Accumulated depreciation–equip. 7,750.00
Equipment 10,000.00
Assumption 2 Sales value Br 1,000.00, below book value
Oct 12 Cash 1,000.00
Accumulated depreciation–equip. 7,750.00
Loss on Disposal – Equipment 1,250.0
Equipment 10,000.00
Assumption 3 Sales value Br 3,000.00, above book value
Oct 12 Cash 3,000.00
Accumulated depreciation–equip. 7,750.00
Equipment 10,000.00
Gain on disposal- equipment 750.00
2.1.3 Exchanging Similar Fixed Assets
Old equipment is often traded in for new equipment having a similar use. In such cases, the seller
allows the buyer an amount for the old equipment traded in. This amount, called the trade-in
allowance, may be either greater or less than the book value of the old equipment. The remaining
balance the amount owed is either paid in cash or recorded as a liability. It is normally called boot,
which is its tax name.
Accounting for the exchange of similar assets depends on whether the transaction has commercial
substance. An exchange has commercial substance if future cash flows change as a result of the
exchange. If an exchange of similar assets has commercial substance, a gain or loss is recognized
based on the difference between the book value of the asset given up (exchanged) and the fair
market value of the asset received. In such cases, the exchange is accounted for similar to that of a
sale of a fixed asset.
Gain on Exchange
To illustrate a gain on an exchange of similar assets, assume the following:
Similar equipment acquired (new):
Price (fair market value) of new equipment . . . . . . . . . . . . . . . . . . . . . . . . . $5,000
Trade-in allowance on old equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . __1,100_
Cash paid at June 19, date of exchange . . . . . . . . . . . . . . . . . . . …$3,900
Equipment traded in (old):
Cost of old equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . …$4,000

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 Accumulated depreciation at date of exchange . . . . . . . . . . .. . . . . .3,200
Book value at June 19, date of exchange . . . . . . . . . . . .. . . . . . . ….$800
The entry to record this exchange and payment of cash is as follows:
June 19 Accumulated Depreciation—Equipment . . . . . . . . . . . . . 3,200
Equipment (new equipment) . . . . . . . . . . . . . . . . . . . . …5,000
Equipment (old equipment) . . . . . . . . . . . . . . . . . . . ……..4,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ……..3,900
Gain on Exchange of Equipment . . . . . . . . . . . . . . . ……. 300
The gain on the exchange, $300, is the difference between the fair market value of the new asset of
$5,000 and the book value of the old asset traded in of $800 plus the cash paid of $3,900 as shown
below.
Price (fair market value) of new equipment . . . . . . $5,000
Less assets given up in exchange:
Book value of old equipment ($4,000-$3,200) . . . $ 800
Cash paid on the exchange . . . . . . . . . . . . . . . . . . _3,900_ 4,700
Gain on exchange of assets . . . .. . . . . . . . . . . . . . . . $300
Loss on Exchange
To illustrate a loss on an exchange of similar assets, assume that instead of a trade-in allowance of
$1,100, a trade-in allowance of only $675 was allowed in the preceding example.
In this case, the cash paid on the exchange is $4,325 as shown below.
Price (fair market value) of new equipment . . . . . . . . . . . $5,000
Trade-in allowance of old equipment . . . . . . . . .. . . . . . . . . _675
Cash paid at June 19, date of exchange . . . . . . . . . . . . . . . $4,325
The entry to record this exchange and payment of cash is as follows:
June 19 Accumulated Depreciation—Equipment . . . . . . . . . . .3,200
Equipment (new equipment) . . . . . . . . . . . . . . . . . . . . 5,000
Loss on Exchange of Equipment . . . . . . . . . . . . . . . . . 125
Equipment (old equipment) . . . . . . . . . . . . . . . . . . . 4,000
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,325
The loss on the exchange, $125, is the difference between the fair market value of the new asset
of $5,000 and the book value of the old asset traded in of $800 plus the cash paid of $4,325 as
shown below.
Price (fair market value) of new equipment . . . . . . . . $5,000
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 Less assets given up in exchange:
Book value of old equipment ($4,000-$3,200) . . . ….$ 800
Cash paid on the exchange . . . . . . . . . . . .. . . . …… 4,325 5,125
Loss on exchange of assets . . . . . . . . . . . . . . . . . . . .….$(125)
In those cases where an asset exchange lacks commercial substance, no gain is recognized on
the exchange. Instead, the cost of the new asset is adjusted for any gain. For example, in the first
illustration, the gain of $300 would be subtracted from the purchase price of $5,000 and the new
asset would be recorded at $4,700. Accounting for the exchange of assets that lack commercial
substance is discussed in more advanced accounting texts.
Depletion: - are the periodic allocation of the cost of material ores and other minerals removed
from the earth. The depletion is allocated based on the relationship of cost of the estimated size
of mineral deposit on the quantity extracted during the particular period.
Example:
Assume that the cost of certain minerals right is Br 400,000.00 and that the deposit is estimated at
1,000,000 tons of one of uniform grade.
The depletion per ton = Br 400,000.00 = Br 0.40/ tone
1,000,000
If during 2002, 90,000 thousand tons of ores were extracted the depletion expense, journal entry
December 31, Depletion Expense 36,000.00
Accumulated Depletion 36,000.00
(Calculation= 90,000 X Br 0.40 = 36,000.00)
Accumulated depletion account is contra asset account. It is presented in the balance sheet as a
deduction form the cost of mineral deposit.
Intangible Asset: - The basic principle of accounting for intangible assets are like those described
earlier for plant assets. The major concerns are the determination of the acquisition costs and the
recombination of periodic cost expiration. These periodic costs expiration are called amortization.
Patent: rights to inventors, evidenced by patent. Some organization may acquire (Purchase).The
cost of airing the patent is debited to an asset account; and then written off or amortized over its
expected useful life. A separate contra account is not used mostly for amortizing intangible assets.
Periodical amortizations are directly written off to the asset account.
Example: Assume that on January 01, 2000, an enterprise acquired a patent for Br 100,000.00
a patent is granted, six years earlier.
Although the patent has eleven years legally, it is expected to be of value for only five years: -
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 The entry to record the amortization for 2000 is: -
Dec. 31, 2000 Amortization Expense 20,000.00
Patent 20,000.00
Furthermore, assume at the end of the year 2002 year it was known that the patent will not be
useful after two years;
Journal the amortization of the year ended 2003
Book value of patent = Br 100,000.00 – 40,000.00 = 60,000.00
= Cost - Two years accumulated deprecation
The revised amortization /year = Br 60,000.00 (Book Value)
2Years (revised expected useful life)
= Br 30,000.00
Journal entry: -
Dec 31, 2003 Amortization Expense 30,000.00
Patent 30,000.00
Copy Rights: - These are exclusive rights to publish and sell literary, artistic or musical
compositions. The cost assigned to copy rights included all costs of creating the work plus the cost
of obtaining the copy right. The copy right that is purchased form another should be debited at a
price paid for it. Copy rights are issued by federal government and extend for 50 years beyond the
authors death. But because of uncertainty regardless of useful life they are usually amortized in a
short period of time.
Good Will: - is an intangible asset that attaches to a business as a result of such favorable factors
as location, product superiority, reputation, and managerial skill. Its existence is evidenced by the
ability of the business to earn a rate of return on the investment that is in excess of the normal rate
for other firms in the same line of business. Good will is recorded only if it could be objectively
measured, then it will be deprecated over its expected period of time
2.2 Adjust prepayment and accrual accounts

2.2.1 Adjusting Process

Nature of the Adjusting Process
 Accounting Terms and Definitions
 Accounting Periods
 Basis of Accounting
 Types of account requiring adjustment

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  Adjust revenue and expense account
2.2.2 Terms and Definitions
Revenue Recognition Principle – Recognize revenues when earned, not when cash is received
Matching Principle – Requires expenses be recognized when incurred and in the same period
expenses were used to derive revenues
Revenue Recognition Principle requires that revenues are reported in the period in which
they are earned, regardless of when payment is received.
Matching Principle requires that all expenses incurred (whether paid or not) are recorded in the
same accounting period as the revenues earned as a result of these expenses.
Basis of Accounting – How you construct financial statements.
Financial Statements – Income Statement, Statement of Owner’s Equity, Balance Sheet, and
Statement of Cash Flows.
GAAP – Generally Accepted Accounting Principles
When preparing financial statements, the economic life of the business is divided
into time periods.
A. This accounting period concept requires that revenues and expenses
be reported in the proper period.
1. Calendar Year
2. Fiscal Year
Calendar Year: The companies that follow the calendar year, their accounting period starts from 1st
January to 31st December of the same year.
Fiscal Year: For companies that follow the fiscal year, the accounting period starts from the first day
of any other month apart from January.
B. accounting period
Definition of Accounting Period
An accounting period is the period of time covered by a company's financial statements. Common
accounting periods for external financial statements include the calendar year (January 1 through
December 31) and the calendar quarter (January 1 through March 31, April 1 through June 30, July 1
through September 30, October 1 through December 31). It is common for these companies to also
have monthly accounting periods. However, the financial statements for the monthly accounting
periods are likely to be used only by the companies' managements.
Examples of Accounting Periods
 The following are some examples of accounting periods used by U.S. companies:
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  Annual calendar year of January 1 through December 31
 Annual fiscal year such as July 1, 2020 through June 30, 2021; April 1, 2020 through
March 31, 2021; etc.
 52- or 53-week fiscal year such as the 52 or 53 weeks ending on the last Saturday of
January, etc.
 Calendar quarters such as January 1 through March 31, April 1 through June 30, etc.
 Fiscal quarters such as May 1 through July 31, August 1 through October 31, etc.
 13-week fiscal quarters such as the 13 weeks ending on the last Saturday in April, etc.
 Calendar months such as March 1 through March 31, November 1 through November 30,
etc.
 4- or 5-week fiscal months such as the 4 weeks ending the last Saturday of February, etc.
C. Principles of accounting
Matching principle: - The matching principle says that revenue is recognized when earned and
expenses when they occur (not when they’re paid).
This principle only applies to the accrual basis of accounting, however. If your business uses the
cash basis method, there’s no need for adjusting entries.
D. Basis of Accounting
 A foundation for financial transactions
 Focuses accountant on how to apply rules
 several different types of bases, Examples include Cash, Accrual, and Tax basis for
accounting
Cash Basis
 Record revenues when cash is received
 Record Expenses when cash is paid
 Not approved for use by GAAP
Accrual Basis
 Record revenues when earned
 Record expenses when incurred
 Approved by GAAP
 More accurately reflects business performance
E. Fundamental Accounting Assumption:

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Fundamental accounting assumptions are the assumptions which are presumed to have been followed
while preparing the books of accounts. If they are not followed, then reasons should be disclosed for
not following them.
There are 3 basic Accounting Assumptions:
Going Concern Assumption
The concept of going concern assumes that a business firm would continue and carry out its
operations for a foreseeable future. There is no intention to close down the business, not any necessity
to scale down its business activities.
Consistency Assumption
According to this assumption, accounting policies and practices once selected and adopted are followed
every year. They should be applied consistently over the period of time. It helps in the comparative
study of financial statement of the current year with that of the previous year.
 It eliminates the factor of personal bias.
 Previous policies can be changed if:
 Required by law or accounting standards
 It will result in a more meaningful presentation.
 Changes should be disclosed.
Accrual Basis Assumption
 Revenue and expenses are recognized in the period in which they occur rather than when they
are received or paid cash.
 It is an important concept because it recognizes the assets, liabilities, incomes and expenses
only when transactions related to it are entered into.
 Profit is recognized when the sale of goods & services has been made, and obligation is
transferred to the customer to pay in return.
 Similarly, Expense is also recognized when goods and services are purchased, and obligation is
created to pay for them.

Adjusting process
The life of a business is divided into accounting periods, which is the time frame (usually a fiscal year) for
which a business chooses to prepare its financial statements.
 At the end of each accounting period, businesses need to make adjusting entries.
 Adjusting entries update previously recorded journal entries, so that revenue and expenses are
recognized at the time they occur.
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 2. 2.3 Adjusting Entry
A crucial step of the accounting cycle is making adjusting entries at the end of each accounting period. An adjusting
entry is an entry made to assign the right amount of revenue and expenses to each accounting period. It updates
previously recorded journal entries so that the financial statements at the end of the year are accurate and auto-da-fe
adjusting entry in this case is made to convert the receivable into revenue.

2.2.4 Types of Adjusting Entries

We divide adjusting entries into three main types:
A. accruals,
B. Deferrals
C. Non-cash expenses.
A. Deferral
 Deferral refers to the payment of an expense made in one period, but the reporting of that
expense is made in some other period.
 Deferral accounts are an advance receipt, before providing and deliver services
 Deferral accounts Future and advance payment before using or delivering services payment
of cash basis
Deferred revenue is sometimes known as unearned revenue, i.e., not earned by the company. The
company owes goods or services to the customer, but the cash has been received.
For example, the company XYZ gets $10,000 for service over ten months from January to December.
The money has been accepted in advance by the company. In that scenario, the accountant should defer
$9,000 from the books of account to a liability account known as “unearned revenue” and should only
record $1,000 as revenue for that period. The remaining amount should be adjusted every month and
deducted from the Unearned Revenue monthly as their customers will render the services.
Examples of deferrals (expenses)

 Insurance  Supplies
 Rent  Equipment
Unearned revenue account is liability account before delivering or rendering services, but after
performing services it become revenue account. Unearned revenue is the number of advance
payments which the company has received for the goods or services which are still pending for the
delivery and includes transactions like Amount received for the goods delivery of which is to be made
on the future date etc. It is a category of accrual under which the company receives cash before it
provides goods or renders services. Under this, the exchange happens before actual goods or service
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delivery, and as such, no revenue is recorded by the company. The company, however, is under an
obligation to provide the goods or render the service, as the case may be, on due dates for which
advance payment has been received by it. As such, the Unearned Revenue is a Liability till the time it
doesn’t completely fulfill the same, and the amount gets reduced proportionally as the business is
providing the service. It is also known by the name of Unearned Income, Deferred Revenue, and
Deferred Income as well.
Table 2.1 Accrual vs. Deferral Head-to-Head Difference
Let us now look at the head-to-head differences between accrual and deferral.

Accrual Deferral

Accrual occurs before a payment or receipt. Deferral occurs after a payment or receipt.

Accrued expenses are already incurred but not Deferral expenses are already paid off but
yet paid. not yet incurred.

Accrual is related to the postponement of an Deferral leads to postponing an expense or

expense or revenue, leading to cash receipt or revenue, which puts that amount in liability
expenditure. or an asset account. .

Deferral is paying or receiving cash in

Accrual is incurring expenses and earning
advance without incurring the expenses or
revenue without paying or receiving cash.
earning the revenue.

The accrual method leads to an increase in The deferral method leads to a decrease in
revenue and a decrease in cost. revenue and an increase in cost.

The end objective of the accrual system is to The end objective is to decrease
recognize the revenue in the income the debit account and credit the account
statement before the money is received. Revenue examples. Read..

Accrual
 A firm delivering a good or service before receiving cash

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  A firm generating a salary expense before paying the employee in cash
Examples of Accrual accounting include the following: –
 Interest expense and interest income
F. Non-Cash Expenses
The most common method used to adjust non-cash expenses in business is depreciation.
2..2.5 Types of Accounts Requiring Adjustment
Four basic types of accounts require adjusting entries as shown below.
1. Prepaid expenses .
2. Accrued revenues
3. Unearned revenue
4. Accrued expenses
1. Prepaid expense
Prepaid expenses are the advance payment of future expenses and are recorded as assets when cash is
paid. Prepaid expenses become expenses over time or during normal operations
Example, Dec. 1 XYZ company paid birr3, 600 as a premium on a one-year insurance policy
On December 1, prepaid insurance …………birr3600
Cash…………………………...birr3600
At the end of December, only birr300 (birr3,600 divided by 12 months) of the insurance premium is
expired and has become an expense. The remaining birr3,300 of prepaid insurance will become an
expense in future months. Thus, the birr300 is insurance expense
On December 31, insurance expense……...birr300
Prepaid insurance …………. birr300
2. Unearned revenues
Unearned revenues are the advance receipt of future revenues and are recorded as liabilities when cash
is received. Unearned revenues become earned revenues over time or during normal operations.
Example, Dec. 1 XYZ company s received birr360 from a local retailer to rent land for three months
Cash............................birr360
Unearned rent ................birr360
At the end of December, birr120 (birr360 divided by 3 months) of the unearned rent has been earned.
The roaming birr240 will become rent revenue in future months. Thus, the birr120 is rent revenue of
December and should be recorded with an adjusting entry.
On December 31, unearned rent …………...birr120

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 Rent income……………………. birr120
3. Accrued revenues/revenues/another name
Accrued revenues are unrecorded revenues that have been earned and for which cash has yet to be
received. Fees for services that an attorney or a doctor has provided but not yet billed are accrued
revenues
Example: - Dec. 15 XYZ signed an agreement with ABC Co. on December 15 under which XYZ
company will bill ABC Co. on the fifteenth of each month for services rendered at the rate of birr20 per
hour. From December 16–31, XYZ provided 25 hours of service to ABC Co. Although the revenue of
birr500 (25 hours × birr20) has been earned, it will not be billed until January 15. Likewise, cash of
birr500 will not be received until ABC pays its bill. Thus, the birr500 of accrued revenue and the
birr500 of fees earned should be recorded with an adjusting entry on December 31.
FROM December 16 – 31, fees receivables .................................birr500
Fee earned .............................................birr500
Other examples of accrued revenues include accrued interest on notes receivable and accrued rent on
property rented to others.
2.3 Record bad and doubtful debts
2.3.1 Bad Debt
A bad debt is an account receivable that has been clearly identified as not being collectible. This means
that a specific account receivable is removed from the accounts receivable account, usually by creating
a credit memo in the billing software and then matching the credit memo against the original invoice;
doing so removes both the credit memo and the invoice from the accounts receivable report.
2.3.2 Doubtful Debt
A doubtful debt is an account receivable that might become a bad debt at some point in the future. You
may not even be able to specifically identify which open invoice to a customer might be so classified.
2.3.3 Accounting for a Bad Debt
When you create the credit memo, credit the accounts receivable account and debit either the bad debt
expense account (if there is no reserve set up for bad debts) or the allowance for doubtful accounts
(which is a reserve account that is set up in anticipation of bad debts). The first alternative for creating
a credit memo is called the direct write off method, while the second alternative is called the allowance
method for doubtful accounts.

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 Example of a Bad Debt and Doubtful Debt
ABC International has birr 100,000 of accounts receivable, of which it estimates that birr 5,000 will
eventually become bad debts. It therefore charges birr5, 000 to the bad debt expense (which appears in
the income statement) and a credit to the allowance for doubtful accounts (which appears just below
the accounts receivable line in the balance sheet). A month later, ABC knows that a birr1, 500 invoice
is indeed a bad debt. It creates a credit memo for birr1,500, which reduces the accounts receivable
account by birr1,500 and the allowance for doubtful accounts by birr1,500. Thus, when ABC
recognizes the actual bad debt, there is no impact on the income statement - only a reduction of the
accounts receivable and allowance for doubtful accounts line items in the balance sheet (which offset
each other)

2.4 Adjusting inventories

Inventories: inventories a raw material that can be available for sale or used for production purpose.

A merchandising business manufactures products, marks them up, and sells them to customers. A
merchandiser may therefore be either the buyer or the seller in a given transaction. Inventory is items
that are purchased for resale. The process of inventory valuation involves determining the quantities
and dollar value of the inventory that a company owns. The perpetual inventory system is the process
of keeping a current running total of inventory, both in number of units on hand and its dollar value, at
all times. When product is purchased for resale, inventory immediately increases. When inventory is
sold, its total value is immediately reduced. Items in inventory are not always purchased at the same
price; the same items may cost different amounts at different times. Therefore, a business needs a
system of deciding which cost to select as its expense amount for Cost of Merchandise Sold when it
sells an item
2.4. 1 Inventory Adjustments
The inventory account's initial balance stays the same until the accounting period is over. Then, there
are physical counts of the inventory to determine its value at that time. The inventory account's balance
is then updated with inventory adjustment entries. There are specific ways to do this, depending on the
type of accounting system in use.
When an accounting period ends, inventory account adjustments are made to show the correct value of
the company's remaining inventory. The adjustments reconcile any discrepancies that arise from
inventory losses. In addition, journal entries are updated to reconcile changes in current inventory
compared to what is left over from the previous year.

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 2.3.2 Inventory Adjustment Examples
Inventory adjustments are usually part of the company's closing entry process. When adjusting
entries are needed, two separate entries must be made. The first one clears out the inventory
account's beginning balance, and the second credits it. Here are two examples.
Example
On December 1, 2019, ABC Company purchased merchandise, invoice price Birr25,000, and
issued a 6%, 120-day note to Ringo Chemicals Company ABC uses the calendar year as its fiscal
year and uses the perpetual inventory system.
Adjusting entries can be defined as the journal entries which are made to recognize the expired revenue and
expenditures in the current financial year. The adjusting entries are made at the end of the financial year.

Credit
Date Particulars Debit (BIRR) Calculation
(BIRR)

Dec. 1, 2019 Merchandise inventory 25,000

Notes payable 25,000

Dec. 31,
Interest expenses 125 Birr25,000 * 6% * 30/360
2019

Interest payable 125

Apr. 1, 2020 Interest expense 375 Birr25,000 * 6% * 90/360

Interest payable 125

Notes payable 25,000

Cash 25,500

Example:
At the beginning of the new accounting period, the cost of ABC Company’s goods/inventory
is birr80, 000. At the end of the period, the general ledger shows an increase, and it stands

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at birr130, 000. Credit entries are made to adjust for the birr50, 000 increase. The new totals
accurately reflect the value of the inventory that the company owns

2.3.4 Adjusting the Inventory Account

Under the periodic system of accounting for inventory, the inventory account's balance remains
unchanged throughout the accounting period and must be updated after a physical count
determines the value of inventory at the end of the accounting period. The inventory account's
balance may be updated with adjusting entries or as part of the closing entry process. When
adjusting entries are used, two separate entries are made. The first adjusting entry clears the
inventory account's beginning balance by debiting income summary and crediting inventory for
an amount equal to the beginning inventory balance.
Adjusting entries can be defined as the journal entries which are made to recognize the expired revenue and
expenditures in the current financial year. The adjusting entries are made at the end of the financial year.

Credit
Date Particulars Debit (BIRR) Calculation
(BIRR)

Dec. 1, 2019 Merchandise inventory 25,000

Notes payable 25,000

Dec. 31,
Interest expenses 125 Birr25,000 * 6% * 30/360
2019

Interest payable 125

Apr. 1, 2020 Interest expense 375 Birr25,000 * 6% * 90/360

Interest payable 125

Notes payable 25,000

Cash 25,500

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Example:
At the beginning of the new accounting period, the cost of ABC Company’s goods/inventory
is birr80, 000. At the end of the period, the general ledger shows an increase, and it stands
at birr130, 000. Credit entries are made to adjust for the birr50, 000 increase. The new totals
accurately reflect the value of the inventory that the company owns

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