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‡ ADJUSTING ENTRIES: End-of-period

entries that assign the financial effects of
implicit transactions to the appropriate
time periods.
_eatures of Adjusting Entries
1. Every adjusting entry affects both a
balance sheet account (i.e. asset or
liability) and an Income Statement (i.e.
revenue or expense).
2. Adjusting entries never affect the cash
account since adjustments are needed
when transactions affect the revenue or
expenses of more than one accounting
Transactions result in Deferrals

‡ Deferrals: It is a delay of the recognition of

expenditure or revenue already received ±
Concerned with past cash receipts and
‡ Expl: Prepaid Expenses & unearned
Transactions result in Accruals

‡ Accruals: Recognition of an expense that

has not been paid or of revenue that has
not been received ± Concerned with future
cash receipts and payments.
‡ Expl.: Salaries of employees neither billed
nor paid.
Types of Adjusting Entries
‡ Recorded costs to be apportioned among
two or more accounting periods.

‡ By the end of the period, the portion of

these services that has been consumed
during the period has become an expense
and the unused portion represents an
‡ Expl.: Inventory, prepaid expenses etc.

‡ Insurance protection, originally recorded

as prepaid insurance for Rs.7,200 of which
Rs.3,000 becomes an expense for the
current period.

‡ Analysis:Increase in Insurance expense

and decrease in prepaid expense.
‡ Rule: Increase in expense is recorded by a
debit and decrease in asset is recorded by
a credit.

‡ Insurance Expense Prepaid Insurance

3,000 7,200 3,000
2. Unrecorded / Accrued /
Outstanding Expenses
‡ These expenses were incurred during the
period, but no record of them has yet been
made (Expense Payable).
‡ Expl.: RS.5,000 of wages earned by an
employee during the period, but not yet
paid to the employee.
‡ Analysis: Increase in Wage Expense &
Increase in the liability of Accrued/
Outstanding Wages.
Unrecorded / Accrued /
Outstanding Expenses«««.
‡ Rule: Increase in expense has to be
debited& Increase in liability has to be

‡ Wages Expense Accrued Wages

5,000 5,000
3. Unearned Revenue/ Revenue
Received in Advances
‡ Recorded revenues to be apportioned
among two or more accounting periods.

‡ These amounts were initially recorded in

one account, and at the end of the
accounting period must be properly
divided between a revenue and a liability
Unearned Revenue«««
‡ Expl.: Rent collected during the period and
recorded as rent revenue ± Rs.7,500 of
which, Rs.6,000 is applicable to the next
period and hence is a liability at the end of
the current period.
‡ Analysis: Liability (Unearned rent revenue)
decreased. Revenues (Rent revenue
earned) increased.
Unearned Revenue«««
‡ Rule: Decrease in liability is recorded by a
debit and increase in revenue is recorded
by a credit.

‡ Rent Rev. Earned Unearned Rent Rev

1,500 1,500 7,500
‡ These revenues were earned during the
period but no record of them has yet been
‡ Expl.:Rs.1,200 of interest earned by the
entity during the period but not yet
‡ Analysis: Increase in asset (Interest
Receivable) and increase in revenue
(Interest Revenue).
‡ Rule: Increase in asset is recorded by a
debit and increase in revenue is recorded
by a credit.

‡ Interest Receivable Interest Revenue

1,200 1,200
5. Depreciation
‡ Portion of long-lived asset costs that has
become expense during an accounting

‡ _actors: 1.Service life of asset, 2. Residual

Value, 3. Cost of the asset along with
additional maintenance expenses.
Depreciation Methods
1. Straight Line Method (SLM)
Original Cost ± Estimated Scrap
Estimated useful life
(Amount of Depreciation is fixed)
2. Written Down Value Method
1 - n Estimated Scrap Value
Original Cost
(Depreciation Rate is fixed)
Depreciation Methods
‡ Sum of the Year Digit method (SYD)
‡ Rate of Depreciation =
(n/SYD) = for the first year
{(n-1)/SYD} = for the second year
{(n-2)/SYD} = for the third year
‡ SYD = 1+2+3+«««.+n
‡ Rate is applied to the net cost.
‡ A Construction company purchased an
earthmoving equipment for Rs.20,00,000,
expected to have an useful life of 6 years,
or 15,000 hours with an estimated residual
value of Rs.2,00,000 at the end of the
time. The equipment logged 2,000 hours
in the first year.
‡ Compute depreciation expenses under
various methods.
‡ Business acquires intangible assets viz. patents,
copyright, trademark, goodwill by paying large
sums of money ± Unexpired cost.
‡ Expiration of these costs (similar to depreciation)
is known as Amortization.
‡ Amortization is always on straight line basis.
‡ Intangible assets are amortized over a
reasonably short period (as it is difficult to
determine the useful life precisely).
Accounting Treatment of
1. Amount of depreciation is debited to
Depreciation Expense.
2. A separate account called µAccumulated
Depreciation¶ is credited for the amount
allocated to the period instead of making a
direct credit to the asset account.
3. The µAccumulated Depreciation¶ is a contra
asset account (this is reported as a deduction
from related asset account in the balance
‡ Rs.3,500 is the depreciation expense for
‡ Analysis: Depreciation expense increased,
concerned asset decreased through
accumulated depreciation.
‡ Entry: Increase in expense is recorded by a
debit and decrease in asset is recorded by a
credit to contra-asset account ± accumulated
Depreciation, concerned asset.
‡ Depn. Expense Acc.Depn.,_urniture
3,500 3,500

‡ Depreciation is recorded in the Income

Statement as expense.

‡ _urniture will be shown in the B/S as:

_urniture««««.. 35,000
Less, Accumulated Depn« 3,500 31,500
‡ GAAP requires separate disclosure of:

1. Original cost of entity¶s depreciable


1. Depreciation that has been accumulated

on these assets from the time they were
required until the date of Balance sheet.
‡ Arises because of credit sales.
‡ Such a state initially is recorded as: Debit
Accounts Receivable, Credit Sales Revenue.
‡ But when bad debts occur, another entry must
be made to show that:
‡ Amount debited to A/R does not represent the
amount of the additional asset and that O.E. has
not in fact increased by the amount of sale.
Accounting Treatment
1. Direct Write-Off Method: Amounts that are
believed to be bad are subtracted from A/R
and same accounts are shown as expenses in
Income Statement.

‡ Entry: Debit Bad Debt Expense

Credit Accounts Receivable

‡ This method, however, requires that specific

uncollectible accounts be identified, which is
not usually possible.
Accounting Treatment«««
2. Allowance Method: Here, the total amount of
uncollectible accounts is first estimated to be
shown under µBad Debts Expense A/c¶ in the
Income statement.
‡ Then, the estimate is shown as a Contra Asset
in the B/S in the form of µAllowance for
Doubtful Debts Account¶.
‡ Entry: Debit Bad Debts Expense
Credit Allowance for Doubtful Debts A/C
Accounting Treatment«««
‡ Bad Debts Exp. Allow. for Doubtful Debt
300 300

‡ In the Balance sheet:

Accounts Receivable-10,000
Less, Allow. for Doubtful Debts- 300
Accounts Receivable Net - 9,700
Accounting Treatment«««
‡ Now, if a company decides a specific customer
is never going to pay the amount owed, then:

‡ Entry:
Debit Allowance for doubtful debts«50
Credit Accounts Receivable «««..50

‡ This entry does not have any effect on Bad Debt

Expense or on income of the period in which
account is written off.
‡ Cash discounts to induce the customers
pay quickly.

‡ Expl.: µ2/10, net 30¶- permits customers to

deduct 2% from the invoice amount if the
amount is paid within 10 days, or the full
amount is due within 30 days.
Recorded in three ways:

1. Can be recorded as a reduction from

gross sales;
2. Can be recorded as µexpense¶ of the
3. Sales revenue can be initially recorded at
the net amount after deducting discount.
Amount received from customers who do
not take discount would then be recorded
as additional revenue.
Thus, for Rs.1,000 sale subject to a 2%
cash discount, the entry can be:

‡ Debit Accounts Receivable««..980

Credit Sales Revenue««««...980
‡ If the customer does not take discount,
then entry upon receipt of payment is:
Debit Cash«««««««««.1,000
Credit Discount Not Taken««««20
Credit Accounts Receivable«««980

1. _inancial data collected from invoices, sales

memoranda, cheque, cash book etc. are
analyzed & journalized.
2. Posted to General Ledger to determine the
effect of basic accounting equation.
3. Trial balance is prepared at the end of the
accounting period.
m. Passing adjusting entries for final statements ±
Adjusted trial balance is prepared.
5. _rom adjusted trial balance, 3 primary
financial statements are prepared.
6. Revenue & expenses accounts are
closed and Net Income/ Net Loss is
transferred to Retained Earnings A/c.
7. A post-closing trial balance is prepared in
order to see that accounting records are
in balance ready to start accounting
process in the next accounting period.
Steps in formation of accounting
‡ Identify transactions
‡ Analyze & record them in journals
‡ Ledger posting
‡ Trial Balance
‡ Preparing Adjusting entries
‡ Worksheet
‡ Income Summary & Balance sheet
‡ Transfer entries
Completion of Accounting cycle
‡ After identifying the adjustments,
accountants accommodate them through
Work Sheet.
‡ Proforma Worksheet
‡ Accounts Trial balance Adjustments Adjusted TB P&L A/c B/S
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
Steps to prepare Worksheet
1. Enter the A/c balances in Trial balance column, in
adjustments column & in Adjusted Trial balance

2. Enter each account in the Adjusted T.B. column to

either P&L or B/S column.

3. Total P&L A/c and B/S columns & enter the Net profit
or loss as a balancing figure in both pairs of columns.
Total the four columns with the balancing figure
1. After preparing the work sheet, the
adjusting entries must be entered in the
general journal & posted to the ledger
2. Next, closing entries should be designed
to transfer the balances in revenue and
expenses accounts to P&L account.
3. Balancing P&L A/c to identify Net profit
or loss for the accounting period.
‡ Journal entries designed to transfer the
balances in revenue and expense
accounts at the end of an accounting
period to a balance sheet equity account.
‡ Temporary accounts are closed now by
transferring their balances to Income
Summary or Profit & Loss account.
‡ Permanent accounts are also closed to
extract their balances to prepare B/S.
Closing Revenue & Expenses
(Temporary Accounts)
1. Transferring Revenue Accounts
Debit All revenue accounts
Credit Profit & Loss A/c or Income Summary
2. Transferring Expenses Accounts
Debit Profit & Loss A/c or Income Summary
Credit All expenses accounts
Closing Revenue & Expenses
(Temporary Accounts)««.
3. Balance of Profit & Loss a/c transferred to
Retained Earnings or Profit & Loss
Appropriation Account.
(i) If net profit:
Debit Profit & Loss Account
Credit Retained Earnings Account
(ii) If net loss:
Reverse entry
Closing Revenue & Expenses
(Temporary Accounts)«««
m. Closing Dividend Account ( Having Debit
Debit Retained Earnings Account
Credit Dividend Account
5. Now all temporary accounts relating to
revenue expenses, dividend have zero
balance & ready to be used for next
accounting period.
Accounts after closing
‡ All temporary accounts have now zero
balances & balances of permanent
accounts are carried forward to next
‡ Post-Closing Trial Balance: Accuracy
check for all permanent accounts and
temporary accounts to be reflected in the
balance sheet.
Reversing Entries
‡ A reversing entry is the exact reverse of
the adjusting entry for accruals (Accrued
Expenses & Revenues) to which it relates.
‡ The amounts and the accounts are same,
the debits and credits are just reversed.
‡ Adjusting entries for deferrals viz. prepaid
expenses & unearned revenue are not to
be reversed.