A lot of students get confused with this topic.
Allow me to share how I fully understood this lesson.
I'm going to explain it as thoroughly as I can. ^.^
There are FIVE types of adjusting entries right?
I won't discuss depreciation because it's easy.
I'll have a seperate post
Always remember that
"you adjust TO UPDATE the financial statements."
1. Accruals- INCURRED but NOT YET PAID
a. Accrued Income- service is ALREADY RENDERED
but client have NOT YET paid you.
- these are the receivables.
- (accrue means INCREASE or ACCUMULATE, thus,
INCREASE INCOME.
Who receives income? YOU. Babayaran ka. )
--------------------------------------------------------------dr------cr
Ex. Interest Receivable XX
Interest Income XX
To take up accrued rent income.
b. Accrued Expense - expense incurred but YOU HAVE NOT YET paid.
- these are the payables.
- (EXPENSE INCREASE, you pay the expense of course.
Ikaw naman magbabayad.)
Ex. Salaries Expense XX
Salaries Payable XX
To take up unpaid salaries.
2. Deferrals- PAID but SERVICE NOT YET INCURRED
(client PAYS YOU IN ADVANCE).
- here YOU GET PAID.
Ex. On March 1, received from tenant
120000 pesos advance rent for one year.
2 methods
INCOME METHOD (Original entry, credit to a INCOME ACCOUNT)
(first/original entry)
March 1 Cash-------------------------------------120000
Rent Income------------------------------------- 120000
(second/ADJUSTING ENTRY)
Dec. 31 Rent Income---------------------------20000
Unearned Rent Income ---------------------20000 To take up rent income for
10 months.
Note: Tenant paid 120000 for one year so that makes 10000/month
(120000/12months=10000). When using Income method the AMOUNT
you put in the adjusting entry is the UNused amount.
Income account represents the amount that you have
earned so offset the 2 unearned remaining months.
LIABILITY METHOD (Original entry, credit to a LIABILITY ACCOUNT)
(first/original entry)
March 1 Cash-----------------------------------------120000
Unearned Rent Income--------------------------120000 To record one year rent receive
from tenant.
(second/ADJUSTING ENTRY)
Dec. 31 Unearned Rent Income -------------------100000
Rent Income ---------------------------------------100000 To take up rent income for 10 months.
Note: When using Liability method the AMOUNT you put in the adjusting entry is the
USED amount. Unearned Income should represent the amount/service you owe to
the client so at the end of the term you offset the amount you already EARNED.
3. PREPAYMENTS-same with deferral PAID but SERVICE NOT YET INCURRED.
- their difference is YOU PAY.
Ex. On May 1, paid one year insurance premium, 60000 pesos. 2 methods
EXPENSE METHOD (original entry debit to EXPENSE ACCOUNT)
(first/original entry)
May 1 Insurance Expense--------------------------------60000
Cash ----------------------------------------------------60000 To record payment of 1 year
insurance premium.
(second/ADJUSTING ENTRY)
Dec. 31 Prepaid Insurance ---------------------------------40000
Insurance Expense -------------------------------------40000(not yet used) To take up unexpired insurance premium.
Note: The amount to be entered in the adjusting entry is the UNUSED amount.
Expense account represents amount already used so in
the second/adjusting entry you have to credit the unused amount.
ASSET METHOD (original entry debit to ASSET ACCOUNT)
(first/original entry)
May 1 Prepaid Insurance ---------------------------60000
Cash-------------------------------------------------60000 To record payment of 1 year
insurance premium.
(second/ADJUSTING ENTRY)
Dec. 31 Insurance Expense--------------------------------40000
Prepaid Insurance--------------------------------------40000 (already used) To take up expired insurance premium.
Note: Amount to be entered is EXPIRED/USED amount. Why used amount?
The asset account, prepaid insurance, represents the amount not yet used or unexpired
insurance so in the second/adjusting entry you have to credit the used amount.
I hope I didn't confuse you. Feel free to correct me.
To be continued...
