6-Principles and Concepts of Measuring Income

Fundamentals of Accounting Part 1
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Principles and Concepts of Measuring Income
Module 006 Principles and Concepts of

Measuring Income
The lessons covered in this module include important concepts and

principles of calculating income such as the distinction between the accrual
basis accounting versus cash basis accounting, accounting period, revenue
principle, matching principle, time-period concept. We also include an
overview of the adjusting process and the accounts to be adjusted. At the end,
prepare an adjusted trial balance and the financial statements.
After studying this module, the students should be able to
1. Understand the different principles that will guide us in calculating and
reporting the right income.
2. Understand the difference between accrual basis and cash basis of
accounting.
3. Explain and apply the revenue principle, matching principle and time-
period concept.
4. Understand an overview of the adjusting procedures and the accounts to
be adjusted.
5. Prepare an adjusted trial balance.
6. Prepare the financial statements from the adjusted trial balance.
Introduction
How do businesses determine whether its operation is profitable? At the end of an
accounting period, be it monthly, bi-monthly, quarterly, semi-annually, or annually, the
firm prepares its financial statements, the final output of any accounting system. What the
business stakeholders consider as the most important figure in the financial statements is
the net income or net loss or profit or loss.
Net income or net loss results from the many information on revenues and expenses for
any given accounting period. A business entity must keep updated records at the end of the
period in order to calculate and report the correct amount of income. Thus, the adjusting
the books process is applied.
Many accounting concepts and principles are developed to guide the measurement of the
firm’s profit (or loss). These include the accrual basis accounting, the accounting period,
revenue principle, and matching principle.
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Accrual-basis Accounting and Cash-basis Accounting

Accrual-basis accounting is an accounting method that records the effects of business
events as they occur, notwithstanding of whether the transactions affected cash.
Cash-basis accounting, on the hand, is accounting that records the business transactions
only when cash is received or paid.
An illustrative example is presented below for you to fully understand the difference
between the two methods of accounting.
Suppose ABC Corporation purchased supplies worth P 10,000 on account from their
supplier.
Under the accrual basis, the ABC records the transaction by debiting Supplies and crediting
Accounts Payable (supplies is an asset, increase in asset requires a debit entry, and
increase in a liability needs a credit entry). The journal entry is
Supplies P 10,000
Accounts Payable P 10,000
Purchased supplies on account.
Therefore, under the accrual basis, ABC reports on its balance sheet the asset Supplies and
recognizes the liability Accounts Payable.
In contrast, the cash-basis accounting disregards this transaction, simply because there is
no cash involved or no cash payment has been made for the supplies. Under the cash basis,
ABC will only record the purchase of supplies when the payment has been made and
instead of recording the supplies as asset, it will consider it as an expense. Their entry upon
payment is
Supplies Expense P10, 000
Cash P10, 000
Cash-basis accounting records only cash receipts and cash payments, treating cash receipts
as Revenues and cash payments as Expenses. This is a flawed accounting. ABC bought the
supplies which are assets that will give the company future benefits.
Another example will show us the difference between the two accounting methods is terms
of recognizing revenue.
Suppose ABC sold their produce worth P 25,000 on credit to a customer.
Under the accrual-basis accounting, ABC will record this event as follows
Accounts Receivable P25, 000

Sales Revenue P 25,000
Sold goods on credit.
Accounts Receivable, an asset will be reported in the balance sheet of ABC and reports on
the income statement the sales revenue even there is no payment from the customer yet.
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Under the cash-basis accounting, the transaction will not be recorded by ABC because no
cash was received yet. No receivable from customers will be recorded. It will only record
the sale when cash is received. Their entry will be:
Cash P25, 000
Sales Revenue P25, 000
Sale of goods.
This is a faulty practice because it might be reporting revenues in the wrong accounting
period.
It should be noted that revenues should be recorded when it is earned and not only when it
is collected in cash. This is the accrual-basis accounting way.
Accounting Period
Businesses need not to close its doors in order to determine if it profiting or losing. It is
very impractical to liquidate the business just to know how much it really earns or loses.
Periodic reports will help them know the real score of the business. This is the reason why
in accounting, business has to divide time into segments and prepare the financial reports
or statements for specific periods.
Accounting period is simply defined as the range of time covered by the financial
statements. This is very important for potential investors because they analyze the
company’s performance through the financial statements that are prepared with a fixed
accounting period.
An accounting period can be monthly, bi-monthly, quarterly, semi-annually, or annually.
Most companies have yearly accounting period be it on a calendar year basis or a fiscal year
basis. Many investors and managers cannot wait for year end to know how the business is
doing, so interim financial statements are prepared usually on a monthly basis. Monthly
financial statements can be consolidated for a quarterly or semi-annual report.
A calendar year period starts on first day of January and ends on the last day of December.
On the other hand, a fiscal year is a period that starts on any month except January and
ends on the twelfth month.
Accounting periods are created for the purposes of analysis and reporting the business
operations. The accrual basis of accounting has been supporting the theory that a firm
wants to practice consistency in business growth throughout the accounting periods to
show stability and long-term profitability.
(In our discussions and problems, the accounting period will be specified to avoid
confusion.)
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Revenue Principle
The revenue principle or revenue recognition principle is a principle under the generally
accepted accounting principles (GAAP) that stated the specific conditions under which
revenue is recognized or properly accounted for.
The revenue principle is the cornerstone of the accrual basis of accounting, thus it
determines when to record revenue and in what amount. This principle suggests a
recording of revenues when it has been earned. Revenues earned here means that the
business has delivered the goods or rendered the services to the customer even if the
payment has not been made by the clients.
Just to mention, under the accrual method of accounting, if a firm receives an advance
payment for the sale, such payment is consider a liability not revenue. Revenue will only be
recognized if the firm has completely delivered the sales under their agreement with the
customer.
When it comes to the amount of revenue to be recorded, it should be equal to the cash
value of the goods or services delivered or rendered to the customers. Example: XYZ
Corporation, a heavy equipment dealer, sold equipment that regularly sells at P 500,000 to
ABC Company for P 450,000. The amount to be recorded is P 450,000 because that is the
agreed value and the amount paid by ABC and what XYZ received.
Matching Principle
Another very important principle in income measurement and is very much related to the
application of the accounting period principle is the matching principle. The matching
principle necessitates that expenses should be reported in the accounting period when the
expenses were incurred and all revenues related or associated to these expenses were
earned.
Stated simply, the matching principle guides the accountants in
1. Identifying all the expenses incurred during a given accounting period.
2. Determine the amount of expenses, and
3. Match up these expenses versus the revenues earned during the same accounting
period. Matching expenses against revenue means deducting expenses from the
revenues to calculate the net income or net loss during that period.
Example: Suppose XYZ Corp. registered P 2,500,000 revenue on the first quarter of the
year (assuming the firm is preparing a quarterly income statement) and the expenses
incurred to earn that revenue is 65 percent of sales. Therefore, the net profit is P875, 000.
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The time-Period Concept

The time-period concept warrants that all accounting information and financial results of
business operations or activities are reported at regular intervals, usually monthly,
quarterly or annually.
Accounting for the business performance and position on certain time periods is very
useful in providing well-timed feedback to the firm’s stakeholders specially the
management and owners for this will help them in making timely decisions.
Financial statements are prepared either quarterly, semi-annually, or annually under the
time period assumption (another term for time period concept). The income statement
gives us an overview of the firm’s performance for a given period. The statement of
financial position or balance sheet provides the status of the business’ assets, liabilities, and
equity at the end of given time period. The cash flow statement and the statement of
changes in equity give the stakeholders the details of the composition of the balance sheet
change during the period. The mentioned financial statements tell financial stories of the
firms at a certain point and time.
Applying the time-period concept will result to making estimates and other assessments at
the end of the time period to properly decide which activities have to be recognized and
reported in the current period and which one will be recorded in the next time-period. At
this point, adjusting the accounts needs to be done to facilitate reporting of the right
amount of revenue, expenses, assets, and liabilities at the end of the time period.
The two previous principles or concepts are very much related to the time-period concept.
Revenue recognition concept and matching principles serves as guide on when to record
revenues or income and how to measure an accurate bottom line figure in the income
statement.
The Adjusting Process

The financial statements are prepared at the end of the period. In the previous module, we
have prepared simple financial statements. I called it simple because they are not yet
adjusted for revenues, expenses and some assets and liability internal transactions that
affect more than one accounting period. The trial balance accounts and amounts that we
have prepared in that problem are incomplete because there are certain revenue and
expense transactions that are omitted for these affects the next accounting period.
The end of period process starts with the unadjusted trial balance. Accrual basis of
accounting mandates that adjusting entries be prepared, recorded, and posted to arrive at
the correct balances that should be reflected in the income statement and balance sheet.
Adjusting entries are entries made at the end of the accounting period to report revenues
to the period in which they are earned and expenses to the period in which they are
incurred. It also helps in presenting the correct balances of assets and liabilities in the
statement of financial position.
The end-of-period procedure of updating the accounts is called adjusting the accounts or
adjusting the books.
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The Purposes of Adjusting Entries

To summarize the need for adjusting entries mentioned in the above paragraph will be:
1. To show the proper or correct amount of revenues earned and expenses incurred
during a specific period of time.
2. To present fairly the amount of assets, liabilities, and owner’s equity in the balance
sheet.
The Accounts that need to be adjusted
Categories of adjusting entries are
1. Prepaid Expenses
2. Depreciation of plant assets
3. Accrued Revenues
4. Accrued Expenses
5. Unearned Revenues
6. Provision for Doubtful Accounts
Adjusting entries is said to be most challenging of all introductory topics in
accounting, so students should be very careful in studying this.
Prepaid Expenses
Prepaid expenses are expenses paid in advance. Prepaid expenses are classified as
current assets that usually expired or used in the near future.
Examples of prepaid expenses are Supplies or Unused supplies, prepaid insurance,
prepaid advertising, prepaid rent. Salaries expense and utilities expense do not fall
under prepaid because they are not paid in advance.
The adjusting entry for prepaid expenses will depend on the method used in
recording the payment. There are two methods of recording prepaid expenses:
1. Asset method – The payment was originally debited to an asset account.
Example: On March 4, 2017 Mr. Santos bought supplies for his repair shop for
cash, P 1,000.
The journal entry is
Mar. 4 Supplies P 1,000
Cash P 1,000
Paid cash for supplies.
2. Expense method – The payment for the asset is debited to an expense account.
Using the same transaction above, the entry is
Mar. 4 Supplies Expense P1, 000
Cash P1, 000
Paid cash for supplies.
Example 1: Assuming, Mr. Santos has started his Repair shop business on March
1, 2017 and is using a monthly accounting period. On March 31, a physical count
reveals a P450 worth of unused supplies.
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The adjusting entry will be:

1. Using the Asset Method
March 31 Supplies Expense P 550
Supplies P 550
On March 4, the available supplies to be used are P1, 000, at the end of the
month, what is left is P450, and so the difference is the amount of supplies
used. Let’s illustrate using T-accounts.
Supplies Supplies Expense

3/4 1,000 3/31 550 3/31 550
Bal. 450 Bal. 550
The amount of Supplies to be shown in the balance sheet is P 450.

Income Statement will reflect Supplies Expense of P 550.
2. Using the Expense Method
March 31 Supplies P 450

Supplies Expense P450
On March 4, the Supplies Expense was debited for P 1,000. But at the
end of the month, there was an inventory of P450, so the supplies used or
expensed is only P 550. The P1, 000 supplies expense should be lowered to P
550. Using the T-accounts:
Supplies Expense Supplies

3/4 1,000 3/31 450 3/31 450
Bal. 550 Bal. 450
Just the same, Supplies of P450 will be reported on the balance sheet and
Supplies Expense of P550 in the income statement.
Example 2: Assuming that the Unadjusted Trial Balance of Mr. Santos on

March 31 includes the Prepaid Rent with an amount of P 15,000. The
adjustment data provided at the end of the month relative to Prepaid Rent
states that ‘The rent paid on March1, 2015 was intended for three months’.
It is implied that the method used is Asset Method, because of the Prepaid
Rent account. Analyzing the adjustment data will give us a monthly rent of P
5,000 (P15, 000 / 3 months).
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The adjusting entry would be:
March 31 Rent Expense P 5,000

Prepaid Rent P 5,000
In the income statement, Rent Expense will be reported at P5, 000 and the
Prepaid Rent account will be shown in the balance sheet with an amount of P
10,000.
If the Prepaid Rent account is not adjusted, the expenses in the income
statement will be overstated, net income will be understated while the asset
account in the balance sheet will be understated.
Depreciation of Plant Assets

Plant Assets is another account name for Long-Lived Tangible Assets or Non-current
Assets or Fixed Assets. Others use the title Plant, Property, and Equipment.
(We will use Plant Assets in our discussion.) Plant Assets include land, building,
furniture, machinery, and equipment that are used in the operations of the business.
All these assets except land decrease in usefulness over a period of time. This
decrease in usefulness of plant assets as they age or as they are used over a period
of time is an expense which is called depreciation. Depreciation is then defined as
the allocation of the cost of a plant asset over its useful life.
Reasons for depreciation include wear and tear, inadequacy, obsolescence (due
mainly to the evolution of technology).
Example: Let us assume that on March 1, 2017, Mr. Santos bought repair
equipment worth P100, 000. The equipment has as estimated useful life of 10 years
with a salvage value of P 10,000. The depreciation will be computed as follows:
Solution:
We will be using the simplest method of computing depreciation, the straight-line
method. The formula is:
D =(C –S) / n
Where D = Depreciation
C = cost of the plant asset
S = salvage value
n = estimated useful life (in years)
D = (C –S) /n
D = {(P100, 000 – P10, 000) / 10 years x} 1/12
D = P750
The adjusting will be:

March 31 Depreciation Expense- Repair Equipment P750
Accumulated Depreciation –Repair Equipment P750
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Depreciation is an expense account while Accumulated Depreciation is a contra

account that accompanies plant asset. Contra accounts have a normal credit balance
and have two characteristics: it has a companion account and its normal balance
(debit or credit) is contrasting with its companion account.
Accumulated Depreciation is credited instead of Repair Equipment because the
original cost of the plant asset should be in the asset account as long as the business
is using the asset.
The depreciation is just an estimate. The accumulated depreciation account keeps
the cumulative sum of all depreciation expense recorded for the asset.
After the adjusting entry, the accounts affected will appear as follows:
Repair Equipment Accumulated Depreciation-

3/1 P 100,000 Repair Equipment
Bal. P100,000 1/31 P 750
Bal. P 750
Depreciation Expense
Repair Equipment
1/31 P 750
Bal. P750
The balance sheet reflects the relationship between the plant asset and the
accumulated depreciation. The difference derived by subtracting the total
accumulated depreciation from the balance of the plant asset is called the
book value or net book value of the plant asset.
The above accounts are presented in the balance sheet as follows:
Plant Assets
Repair Equipment P100, 000
Less: Accumulated Depreciation 750 P99, 250
Accrued Revenues (Income)

Accrued Revenues are income earned but not yet collected or not yet due for
collection. Accrued revenue is an Asset, a Receivable.
To avoid the understatement of income and asset, accrued income is adjusted at the
end of the accounting period.
Example 1: Assume that Mr. Santos Repair Shop was hired by XYZ Travel and Tours
to perform repairs and maintenance on a regular continuing basis effective March
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15, 2017. The contract between the two states that XYZ will pay Mr. Santos P1, 500
monthly and the first payment will be made on April 15, 2017.
The following adjusting entry should be made on March 31, 2017 to record the
accrual of income;
March 31 Accounts Receivable P750
Service Income P750
(P1, 500 /1/2 = P750)
1/2 refers to March 15 to March 31, the end of the accounting.
Example 2: Let us assume that Mr. Santos performed repairs and a maintenance
service to ABC, a taxi operator, for the latter’s five taxi units on March 2. The
services cost ABC P P10, 000. ABC paid Mr. Santos P 2,000 cash and issued a 12%
interest-bearing note for the balance payable on April 30, 2017.
Our example will result to an adjustment for interest income.
The adjusting entry to be made on March 31 will be:
March 31 Accrued Interest Income

(Or Interest Receivable) P 80
Interest Income P80
Computation:
({P10, 000-P2000} x 12% x 60/360) x (30/60) = P80
We used 360 days in a year. 12% is understood to be the interest rate
per year. 30/60 pertains to March 2 to March 31, which is half of the
term of the note.
The interest is accrued because Mr. Santos has earned it already but he can collect it
only with the interest for April on April 30 as agreed upon.
This adjusting entry is an illustration of the revenue principle and the accrual basis
of accounting stating that revenue should be recognized or recorded when it is
earned even if the payment has not yet been received.
Accrued Expenses
Accrued Expenses are expenses incurred during the accounting period but not yet
paid or not yet due for payment. Accrued expense is perceived as opposite of the
prepaid expense.
Accrued expense is a liability account with a normal credit balance. Adjustment
requires a debit to an expense account and a credit to a liability account (accrued
expense).
Example: Let us assume that the P 100,000 worth of equipment purchased by Mr.
Santos on March 1 was 50 percent paid in cash and he issued a promissory note for
the balance dated March 1. Terms of the note: 12%, 90-day.
The adjusting would be:
March 31 Interest Expense P 500
Accrued Interest Payable P 500
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(Or Interest Payable)

Computation of the amount:
({P100, 000 x 50%} x 12% x {90/360}) /3 = P500)
Divided by 3 because 90 days = 3 months
Unearned Revenues
Unearned revenue, also called deferred revenue, is receiving cash payment for
goods or services in advance. The customer paid the goods or the services before
they are delivered or performed by the business.
Unearned revenue or income is a liability and has a normal credit balance.
Adjustment of deferred revenue will require a debit to Unearned Revenue (because
this was credited when the payment was received) and credit to Revenue or Income.
Unearned revenue is a liability to one company and a prepaid expense to the other
transacting company.
Adjusting unearned revenue will depend on the method used recording the original
transaction of the receipt of payment. There are two methods of recording the
original transaction for unearned revenue:
1. Income method - the receipt of payment was debited to Cash and credited to an
Income account.
2. Liability method - the receipt of payment was debited to Cash and credited to a
Liability account (Unearned Revenue)
Example: Assume that on March 20, Mr. Santos received an advance payment of P
5,000 from a customer whom he agreed to repair the latter’s car on April 5, 2017.
The adjusting entry will be:
1. Income method
March 31 Service Income P 5,000
Unearned Service Income P 5,000
We debited Service Income to close it since the service was not yet performed as
at the end of March.
If the service was partly done as at the end of the accounting period, the amount
for uncompleted works will be adjusted.
Example: Assume that the job partly performed as at March 31 is worth P3, 000.
March 31 Service Income P2, 000

Unearned Service Income P 2,000
So that what would be reported in the income statement is a Service Income of P

3,000 and the liability-Unearned Service Income in the Balance Sheet is P 3,000.
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2. Liability method
The original journal entry made to record the receipt of payment from the
customer was
March 20 Cash P5, 000
Unearned Service Income P5, 000
If the job was not performed as of March 31, 2017 no need to adjust.
But if the job was partly done as given above (P3, 000 worth of services was
performed as of March 31), the adjusting entry would be
March 31 Unearned Service Income P3, 000

Service Income P 3,000
The amount used is the amount of the service income already earned.
Provision for Doubtful Accounts

Another business activity that makes companies earn more is selling on credit or on
account and we cannot deny the fact that as revenues are increasing so with the
accounts receivable or trade receivable. Granting credits to customers or clients can
have two consequences: one, it will help increase revenues and it represents a claim
against the customers’ cash; second, the cost that the company will incur if some
customers failed to pay. This cost is called Uncollectible Account Expense or
Doubtful Account Expense or Bad Debts Expense.
Receivables are monetary claims from customers (business or individuals) who
purchase goods or services on account. The main types of receivables are
Accounts Receivable, also called Trade Receivables, and Notes Receivable.
There are two methods of estimating uncollectible accounts:
1. Allowance method
2. Direct Write-off method
Allowance Method is a method of recording uncollectible accounts based on

estimates. Estimates are based on the company’s experiences. The company uses the
Allowance for Uncollectible Accounts ( also called Allowance for Doubtful Accounts),
a contra account to Accounts Receivable, to sum up the trade receivables that the
firm anticipates not to collect.
The net realizable value of accounts receivable is the difference between the
accounts receivable and the it’s contra account, Allowance for Uncollectible
Accounts.
The basic methods of estimating uncollectibles are

1. Percentage of sales method
2. Aging of Accounts Receivable
3. Percentage of Accounts Receivable
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Percentage of sales method or the Income Statement Approach calculates

uncollectible accounts expense as a percentage of net credit sales.
Example: Assume that Mr. Cruz, a grocery owner, has an unadjusted trial balance at
the end of December 2016 that includes the following accounts:
Accounts Receivable, P 80,000; Sales Revenue, P 600,000, 70% of which are cash
sales; Sales Returns and allowances associated with credit sales, P2, 000. Allowance
for Uncollectible Accounts, P 2,500 (this was a carry-over from his 2015 balance
sheet). Adjustment data given on December 31, 2016 include this statement: Three
percent of credit sales are estimated to be uncollectible.

December 31 Uncollectible Account Expense P 5,340
Allowance for Uncollectible Account P5, 340
Supporting Computation:
Credit sales (P600, 000 x 30%) = P180, 000
Less: Sales Returns and Allowances 2,000
Net Credit Sales P178, 000
Estimated uncollectible rate 3%
Estimated uncollectible P5, 340
In the event that the credit sales cannot be easily separated from cash sales, the total
sales can also be used as the basis.
Percentage of Accounts Receivable Method apportions uncollectible accounts as a

percentage of the total accounts receivable.
Assuming in our example above, Mr. Cruz, based on previous experience in his
business, estimated that two percent of the total accounts receivable is deemed
uncollectible.

Computation: P 80,000 x 2% = P1, 600
Aging of Accounts Receivable Method. Also called the Balance Sheet approach, this
method, this method calculates the doubtful accounts by analyzing individual
accounts receivable as to the length of time they have been receivable from the
customers.
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Below is a simplified example. Given the following data from the aging analysis of
accounts receivable of Mr. Cruz:
Age of Accounts Receivable
0-30 days 31-60 days 61-90 days over 90 days Total
Account Receivable P30,000 P25,000 P15,000 P10,000 P80,000
Percent Uncollectible 1% 3% 5% 55%
Allowance for
Uncollectible Accounts P300 P750 P750 P5,500 P7,300

Direct Write-Off Method. This is a simple and practical way of accounting for
uncollectible accounts. Once the management decides not to collect anymore from
the customer, the accountant will write off the customer’s account by debiting the
Uncollectible Account Expense and crediting Accounts Receivable.
Assuming Mr. Cruz, after several attempts of collecting, decides to write off the
accounts of the customers under the over 90 days group (disregard the computation
of allowance for uncollectible accounts in the aging of receivables above), the
adjusting entry would be:

Accounts Receivable P 5,500
This method, simple and practical, is defective because it does not set up an
allowance for uncollectible resulting to the reporting of accounts receivable in full
which is greater than what the firm expects to collect. Another reason is that the
uncollectible account expense may not match the revenue for the period. The direct
write-off method is acceptable when the amount of uncollectible receivables is very
low.
Recap of the Adjusting Process

Things to remember in going about the adjusting entries:
 Adjusting entries are result of internal transactions of a firm.
 Adjusting entries have no debit nor credit to Cash.
 Adjusting entries are prepared and recorded at the end of the accounting period
only.
 Adjusting entries should be recorded in a journal and posted in the ledger.
 Adjusting entries will complete the trial balance (Adjusted) that will be the basis of
preparing the final financial statements.
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Pro-forma entries that will help you in preparing the adjustments:

Accounts Debit Credit
1. Prepaid Expenses
1.1 Asset method
Expense P XXX
Asset (Prepaid Expense) P XXX
1.2 Expense Method

Asset (Prepaid Expense) P XXX
Expense P XXX
2. Depreciation of Plant assets

Depreciation Expense -(Plant Asset) P XXX
Accumulated Depreciation -(Plant Asset) P XXX
3. Accrued Revenue
Asset (Accrued Revenue or Receivable) P XXX
Revenue P XXX
4. Accrued Expense
Expense P XXX
Liability (Accrued Expense) P XXX
5. Unearned or Deferred Revenue

5.1 Income method
Revenue or Income P XXX
Liability (Unearned Revenue) P XXX
5.2 Liability Method

Liability (Unearned Revenue) P XXX
Revenue or Inocme P XXX
6. Provision for Uncollectible Account

Uncollectible Account Expense
or Doubtful Account Expense P XXX
Allowance for Uncollectible Account P XXX
or Allowance for Doubtful account
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Adjusting Accounts, type of accounting element and normal balance

Accounts Type of Accounting Normal
Element Balance
1. Prepaid Expenses Asset Debit
Examples:
Supplies or Unused supplies
Prepaid Rent
Prepaid Insurance
Prepaid Advertising
2. Depreciation Expense Expense Debit
3. Accumulated Depreciation Contra account of
Plant Assets Credit
4. Uncollectible Accounts Expense Debit
5. Allowance for Uncollectible Accounts Contra account of
Current Asset
( Account Receivable) Credit
6. Accrued Expense Liability Credit
Examples:
Accrued Interest Payable or
Interest Payable
Accrued Salaries Payable or
Salaries Payable
7. Accrued Income Asset (Receivable) Debit
Example:
Accrued Interest Income or
Interest Receivable
8. Unearned Revenue or Income Liability Credit
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The Adjusted Trial Balance

Adjusted Trial Balance is a list of all the accounts with their adjusted balances.
Illustrative Problem 6.1 Adjusted Trial Balance
Below is the unadjusted trial balance of Santos Repair Shop on March 31, 2017.
Santos Repair Shop

Unadjusted Trial Balance
March 31, 2017
Cash P180,000
Accounts Receivable 6,000
Notes Receivable 8,000
Supplies 1,000
Prepaid Rent 15,000
Equipment 100,000
Furniture 5,000
Accounts Payable P5,000
Notes Payable 50,000
Juan, Santos, Capital 180,000
Service Income 92,500
Salaries Expense 9,500
Utilities Expense 3,000
Total P327,500 P327,500
On March 31, the following adjustment data are given:

1. A physical count resulted to P450 worth of supplies on hand.
2. The rent paid on March 1 is good for three months.
3. The 12% notes received from a customer on March 2 was due on April 30, 2017.
4. The Equipment purchased on March 1 with an estimated useful life of 10 years
and salvage value of P 10,000 was 50% paid in cash and Mr. Santos issued a
12%, 90-day note for the balance.
5. The furniture bought on March 1 has an estimated useful life of 2 years with no
salvage value.
6. Of the total service income, P5, 000 is still unearned.
7. Services partly rendered to a client on March 25 worth P 750 will be paid on
April 15, 2017.
8. The whereabouts of one of the debtors (included in the Accounts Receivable)
cannot be traced and due from him is P 500. Use Allowance method.
Required: Prepare an Adjusted Trial Balance on March 31.
Course Module
18
Solution:
First, we will have the adjusting entries. In the date column, I just put the
number of the adjustment data for easy reference.
Santos Repair Shop
Adjusting Entries
March 31, 2017
Account Titles Debit Credit
1 Suppl i es Expens e P 550
Suppl i es P 550
2 Rent Expens e 5,000

Prepa i d Rent 5,000
3 Accrued Interes t Income 80

Interes t Income 80
4 Depreci a tion-Equi pment 750

Accumul a ted Depreci a tion-Equi pment 750
4 Interes t Expens e 500

Accrued Interes t Expens e 500
5 Depreci a tion-Furni ture 208

Accumul a ted Depreci a tion-Furni ture 208
6 Servi ce Income 5,000

Unea rned Servi ce Income 5,000
7 Accounts Recei va bl e 750

or Accrued Servi ce Income 750
Servi ce Income
8 Doubtful Accounts Expens e 500

Al l owa nce for Doubtful Accounts 500
Second, I will show you the posting to the ledger using T-accounts. Only the
balances before adjustment and the adjusting entries will be shown in the T-
account to simplify the presentation.
Accumulated Depreciation
Cash Furniture Utilities Expense
Bal. 180,000 5) 208 Bal. 3,000
Bal. 208
19
Accounts Recei va bl e Al l owa nce for Interes t Expens e

Ba l . 6,000 Doubtful Accounts 4) 500
8) 500 Ba l . 500
Ba l . 500
Notes Recei va bl e Accounts Pa ya bl e Rent Expens e

Ba l . 8,000 Ba l . 5,000 2) 5,000
Ba l . 5,000
Suppl i es Notes pa ya bl e Depreci a ti on- Equi pment

Ba l . 1,000 1) 550 Ba l . 50,000 4) 750
Ba l . 450 Ba l . 750
Prepa i d Rent J. Sa ntos , Ca pi ta l Depreci a ti on-Furni true

Ba l . 15,000 2) 5,000 Ba l . 180,000 5) 208
Ba l . 10,000 Ba l . 208
Equi pment Accrued Servi ce Income Suppl i es Expens e

Ba l . 100,000 7) 750 1) 550
Ba l . 750 Ba l . 550
Furni ture Servi ce Income Interes t Income

Ba l . 5,000 6) 5,000 Ba l . 92,500 3) 80
7) 750 Ba l . 80
93,250
Ba l . 88,250
Accumul a ted Depreci a ti on
Equi pment Sa l a ri es Expens e Doubtful Account Expens e
4) 750 Ba l . 9,500 8) 500
Ba l . 750 Ba l . 500
Accrued Interes t Income Unea rned Servi ce Income Accrued Interes t Expens e
3) 80 6) 5,000 4) 500
Ba l . 80 Ba l . 5,000 Ba l . 500
Course Module
20
Third, Preparing the Adjusted Trial Balance from the ledger balances.
Below is the Adjusted Trial Balance of Santos Repair Shop.
Santos Repair Shop
Adjusted Trial Balance
March 31, 2017
Accounts Debit Credit

Cash P 180,000
Accounts Receivable 6,000
Allowance for Doubtful Accounts P 500
Accrued Interest Income 80
Assets Accrued Service Income 750
Supplies 450
Prepaid Rent 10,000
Equipment 100,000
Accumulated Depreciation-Equipment 750
Furniture 5,000
Accumulated Depreciation-Furniture 208
Accounts Payable 5,000
Liabilities Notes Payable 50,000
Accrued Interest Expense 500
Unearned Service Income 5,000
Owner’s Equity J. Santos, Capital 180,000
Service Income 88,250
Revenues
Interest Income 80
Salaries Expense 9,500
Rent Expense 5,000
Supplies Expense 550
Expenses Depreciation -Equipment 750
Depreciation- Furniture 208
Doubtful Accounts Expense 500
Interest Expense 500
Total P 330,288 P 330,288
In preparing the Adjusted Trial Balance, arrange the accounts in sequence as
much as possible, to facilitate an easy preparation of the financial statements.
The sequence: Assets (current followed by non-current), Liabilities (short
term followed by long-term), Owner’s Equity, Drawing or Withdrawal (if
any) Revenues, and Expenses.
21
Preparing the Financial Statements

The financial statements will be prepared from the adjusted trial balance. These are
presented in the order:
1. Income Statement
2. Statement of Changes in Owner’s Equity
3. Statement of Financial Position or Balance Sheet
We will skip the Statement of Cash Flows in this module.
Every financial statement should have a heading before the body of the statement. The
Heading consists of the following in sequence: Name of the business, Title of the statement,
then the date or period covered by the statement.
Income Statement is the financial statement that shows the results of operations – Net
Profit or Net Loss. It is composed of the nominal or temporary accounts – Revenues and
Expenses.
The Income Statement of J. Santos Repair Shop follows:
J. Santos Repair Shop

Income Statement
For the Month Ended March 31, 2017
Revenues:
Service Income P 88,250
Interest Income 80
Total Revenues P 88,330
Expenses:
Salaries Expense P 9,500
Rent Expense 5,000
Depreciation -Equipment 750
Supplies Expense 550
Doubtful Accounts Expense 500
Interest Expense 500
Depreciation- Furniture 208
Total Expenses 20,008
Net Profit (Loss) P 68,322
In preparing the income statement, the traditional or normal to enumerate the expenses in
a descending sequence by amount. If there is a Miscellaneous Expenses account, it should
always be the last, no matter how big or small the amount was.
Course Module
22
Statement of the Changes in Owner’s Equity shows the changes in the amount of capital
at the end of the accounting period. The net profit or net loss is transferred to this
statement. Net profit or net income is added to capital, beginning; net loss, on the other
hand, is deducted from the capital beginning. Withdrawals or drawings, if any, are
deducted from the total of the net profit or net loss and capital beginning. The resulting
figure is the Capital or Owner’s Equity, End of the accounting period.
The Statement of Owner’s Equity of Santos Repair Shop is given below:

Statement of Owner's Equity
For the Month Ended March 31, 2017
J. Santos, Capital, March 1, 2017 P 180,000

Add: Net Profit 68,322
J. Santos, Capital, March 31, 2017 P 248,322
Statement of Financial Position or Balance Sheet is the financial statement that shows
the financial position of the company. The real or temporary accounts - Assets, liabilities,
and capital are presented in the balance sheet.
In the balance sheet, you can see the proof of the accounting equation
Assets = Liabilities + Capital or Owner’s Equity
You will also notice in our example on next page, that the total assets do not equal the total
debits in the adjusted trial balance so with the total liabilities and capital which do not
match the total credits. The reason for disparities is the presence of contra accounts –
Allowance for Doubtful Accounts, Accumulated Depreciation, and withdrawals, if any. The
difference between the total assets of P 308,822 and total debits in the adjusted trial
balance of P330, 288 is P 21,466. This is the sum of contra accounts’ amount and the
expenses.
Balance Sheet can be prepared in two forms:

1. The Account form – This follows the basic accounting equation wherein the Assets are
on the left side and the liabilities and Owner’s equity are on the right side.
2. The Report form – This form presents the accounting elements – Assets, Liabilities and
owner’s Equity continuously in successive order. The example of which is our Balance
Sheet on the next page.
23
Below is the balance sheet of Santos Repair Shop.

Statement of Financial Position
March 31, 2017
Assets
Current Assets
Cash P 180,000
Accounts Receivable P 6, 000
Less: Allowance for Doubtful Accounts 500 5,500
Accrued Interest Income 80
Accrued Service Income 750
Supplies 450
Prepaid Rent 10,000
Total Current Assets P 204,780
Plant, Property, and Equipment
Equipment P 100,000
Less: Accumulated Depreciation 750 P 99,250
Furniture P 5,000
Less: Accumulated Depreciation 208 4,792
Total Plant, Property and Equipment 104,042
Total Assets P 308,822
Liabilities and Owner's Equity

Liabilities:
Accounts Payable P 5,000
Notes Payable 50,000
Accrued Interest Expense 500
Unearned Service Income 5,000
Total Liabilities P 60,500
J. Santos, Capital 248,322
Total Liabilities and Owner's Equity P 308,822
The Relationships among the Three Financial Statements

The income statement was prepared first because the resulting net profit or net loss
will be transferred to the owner’s equity account. Remember that Revenues and
Expenses are equity accounts and net profit or net loss is the difference between the
two.
Course Module
24
Capital is a balance sheet account and the ending balance in the statement of
owner’s equity is transferred to the balance sheet and this is the final balancing
element of the statement of financial position.
We will continue the accounting cycle in the next module.
Glossary
Accrual basis: recording income when earned and expenses when incurred.
Accrued expenses: expenses recognized even when not yet paid.
Accrued income: revenues taken up even when cash is not yet received.
Adjusted trial balance: trial balance after considering the adjustments made on some
accounts.
Cash basis: recording income and expenses when cash is already received or paid out,
respectively.
Depreciation: the reduction of the value or cost of non-current assets except land over
its useful life.
Doubtful accounts: the estimated amount of receivable that might not be collected.
Prepaid expenses: expenses paid even if not yet consumed or used.
References and Supplementary Materials

Books and Journals
Cabrera, ME. B. (2010). Fundamentals of Accounting 1.Manila, Philippines: GIC
Enterprises and Co., Inc.
Horngren, C. T., Harrison, W. T. Jr., Bamber, L. S., (2002). Accounting (International

Edition). New Jersey, USA: Prentice Hall
Garcia, P.C., Mojar, B.Q. & Gemanil, B. A. (2006).Basic Accounting Concepts and
Procedures. Quezon City, Philippines: Rex Book Store, Inc.
Kimwell, M. B. (2009). Fundamentals of Accounting (Second Edition). Manila, Philippines.

GIC Enterprises and Co., Inc.
Online Supplementary Reading Materials

Financial reporting - University of London International Programmes
www.londoninternational.ac.uk/sites/default/files/programme.../ac3091_ch1-3.pdf
Accessed: March 20, 2017
[PDF]Chapter 2 Accounting Review: Income Statements and Balance Sheets

www2.gsu.edu/~wwwfnc/3300/chapter2.pdf
25
Net Income Formula | Calculator | Definition - My Accounting Course

www.myaccountingcourse.com/financial-ratios/net-income
Online Instructional Videos

Measuring Business Income 7-Closing Journal Entries - YouTube
https://www.youtube.com/watch?v=5h6Rqd-S37g
What is Net Income? Accounting Basics - Video 2 - YouTube

https://www.youtube.com/watch?v=tGUbbZPZUYc
Accessed; May 10, 2017
Course Module

6-Principles and Concepts of Measuring Income

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Fundamentals of Accounting Part 1

Module 006 Principles and Concepts of

The lessons covered in this module include important concepts and

Accrual-basis Accounting and Cash-basis Accounting

Accounts Receivable P25, 000

The time-Period Concept

The Adjusting Process

The Purposes of Adjusting Entries

The adjusting entry will be:

Supplies Supplies Expense

The amount of Supplies to be shown in the balance sheet is P 450.

2. Using the Expense Method

March 31 Supplies P 450

Supplies Expense Supplies

Example 2: Assuming that the Unadjusted Trial Balance of Mr. Santos on

The adjusting entry would be:

March 31 Rent Expense P 5,000

Depreciation of Plant Assets

The adjusting will be:

Depreciation is an expense account while Accumulated Depreciation is a contra

Repair Equipment Accumulated Depreciation-

Accrued Revenues (Income)

March 31 Accrued Interest Income

(Or Interest Payable)

March 31 Service Income P2, 000

So that what would be reported in the income statement is a Service Income of P

March 31 Unearned Service Income P3, 000

Provision for Doubtful Accounts

Allowance Method is a method of recording uncollectible accounts based on

The basic methods of estimating uncollectibles are

Percentage of sales method or the Income Statement Approach calculates

The adjusting entry would be:

Percentage of Accounts Receivable Method apportions uncollectible accounts as a

December 31 Uncollectible Account Expense P 1,600

The adjusting entry would be:

December 31 Uncollectible Account Expense P 5,500

Recap of the Adjusting Process

Pro-forma entries that will help you in preparing the adjustments:

1.2 Expense Method

2. Depreciation of Plant assets

5. Unearned or Deferred Revenue

5.2 Liability Method

6. Provision for Uncollectible Account

Adjusting Accounts, type of accounting element and normal balance

The Adjusted Trial Balance

Santos Repair Shop

On March 31, the following adjustment data are given:

Required: Prepare an Adjusted Trial Balance on March 31.

2 Rent Expens e 5,000

3 Accrued Interes t Income 80

4 Depreci a tion-Equi pment 750

4 Interes t Expens e 500

5 Depreci a tion-Furni ture 208

6 Servi ce Income 5,000

7 Accounts Recei va bl e 750

8 Doubtful Accounts Expens e 500

Accounts Recei va bl e Al l owa nce for Interes t Expens e

Notes Recei va bl e Accounts Pa ya bl e Rent Expens e

Suppl i es Notes pa ya bl e Depreci a ti on- Equi pment

Prepa i d Rent J. Sa ntos , Ca pi ta l Depreci a ti on-Furni true

Equi pment Accrued Servi ce Income Suppl i es Expens e

Furni ture Servi ce Income Interes t Income

Accounts Debit Credit

Preparing the Financial Statements