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DEFINITION & IMPORTANCE OF

ADJUSTING ENTRIES
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 Adjusting Journal Entries

• These are entries used to update the accounts prior to the preparation of Financial Statements
because they affect more than one accounting period. Transactions are apportioned properly between
the accounting periods affected. The accounts affected are adjusted so that there will be no
overstatement or understatement of balance sheet items and income statement items.

• The process of determining an entity’s net income or net loss requires certain income and expense
accounts to be apportioned over several accounting periods. According to the accrual principle,
income is recognized at the time it is actually earned and expense is recognized at the time it is
actually incurred or used. Thus, a receipt of cash does not necessarily mean a recognition of an
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income, and payment of cash does not necessarily mean a recognition of an expense.
 Adjusting Journal Entries

• An example of this is the cash received from a customer for the reservation of a hotel room for two
weeks. The receipt of cash from the customer does not necessarily mean that income should be
recognized. The receipt of cash should be recognized more as a liability in the form of service to be
rendered. It is only after the customer has checked in to the hotel for his/her two-week stay can the
advance payment be considered as income because the service has already been rendered.

• Another example is one-year insurance premium paid for the insurance of a house. The amount paid
representing a one-year premium cannot be charged outright as an expense. This is because the
premium paid covers a one-year insurance. Hence, the full amount can only be charged as expense
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after one year.

 Prepayments are expenses already paid but not yet
incurred or used.

The following are the accounts subjected to adjustments:

Asset Method

Prepayme
Journal Entry upon payment:

Prepaid Expenses xxx

Cash xxx

nts Adjusting Journal Entry at the end of the accounting period:

Expense xxx
Prepaid Expense xxx

Note: The amount on the adjusting journal entry represents the

expired or used portion of the prepayment.
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 Example 1
On May 30, 2021, X Co. paid 36,000 worth of insurance premium
for two years. Give the Adjusting Journal Entry on July 30, 2021.

Journal Entry upon payment on May 30, 2021:

Prepayme Prepaid Insurance

Cash
Paid two-year insurance
36,000
36,000

nts Adjusting Journal Entry at end of the accounting period July 30,
2021:

Insurance Expense 3,000

Prepaid Insurance 3,000
To record the expired insurance
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 Computation

The 36,000 amount of insurance premium represents insurance

premium for two years or 24 months. Divide 36,000 by 24 to get the
monthly premium. Then, multiply it by 2 months representing the
premium from June 1 to July 30, 2021.

Prepayme 3,000 is therefore the expired insurance from June 1 to July 30, 2021

nts Analysis: When you paid 36,000 for the two-year insurance premium
on May 30, you debited the asset account Prepaid Insurance
representing 24 months insurance. On July 30, the 36,000 Prepaid
Insurance is not totally asset since it includes the 2-month expired
portion (June 1 to July 30). Hence, an adjusting entry is necessary to
recognize the insurance expense for 2 months by debiting it and
decreasing the balance of Prepaid Insurance by crediting it.
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 Example 2
On September 1, 2021, X Co. paid a one-year advance rent for
30,000. Give the Adjusting Journal Entry on Dec. 31, 2021.

Journal Entry upon payment on September 1:

Prepayme Prepaid Rent

Cash
30,000

Paid rent for one year

30,000

nts Adjusting Journal Entry at end of the accounting period December

31, 2021:

Rent Expense 10,000

Prepaid Rent 10,000
To record expired rent
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 Computation

The 30,000 amount of rent represents one-year or 12-month rent.

Divide 30,000 by 12 to get the monthly rent. Then, multiply it by 4
months representing the rent from September 1 to December 31, 2021.

Prepayme 10,000 is therefore the expired/used

December 31, 2021.
rent from September 30 to

nts Analysis: When you paid 30,000 for the one-year rent in advance on
September 1, you debited the asset account Prepaid Rent representing
12 months rent. On December 31, the end of the accounting period, the
30,000 Prepaid Rent is not totally asset since it includes the 4 months
used portion (Sept. 1- Dec. 31). Hence, an adjusting entry is necessary
to recognize the rent expense for 4 months by debiting it and decreasing
the balance of Prepaid Rent by crediting it.
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 Example 3
Supplies account showed a balance of 4,000. Supplies used during
the year amounted to 2,300. Give the Adjusting Journal Entry on

Prepayme Dec. 31, 2021.

Adjusting Journal Entry on December 31, 2021:

nts Supplies Expense

Supplies
2,300
2,300
To record supplies used for the year
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 Computation

Prepayme There is no computation necessary because the 2,300 supplies used

during the year was already given in the problem.

Analysis: The asset account Supplies showed a balance of 4,000 at the

nts beginning of the year. Supplies used during the year amounted to
2,300. This should be recorded as expense by debiting Supplies Expense
and crediting the asset account Supplies to decrease its balance.
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 Example 4
Supplies account on January 1, 2021, showed a balance of 8,000.

Prepayme
On December 31, 2021, supplies on hand amounted to 3,500.

Adjusting Journal Entry on December 31, 2021:

nts
Supplies Expense 4,500
Supplies 4,500
To record supplies used for the year
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 Computation

Supplies at the beginning of the year is 8,000. At the end of the year,
the remaining balance is 3,500. The difference represents the supplies
used during the year. Subtract 3,500 from 8,000 to get the supplies

Prepayme used during the year.

8,000 – 3,500 = 4,500

nts Analysis: On January 1, 2021, the asset account Supplies has a balance
of 8,000. At the end of the year, the balance of the asset account
Supplies decreased to 3,500. The difference represents the supplies
used during the year. You will have to recognize the used supplies as an
expense by debiting Supplies Expense and decrease the asset account
Supplies by crediting it.
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 ALTERNATIVE METHOD IN RECORDING PREPAYMENTS

An alternative method in recording prepayments is to initially record

them as an expense instead of an asset.

Expense Method
Journal entry upon payment

Prepayme Expense
Cash
Paid expense
xxx
xxx

nts Adjusting Journal Entry at the end of the accounting period

Prepaid Expense xxx

Expense xxx
To record unexpired expense

Note: The amount on the adjusting journal entry represents the

unexpired or unused portion of the prepayments.
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 Example

On April 30, 2021, X Co. paid 36,000 insurance premium for two years.
Give the Adjusting Journal Entry on June 30, 2021.

Journal Entry upon payment on April 30

Prepayme Insurance Expense

Cash
36,000
36,000
Paid insurance for two years

nts Adjusting Journal Entry at end of the accounting period June 30, 2021

Prepaid Insurance 33,000

Insurance Expense 33,000
To record the unexpired insurance
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 Computation

The 36,000 insurance represents a two-year or 24-month premium.

Divide 36,000 by 24 to get the monthly insurance then multiply it by 22
months representing the unexpired insurance from July 1, 2021 to April
30, 2023.

36,000 x 22=33,000

Prepayme
24

33,000 is therefore the prepaid insurance from July 1 to April 30, 2023.

nts
Analysis: When you paid 36,000 for the two-year insurance on April
30, you debited the expense account Insurance Expense representing 24
months insurance. On June 30, the end of the accounting period, the
36,000 Insurance Expense is not really your insurance expense for the
year. It includes the 22 months unexpired or unused portion (July 1,
2021 to April 30, 2023). Hence, an adjusting entry is necessary to
recognize the asset portion by debiting Prepaid Insurance and
decreasing the balance of Insurance Expense by crediting it.
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 Summary for Prepayments

Asset Method Expense Method

Upon Payment on April 30, 2021

Prepayme Prepaid Insurance

Cash
36,000
36,000
Paid two-year insurance premium
Insurance Expense
Cash
36,000

Paid two-year insurance premium

36,000

nts
Adjusting Journal entry on June 30, 2021

Insurance Expense 3,000 Prepaid Insurance 33,000

Prepaid Insurance 3,000 Insurance Expense
To record expired insurance for the year 33,000
To record the unexpired insurance
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 The effect of the adjusting entries on the ledger accounts after posting is
the same regardless of the method used.

Asset Method Expense Method

Prepaid Insurance Prepaid Insurance

Debit Credit Debit Credit

Prepayme 4/30
Bal.
36,000
33,000
6/30 3,000 6/30
Bal.
36,000
33,000

nts Insurance Expense

Debit Credit
Insurance Expense
Debit Credit
6/30 3,000 4/30 36,000 6/30 33,000
Bal. 3,000 Bal. 3,000
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