Course Code and Title : BAEN 1 - Accounting Principles (BSBA)
Lesson Number : 8
Topic : Adjusting Entries - Part 2
Professor : Rosario A. Calamba, CPA, PhD
________________________________________________________________________________________
INTRODUCTION:
This module will be discussing the remaining two items that needed adjustments at the end of the
accounting period - that is the Uncollectible Accounts or Bad Debts and Depreciation.
LEARNING OBJECTIVES:
At the end of this module, the learners are expected to:
1. Identify the methods in establishing the uncollectible accounts and depreciation expense
2. Estimate the amount of bad debts and depreciation expense.
3. Prepare the adjusting entries for bad debts expense and depreciation expense.
4. Explain the effects of omitting the adjustments on the financial statements.
PRE-ASSESSMENT:
ABC Advertising Company billed their clients a total of P1,250,000.00 for the year 2018. Their
records showed P950,000.00 of this was collected in the same year. Based on the percentage of
uncollected accounts to outstanding receivables in the past, the accountant estimated 3% of the
accounts may prove uncollectible.
Required:
1. Assume that the company is using the allowance method, give the entries for the year 2018 to
record the revenue, collection and the doubtful accounts.
2. Post to T accounts and determine the balances.
3. How much is the net realizable value of the accounts receivable and the doubtful accounts
expense to be presented in the financial statements of 2018?
1 of 11
LESSON PRESENTATION:
To continue with the discussion on adjusting entries, we will be illustrating these two (2) remaining
accounts for adjustments. These are the uncollectible accounts or bad debts expense and the
depreciation expense.
A. UNCOLLECTIBLE ACCOUNTS / BAD DEBTS:
In any business entity selling on account to its customers, experience show that some customers
will not be able to pay their accounts as they fall due. Uncollectible accounts or bad debts are
accounts of customers who do not pay what they have promised to pay.
The company or business entity should provide allowance for uncollectible accounts and recognize
an expense or loss from these accounts. Other terms for uncollectible accounts are Bad Debts or
Doubtful Accounts.
There are also various ways wherein uncollectible accounts can be estimated based on past
experiences as follows:
1. By setting-up a certain percent (%) of uncollectible account based on the
outstanding receivable. This is also called the Balance Sheet Approach since bad
debts is directly related to accounts receivable.
- The percentage used under this method is based on company’s past experiences. The
percentage of uncollectible accounts based on past experiences is multiplied by the
outstanding balance of the accounts receivable to determine the required balance of the
allowance. This amount is compared with the ledger balance of the allowance; the difference
shall be adjusted thru a journal entry.
2 of 11
2. By aging the accounts receivable.
- This is the most reasonable basis of calculating Uncollectible Account Expenses based on
classified past due accounts. It attempts to review each of the customers’ accounts and age
them to find out how long they have remained outstanding. The longer they are outstanding,
the more doubtful the accounts are, and the higher will be the percentage provision for doubtful
accounts. The resulting computation based on the aging of accounts will represent the
required ending allowance. The beginning balance will then be deducted from the required
ending balance to arrive at the provision
for doubtful accounts.
3 of 11
3. By setting-up a certain percent (%) of uncollectible account based on credit sales.
This is also called the Income Statement Approach since bad debts expense is
based on the sales made for the period.
- The method is simple to apply and emphasizes matching of expenses to revenues since bad
debts is directly related to sales. Estimating bad debts based on sales is permitted if it is
largely on credit.
A. Allowance Method:
Under this method, uncollectible account is being recognized in anticipation that a certain amount or part of
the Accounts Receivable cannot be collected. The doubtful accounts are determined by estimation based on
the company’s past experiences or the experience of other companies within the same business industry. The
Estimated Uncollectible Accounts is then deducted from Accounts Receivable to arrive at the Estimated
Realizable Value. The other term for Estimated Uncollectible Account is Allowance for Doubtful Accounts.
4 of 11
Illustration:
Let us assume that the business has an outstanding Accounts Receivable from various customers in the
amount of P100,000. At the end of its accounting period, it is estimated that 5% of this, is doubtful of collection.
The anticipated loss due to this doubtful account is recorded at the end of the period by way of an adjusting
entry.
Uncollectible Accounts P 5,000
Estimated Uncollectible Accounts P 5,000
To set up a provision for doubtful accounts,
5% of the outstanding receivable computed
as follows:
Accounts Receivable P 100,000
x % of provision 5%
------------
Uncollectible Accounts P 5,000
=======
The Estimated Uncollectible Accounts or the Allowance for Doubtful Accounts is a contra asset
account which is deducted from the principal account. Net Realizable Value is the difference between the
accounts receivable and the allowance for doubtful accounts.
EFFECTS OF ERROR/OMISSION ON FINANCIAL STATEMENTS:
If uncollectible account expense is not recorded, Expense Section of the Income Statement is understated,
and profit is overstated. In the Balance Sheet, this valuation account is understated so that the Accounts
Receivable is overstated. Owner’s Equity will be overstated because the profit is closed to capital is also
overstated.
FINANCIAL STATEMENT PRESENTATION
Uncollectible Account is an expense and will be presented in the Expense Section of the Income Statement
while the Estimated Uncollectible Accounts will be presented in the Balance Sheet as reduction from the
Accounts Receivable to arrive at its “Estimated Realizable Value” at the end of the particular period as shown
below:
Accounts Receivable P 100,000
Less: Estimated Uncollectible Accounts 5,000
--------------
Estimated Realizable Value P 95,000
=========
B. DIRECT WRITE-OFF METHOD:
Under this method, the business adopts a policy of directly charging to Uncollectible Account
Expense / Doubtful Accounts Expense the account of a customer whom it believed could not pay its
balance anymore without providing an Estimated for Uncollectible / Doubtful Accounts. This results in
identifying the customer’s account that needs to be written-off. This method is called the “Direct Write-
Off Method.”
5 of 11
Illustration:
Let us assume that Ms. Hanna Grace de Leon went abroad leaving an unpaid account balance of
P1,000.
To write-off the above account is by preparing a journal entry as follows:
Doubtful Accounts Expense P 1,000
Accounts Receivable P 1,000
To write-off the account of Ms. de Leon
With the direct write-off, the balance of the Accounts Receivable account will automatically reduce
from P100,000 to P99,000 (P100,000 - P1,000).
You noticed that the account credited was Accounts Receivable and not the Estimated Uncollectible
Accounts / Doubtful Accounts unlike what was done under the Allowance Method.
B. DEPRECIATION EXPENSE:
Property and Equipment as defined by Philippine Accounting Standards (PAS No.16) are
tangible assets which are held by an enterprise for use in the production of supply of goods and
services for rental to others, or for administrative purposes, and are expected to be used during more
than one year period.
These include land, buildings, machineries, motor vehicles, furniture and fixtures, equipment and
improvement to leased facilities which are called depreciable assets except land because it is expected
to be useful to the business enterprise for an indefinite period. The utility value (ability to yield service)
will decrease over time because of wear and tear, obsolescence (becomes outdated) and inadequacy
(cannot cope up with demands for more volume or better quality of service). Depreciation is therefore
recognizing part of the asset as an expense because of its decreasing utility value.
Property and Equipment are generally recorded at cost, less allowance for depreciation. Cost is
measured at the cash price equivalent. This is presented in the Balance Sheet as Non-Current
Assets.
The portion of the property and equipment that should be allocated over the number of years and
chargeable against expenses during the period. This is called depreciation expense.
Methods of Computing Depreciation
There are various methods of computing depreciation. We will discuss only the most common and
simplest method of computing depreciation, the “straight-line method.”
There are three (3) factors that must be considered in determining depreciation. These are:
1. Acquisition Cost - it is the amount paid or liability incurred when the asset is acquired. It
includes the purchase price and other incidental cost of its acquisition.
2. Scrap Value - the estimated value of the asset at the end of its economic or useful life. This is
sometimes called salvage value or residual value.
3. Estimated Economic or Useful Life - the estimated length of time usually stated in years
that the asset can be of use.
ANNUAL Cost of the Asset - Salvage Value
DEPRECIATION = Estimated life of the asset in years
Based on the above formula, the computed depreciation represents the yearly expiration of the
fixed asset and is called Annual Depreciation Expense.
6 of 11
Illustration 1:
A delivery equipment was purchased on January 3, 2018 for P600,000. It is estimated that the
vehicle’s salvage value at the end of 10 years is P50,000.
Cost of Asset - Scrap Value P600,000 - 50,000
Depreciation expense = ________________________ = _______________ = P 55,000/year
Estimated Economic Life 10 years
The adjusting entry on December 31, 2018 will be:
Depreciation expense - Delivery Equipment P 55,000
Accumulated Depreciation - Delivery Equipment P 55,000
EFFECTS OF ERROR/OMISSION ON FINANCIAL STATEMENTS
Income Statement - if depreciation expense is not recorded or understated, Profit is overstated. If
depreciation expense is overstated, Profit is understated. If overstatement or understatement of
depreciation expense will occur in one period, it will continue to overstate or understate profit in the
subsequent periods until such time that the error is discovered and corrected.
Balance Sheet - the overstatement or understatement of depreciation expense has the effect of
overstating its valuation account, the Accumulated Depreciation which has also the effect of
understating or overstating the Net Book Value of the property and equipment. This “domino effect” of
transactions and events will overstate or understate the non-current asset section of the Balance Sheet.
Owner’s Equity will also be affected depending on what this error / omission will have in the Balance
Sheet.
FINANANCIAL STATEMENTS PRESENTATION
Depreciation Expense is a nominal account which will be shown in the Expense section of the
Income Statement while the Accumulated Depreciation is a valuation, contra-asset or asset-offset
account which will be shown in the Balance Sheet as a reduction from the cost of fixed assets as
shown below:
Delivery Equipment P 600,000
Less: Accumulated Depreciation 55,000
--------------
Net Book Value P 545,000
The difference between the cost of Fixed Asset, Delivery Equipment of P 600,000 and the related
Accumulated Depreciation, P55,000 is called Net Book Value, Book Value or Carrying Value of P545,000.
GENERALIZATION:
Adjusting entries are needed to ensure that the revenue recognition and exp ense
recognition principle are followed thus resulting to financial statements reporting the effects of
all transactions at the end of the accounting period. Accountants make adjusting entries to
reflect in the account information on economic activities that have occurred but not yet
recorded. 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.
7 of 11
EVALUATION:
Activity #1:
After operating for some time, the management of Argo Trading Co. was alarmed over the big amount of
Accounts Receivable which has ballooned to P2,700,000. This was the result of the inefficiency of credit and
collection department in handling collections. The accountant, Mr. Pepito Batungbakal suggested that a 2.5%
should be provided for uncollectible accounts and write-off account balances that are hopeless for collection.
Required:
1. Under the allowance method, what should be the adjusting entry to record the estimated
uncollectible accounts?
2. What is the adjusting entry to write-off the account of Mr. Roland Simon, P 42,000 which is
hopeless for collection?
3. What is the estimated realizable value of the Accounts Receivable?
4. Had direct write-off method had been used instead of the allowance method, what should be the
adjusting journal entry to write-off the account of Mr. Roland Simon, P42,000.
8 of 11
Activity #2: Depreciation
Reine Jurix, owner of Ren-Ren All Service Repair bought a brand new “Generator” on account costing
P160,000. His accountant, Irish Micah has erroneously charged this to “Supplies Inventory” account instead of
Property and Equipment believing these were all supplies placed in a wooden box. The error was discovered on
June 30, 20A during the interim audit.
Data about the Machine:
Acquisition Date - February 1, 20A
Estimated Useful Life - 5 years
Salvage Value - P 10,000
Required:
1. What is the adjusting entry to correct the account charging?
2. Compute the amount of the Annual Depreciation.
3. How much is the net value of the machine as of June 30, 20A?
4. Had the error not been discovered, profit as of June 30, 20A would have been?
9 of 11
REINFORCEMENT:
1. The depreciation reported on the Heavy Equipment of XYZ Land is P52,500 per year. The heavy
equipment had an original cost of P581,250 and its expected economic life is 10 years. What is
the estimated salvage value of the heavy equipment? (Provide the computation)
2. On December 31, 2019, the end of company’s annual accounting period, the company has
outstanding accounts receivable of P375,000. The company believes that 3% of the outstanding
accounts receivable might not be collected. If the balance of the allowance for uncollectible
accounts before adjusting entries is P3,750 - credit, how much would be reported as
uncollectible account expense by the company at year end? (Provide the computation)
3. The ledger balance of Office Equipment and Accumulated Depreciation on January 1, 2020 is
P120,000 and P40,000 respectively. On October 1, 2020, another acquisition was recorded in
the amount of P25,000. All Office Equipment are depreciated at 10% annually. Compute the
book value of the Office Equipment on December 31, 2020. (Provide the computation)
10 of 11
REFERENCES:
[Link]
Wild Financial / Managerial Accounting 6th Edition
[Link]
[Link]
[Link]
Suggested Textbook:
Lopez, Jr. Rafael M. (2018 Revised Edition) Basic Accounting for Non-Accountants: Simplified Procedural
Approach based on PAS: MS Lopez Printing & Publishing
Additional Materials:
Vera Cruz-Manuel, Zenaida (2017), 21st Century Accounting Process: Concepts and Procedures: Raintress
Trading & Publishing
Ballada, Win (2017), Fundamentals of Accounting: DomDane Publishers
Balatbat-Cabrera, Ma. Elenita (2019), Financial Accounting and Reporting: GIC Enterprises & Co., Inc.
Rante, Gloria, Fundamentals of Accounting, Millenium Books, Inc.
11 of 11
