ACCOUNTING CYLE
FOR SERVICE BUSINESS
MODULE 3 Part 5
II. ADJUSTMENTS FOR ACCRUALS
Accruals
Adjustments help the entity avoid the impractical preparation of hourly or daily journal entries just to accrue
expenses. It updates the accounting values by recognizing expired transactions that remained unrecorded.
A. ACCRUED EXPENSES
Accrued expenses are expenses already incurred before payment is made as of cut-off date such as
salaries, interest, utilities (electricity, water and telecommunications) and taxes. According to expense
recognition principle, expenses must be recognized in the books of accounts at the time of its incurrence and
not at the time of payment.
Pro-forma adjusting entry is
Expenses xxxx
Accrued Expense or Expense Payable xxxx
To recognize expenses incurred.
ILLUSTRATION 1:
On December 30, 2018, MJ Car Rental Agency hired a daily wage worker for the
maintenance of the office. MJ follows the calendar year as the accounting period. The daily
wage of the worker is P350 or a weekly salary of P2,100 for six days except Sunday. MJ
salary scheme is weekly and pays every Saturday. Assume that December 30, 2018 falls on
Monday. This would imply that December 31, 2018 falls on Tuesday which is the end of
accounting period.
Analysis:
Starting December 30, 2018 salaries expense are incurred daily and the cut-off date of accounting records is
December 31, 2018 while payment of salary on a weekly basis is on January 4, 2019. The unpaid salary expense
is for two days (Dec 30 & Dec 31) as of end of accounting period equivalent to P700. Though the scheduled
payment is on January 4, 2019, the two days salary expense should be recognized because it has been incurred
already.
Adjusting entry:
12/31/2018 Salaries Expense P 700
Salaries Payable or Accrued Salaries P700
NOTE: The account titles for accrual and income should be clearly identified in the adjusting entry.
ILLUSTRATION 2:
On October 1, 2017 , Arcon Service Business issued to JM Trading a 6%, P120,000
promissory note due in 1 year as payment for Office Equipment. Prepare adjusting entry as of
December 31, 2017.
Journal Entry:
10/1/2017 Office Equipment P120,000
Notes Payable P120,000
ANALYSIS: From the time the equipment was purchased up to the end of accounting period,
three months already passed so the interest attached to the note has already been incurred and
therefore should be recorded to meet the requirements of accrual accounting.
Computation: P120,000 x 6% = P7,200/yr. divided by 12 months = 600 x 3 months =P1,800
Adjusting Entry:
12/31/17 Interest Expense P1,800
Interest Payable or accrued Interest Expense P1,800
B. ACCRUED INCOME/ REVENUE
Accrual of income is income already earned but not yet collected or payments have not
been received.
The business already done with services but payment of revenue is received in future date.
They are accumulating income due to passage of time as in the case of rent income and interest
income.
Similar to the recognition principle of expenses, income must also be recognized in the period
earned and not at the time of collection.
Adjustments is needed to avoid understatements of assets and revenues.
Pro-forma adjusting entry
Accrued Receivable or Accrued Income xxxx
Service Revenue xxxx
Illustration:
On December 21, 2018 MJ Car Rental Agency received a contract for the exclusive use of two vans
including two drivers to assist the foreign guests of a well-respected client for three months. MJ will be paid
P24,000 per month for a period of three months. The payment will be made every 21st of the month.
Analysis:
The collection of P24,000 payment will be every 21st of the month, it means the first collection will be
on January 21, 2019. As of Dec. 31, 2018, the cut-off date, MJ already realized an income for 10 days.
Income must be recognized at the time the income is earned paid or unpaid, so an adjusting entry is needed
to reflect this.
Adjusting entry:
12/31/2018 Accrued Rental Revenue P8,000
Rental Revenue/Income P8,000
(P24,000/30 days x 10 days)
C. ADJUSTMENTS FOR ESTIMATED UNCOLLECTIBLE ACCOUNTS
Businesses normally have credit policy in order to generate more revenues. This policy
allows customers to purchase goods or services on terms agreed upon. However, not all of the
credit sales are 100% collectibles within the reasonable period. Adjustment is necessary to
separate losses(uncollectibles) from realizable asset to conform with accounting principle.
Experience dictates that credits are not totally collected due to the following reasons:
• Debtor losses his capacity to pay
• Customer is not willing to pay
• Customer cannot be located anymore
• Customer dies
In this case, the revenue that has been recognized earlier when you sell the goods or service,
was already lost because of non-payment. The service revenue should be adjusted by charging a
small portion to doubtful accounts or uncollectible accounts. Mostly the amount charged against
doubtful or uncollectible account is estimated based on the professional judgement of the
management and business experience.
Pro-forma entry
Doubtful Accounts or Uncollectible accounts xxxx
Allowance for Doubtful or Uncollectible accounts xxxx
Basis of Estimating Uncollectible Accounts or Bad Debts or Doubtful Accounts
Doubtful accounts are computed based on the following:
∙ Percent of credit sales
∙ Percent of receivable balance
∙ Based on aging of receivables
Illustration:
Percent of Credit Sales or Service income
MJ Car Rental Agency provided the following ledger accounts as of December 31, 2018:
Total Credit Sales or Service Income P 6,500,000
Accounts Receivable 2,800,000
Allowance for uncollectible accounts per ledger 150,000
The business estimated that uncollectible accounts at the end of the current year are 5% of
credit service income.
Required: 1. Compute the uncollectible account expense
2. Prepare the adjusting entry.
Credit service income P6,500,000
Multiplied by uncollectible accounts rate 5%
Uncollectible account expense 325,000
Adjusting Entry
12/31/2018 Uncollectible Accounts Expense P325,000
Allowance for Uncollectible Accounts P325,000
Illustration:
Percent of Accounts Receivable
MJ Car Rental Agency revealed the following information from its ledger accounts as at December 31, 2018
as follows:
Credit sales or Service income P6,500,000
Accounts Receivable 2,800,000
Allowance for Uncollectible Accounts 50,000
The business estimated that uncollectible accounts at the end of the current year are 5% of
credit service income.
Required: 1. Compute the uncollectible accounts expense.
2. Prepare the adjusting entry.
Accounts Receivable P 2,800,000
Multiplied by Uncollectible accounts rate 5%
Required Allowance Uncollectible Account Expense 140,000
Less: Allowance per ledger 50,000
Uncollectible account expense 90,000
Adjusting Entry
12/31/2018 Uncollectible Accounts Expense P 90,000
Allowance for Uncollectible Accounts P 90,000
Allowance for Uncollectible Accounts
P 50,000 Bal. per ledger
90,000 Dec 31 adjusting entry
P140,000 Required allowance
Net Realizable Value. Refers to the value of receivable after deducting the
allowance for uncollectible accounts shown as:
Accounts Receivable P2,800,000
Less: Allowance for uncollectible accounts 140,000
Net Realizable value P2,660,000
Note:
The most common method to compute for allowance for uncollectible accounts are
percent of credit sales or service income and percent of receivables, aging of
receivables will be discussed in higher accounting.
Muchas Gracias!
