Introduction on Adjusting Journal Entries

Accounting Cycle – series of steps used to collect

and process financial information in order to

prepare financial statements and maintain financial

records on the desired accounting period.

The preparation of the trial balance proves the

equality of the debit and credit of the recording

process, provides an overview of the balances of

the accounts and to determine if there are accounts

that needs to be adjusted. From the trial balance,

the Accountant needs to perform an analysis of the

accounts. Thus, the 5th step is the preparation of

Adjusting Journal Entries to update and correct the

amount of accounts to ensure that financial

statements are fairly presented.

Accounting principles (GAAP) that guide the

recognition of adjusting entries

1. Time Period – the life of the business is divided

into uniform periods of time so that regular financial

statements can be prepared.

2. Accrual Principle:

a. Revenue Recognition Principle – income

is recognized as earned at the time the service

is rendered or the goods were delivered in the

case of merchandising and manufacturing

type of operations regardless whether cash is

received or not.

b. Expense Recognition Principle – expense

is recognized when incurred regardless of

when payment is made.

c. Matching Principle – expenses should be

matched against the income during the period

it was earned.

The Three Types of Adjusting Journal Entries

1. Estimates:

a. Depreciation b. Bad Debts

2. Deferrals:

a. Supplies and Prepayment of Expense

b. Advance payment from customers

3. Accruals:

a. Accrual of income – for income

already earned but were not collected nor

recorded.

b. Accrual of expense – for expenses

already incurred or consumed but were

not paid nor recorded.

Lesson 2.1: Estimates – Bad Debts

Expense

Introduction on Adjusting Journal

Entries

What are adjusting entries. Why are these necessary?

1. Are prepared at the end of the accounting period

to update the value of the accounts, ensuring the

accuracy before preparing financial statements.

2. Its purpose is to get both income statement and

the statement of financial position to be

presented fairly.

3. Adjusting journal entries consist of:

• 1 nominal/ Income Statement account

(expense or revenue)

• 1 real/Statement of Financial Position

account (asset or liability).

4. Adjusting journal entries can be prepared at any

time but all adjusting entries for the reporting

period must be dated and posted within the

applicable reporting period.

Bad Debts Expense – estimated amount of

receivables that could not be collected from

customers or from those who owe the company. The

required adjusting entry is to reduce the value of

Receivables presented as Asset in the Statement of

Financial Position by recording it as a non – cash

expense using the account Bad Debts Expense of

the Income Statement.

Differences Between the 2 Methods:

Direct Write-Off

Method

– Recognizes bad

debts only when it is

certain that the

account of the

specific customer

could not be

collected anymore.

– Credits the

accounts receivable

to decrease it

Allowance Method

– Recognizes the doubtful amount

every accounting period based on

an estimated amount or a certain

% of the gross receivable. The

estimated amount or the % used

in estimating the amount is based

on the experience of the company

from prior periods.

– Credits the contra-account of

the receivable (allowance for

doubtful account or allowance for