3. REVENUE RECOGNITION
PRINCIPLE
The revenue recognition principle states that revenue
should be recognized in the accounting period in
which it is earned.
In a service business, revenue is usually considered
to be earned at the time the service is performed.
In a merchandising business, revenue is usually
earned at the time the goods are delivered.
4. THE MATCHING PRINCIPLE
The practice of expense recognition is
referred to as the matching principle.
The matching principle dictates that efforts
(expenses) be matched with
accomplishments (revenues).
Revenues
earned
this month
are offset
against....
expenses
incurred in
earning the
revenue
5. ACCRUAL BASIS OF
ACCOUNTING
Adheres to the
Revenue recognition principle
Matching principle
Revenue recorded when earned, not only
when cash received.
Expense recorded when services or goods
are used or consumed in the generation of
revenue, not only when cash paid.
GAA
P
6.
Revenue recorded
only when cash
received.
Expense recorded
only when cash
paid.
N
O
T
G
A
A
P
CASH BASIS OF ACCOUNTING
7. Adjusting entries make the revenue
recognition and matching principles
HAPPEN!
ADJUSTING ENTRIES
8. Reasons for Adjusting Entries
•
•
•
To bring records or balances of accounts
updated
To properly match income against
expense during the period
To split mixed accounts into their real and
nominal elements.
9. Real, Nominal and Mixed Accounts
a.
b.
c.
Real Accounts (Permanent accounts) – accounts
that are not closed at the end of the accounting
period. These accounts include all balance sheet
accounts, except the “Ownerʼs drawings”
account.
Nominal Accounts (Temporary accounts) –
accounts that are closed at the end of the
accounting period. These accounts include all
income statement accounts, drawings account,
clearing accounts and suspense accounts.
Mixed accounts – accounts that have both real
and nominal account components. These
accounts are subject to adjustment.
10.
11.
Adjusting entries are required each time financial
statements are prepared.
Adjusting entries can be classified as
1. prepayments (prepaid expenses or
unearned revenues),
2. accruals (accrued revenues or
accrued expenses), or
3. estimates (amortization).
ADJUSTING ENTRIES
12. TYPES OF ADJUSTING ENTRIES
Prepayments
1. Prepaid Expenses — Expenses paid in cash and
recorded as assets before they are used or
consumed. (expense already paid but not yet incurred)
2. Unearned Revenues — Revenues received in
cash and recorded as liabilities before they are
earned.(income already collected by the business but not yet earned at
the end of the period)
13. TYPES OF ADJUSTING ENTRIES
Accruals
1. Accrued Revenues — Revenues earned but not
yet received in cash or recorded.
2. Accrued Expenses — Expenses incurred but
not yet paid in cash or recorded.
14. TYPES OF ADJUSTING ENTRIES
TYPES OF ADJUSTING ENTRIES
Estimates
1. Amortization — Allocation of the cost of
capital assets to expense over their useful
lives.
15. PREPAYMENTS
Prepayments are either prepaid expenses or
unearned revenues.
Adjusting entries for prepayments are
required to record the portion of the
prepayment that represents
1. the expense incurred or,
2. the revenue earned in the current
accounting period.
16. Methods Recording of Prepayments
1.
2.
Asset method /Real Approach – under this method
cash disbursements for items of expenses are initially
debited to an asset account. At the end of the period,
the incurred portion (‘used upʼ or ‘expiredʼ) is
recognized as expense while the unused portion
remains as asset.
Expense method/ Nominal Approach – under this
method, cash disbursements for items of expenses are
initially debited to an expense account. At the end of
the period, the unused portion (‘not yet incurredʼ or
‘unexpiredʼ) is recognized as asset while the incurred
portion remains as expense.
17.
Prepaid expenses are expenses paid in cash
and recorded as assets before they are used
or consumed.
Prepaid expenses expire with the passage of
time or through use and consumption.
An asset-expense account relationship
exists with prepaid expenses.
PREPAID EXPENSES
18.
Prior to adjustment, assets are overstated and
expenses are understated.
The adjusting entry results in a debit to an
expense account and a credit to an asset
account.
Examples of prepaid expenses include
supplies, rent, insurance, and property tax.
PREPAID EXPENSES
19. Example: (ASSET METHOD)
On September 01, 2020, Joe Marts
Enterprise paid in advance the insurance for
P24,000 covering a period of one year.
Sep 01 Prepaid Insurance 24,000
Cash
24,000
To record advance payment
of insurance
20. On December 31, 2010, when the financial
statements are about to prepared. The
appropriate adjusting entries would be:
Adjusting Entry:
Dec 31 Insurance Expense 8,000
Prepaid Insurance 8,000
To record 4 months
insurance expense
21. Example: (EXPENSE METHOD)
On September 01, 2020, Joe Marts Enterprise
paid in advance the insurance for P24,000
covering a period of one year.
Sep 01 Insurance Expense 24,000
Cash
24,000
To record advance payment
of insurance
22. On December 31, 2020, when the financial
statements are about to prepared. The
appropriate adjusting entries would be:
Adjusting Entry:
Dec 31 Prepaid Insurance 16,000
I n s u r a n c e E x p e n s e
16,000
To record unexpired portion of the
insurance
23. Activity 8
On October 1, 2020, Joe Marts Enterprise
paid in advance his rental for P36,000
covering a period of one year.
Prepare journal entry on Oct. 01, 2020 and
adjusting entry on Dec. 31, 2020.
24.
Unearned revenues or Precollected income
are revenues received and recorded as
liabilities before they are earned.
Unearned revenues are subsequently earned
by performing a service or providing a
servive/good to a customer.
A liability-revenue account relationship
exists with unearned revenues.
UNEARNED REVENUES
25. Methods of Initial Recording of Income
1.
2.
Liability method – under this method, cash
receipts from items of income are initially credited
to a liability account. At the end of the period, the
earned portion is recognized as income while the
unearned portion remains as liability.
Income method – under this method cash receipts
from items of income are initially credited to an
income account. At the end of the period, the
unearned portion is recognized as liability while
the earned portion remains as income.
26.
Prior to adjustment, liabilities are overstated
and revenues are understated.
The adjusting entry results in a debit to a
liability account and a credit to a revenue
account.
Examples of unearned revenues include rent,
magazine subscriptions, airplane tickets, and
tuition.
UNEARNED REVENUES
27. Example: (LIABILITY METHOD)
On August 01, 2020 Kings Court
Pension House received in advance a rent
income of P60,000 covering a period of one
year.
Aug. 01 Cash 60,000
Unearned Rent 60,000
To record advance payment
from customer
28. On Decemebr 31, 2020, a financial statement
is about to prepare, an adjusting entry must be
made:
Dec. 31 Unearned Rent 25,000
Rent Income 25,000
To record rent income
29. Example: (INCOME METHOD)
On August 01, 2020 Kings Court
Pension House received in advance a rent
income of P60,000 covering a period of one
year.
Aug. 01 Cash 60,000
Rent Income 60,000
To record advance payment
from customer
30. On Decemebr 31, 2020, a financial statement
is about to prepare, an adjusting entry must be
made:
Dec. 31 Rent Income 35,000
Unearned Rent 35,000
To record unearned rent
31. Activity 9
#1
On May 31, 2020 Readers Digest received in
advance a magazine subscription of P60,000
two years subscription. On December 31,
2020 a financial statement was about to be
made.
Prepare a journal entry. On May 31 and
December 31, 2020
32. May 31 Cash 60,000
Unearned Subscription 60,000
Two year advance of
magazine subscription
Dec. 31 Unearned Subscription 17,500
Subscription Fees 17,500
To record subscription fees
34. ACCRUALS
A different type of adjusting entry is
accruals.
Adjusting entries for accruals are required to
record revenues earned and expenses
incurred in the current period.
The adjusting entry for accruals will increase
both a balance sheet and an income
statement account.
35.
An income already earned but not yet collected at the end of
the period
Accrued revenues may accumulate with the passing of time
or through services performed but not billed or collected.
An asset-revenue account relationship exists with accrued
revenues.
Prior to adjustment, assets and revenues are understated.
The adjusting entry requires a debit to an asset account and
a credit to a revenue account.
Examples of accrued revenues include accounts receivable,
rent receivable, and interest receivable.
ACCRUED REVENUES
36. Adjusting entries for accrued revenues would be:
12/31 Accrued (appropriate) receivable account xxx
(Appropriate) income account xxx
To recognize revenue earned
37. •
•
–
Ex. A business received a P10,000, 6%,
60 day note from a customer dated
December 2, 20A
Upon receipt of the note on Dec. 2, 20A,
the Journal entry:
Notes receivable P10,000
Cash P10,000
38. •
•
Interest = Principal x Rate of Interest x Time
I = P10,000 x .06 x 60/360
= P100
Interest on N/R for 60 days or 2 months period is P100 or P50/month
Analysis:
Record only interest from Dec. 2 – 31, 20A so as not to violate the matching
principle
Should be Entry:
Dec. 31 Cash 50
Interest income 50
AJE:
Dec. 31 Accrued Interest 50
Interest income 50
to record interest earned
for Dec. 2-31, 20A
39. Activity 8
#3
On October 01, 2020, X Co. received a 5-
month note from a customer amounting to
500,000, 10% interest. Record the adjusting
entry as of December 31, 2020.
40.
Accrued expenses are expenses incurred but not
yet paid.
A liability-expense account relationship exists.
Prior to adjustment, liabilities and expenses are
understated.
The adjusting entry results in a debit to an expense
account and a credit to a liability account.
Examples of accrued expenses include accounts
payable, rent payable, salaries payable, and
interest payable.
ACCRUED EXPENSES
41. Adjusting entries for accrued expenses would be:
12/31 (Appropriate) income account xxx
Accrued (appropriate) liability account xxx
To recognize expense incurred
42. •
–
The business is renting a space of the building it occupies
for P500.00/ month payable every first day of the following
month. The rental for the month of December was not paid
when the accounting period ended on December
31,20A.The business intends to pay the rental on January 2,
20B.
If paid on December 31, 20A
Rent expense 500
Cash 500
Payment of space rental for
Dec 20A
AJE: Dec 31 Rent expense 500
Accrued rent 500
to set up unpaid rent for the month
43. Activity 10
On Sept 21, 2022, Mr. P issued a 1-year
note to X Co. amounting to 200,000, 24%
interest. Record the adjusting entry as of
December 31, 2022.
45.
Amortization is the process of allocating the
cost of certain capital assets to expense over
their useful life in a rational and systematic
manner.
Amortization attempts to match the cost of a
long-term, capital asset to the revenue it
generates each period.
AMORTIZATION
46. AMORTIZATION
Amortization is an estimate rather than a
factual measurement of the cost that
has expired.
Weʼre not attempting to reflect the
actual change in value of an asset!
47. Accumulated Amortization
Amortization Expense
AMORTIZATION
In recording amortization, Amortization
Expense is debited and a contra asset
account, Accumulated Amortization, is
credited.
The difference between the cost of the asset
and its related accumulated amortization is
referred to as the net book value of the asset.
xxx xxx
49. Seatwork:
•
•
•
Your business pays one-year insurance of
P360,000 on Sept. 1, 20X1.
a. Provide the journal entry to record the prepayment on
Sept.1, 20X1 under each of the following methods:
Asset Method
Expense Method
b. Provide the adjusting entries on Dec 31, 20X1
under each of the methods listed above.
50. ILLUSTRATION 3-8 SUMMARY
OF ADJUSTING ENTRIES
ILLUSTRATION 3-8 SUMMARY
OF ADJUSTING ENTRIES
1.Prepaid Assets and Assets overstated
Dr. Expenses expenses
expenses Expenses understated
Cr. Assets
2.Unearned Liabilities and Liabilities overstated
Dr. Liabilities revenues
revenues Revenues understated
Cr. Revenues
3.Accrued Assets and
Assets understated Dr. Assets
revenues revenues
Revenues understated Cr. Revenues
4.Accrued Expenses and Expenses
understated Dr. Expenses expenses
liabilities Liabilities
Type of Account Accounts before Adjusting
Adjustment Relationship Adjustment Entry
51. ADJUSTED TRIAL BALANCE
An Adjusted Trial Balance is prepared after all
adjusting entries have been journalized and
posted.
It shows the balances of all accounts at the end of
the accounting period and the effects of all
financial events that have occurred during the
period.
It proves the equality of the total debit and credit
balances in the ledger after all adjustments have
been made.
Financial statements can be prepared directly from
the adjusted trial balance.
52. ILLUSTRATION 3-11
TRIAL BALANCE AND ADJUSTED TRIAL BALANCE COMPARED
ILLUSTRATION 3-11
TRIAL BALANCE AND ADJUSTED TRIAL BALANCE COMPARED
53. PREPARING FINANCIAL STATEMENTS
PREPARING FINANCIAL STATEMENTS
Financial statements can be prepared directly
from an adjusted trial balance.
1. The income statement is prepared from the
revenue and expense accounts.
2. The statement of ownerʼs equity is derived
from the ownerʼs capital and drawings accounts
and the net income (or net loss) shown in
the income statement.
3. The balance sheet is then prepared from the
asset and liability accounts and the ending
ownerʼs capital balance as reported in the
statement of ownerʼs equity.
54. ILLUSTRATION 3-12 PREPARATION OF THE
INCOME STATEMENT AND THE STATEMENT OF OWNERʼS EQUITY
FROM THE
ADJUSTED TRIAL BALANCE
ILLUSTRATION 3-12 PREPARATION OF THE
INCOME STATEMENT AND THE STATEMENT OF OWNERʼS EQUITY
FROM THE
ADJUSTED TRIAL BALANCE
55. ILLUSTRATION 3-13
PREPARATION OF THE BALANCE SHEET FROM THE
ADJUSTED TRIAL BALANCE
ILLUSTRATION 3-13
PREPARATION OF THE BALANCE SHEET FROM THE
ADJUSTED TRIAL BALANCE
From
Statement of
Ownerʼs
Equity
56. 1. Analyse
transactions 2. Journalize the
transactions
3. Post to ledger
accounts
4. Prepare a trial
balance
5. Journalize
and post
adjusting
entries
6. Prepare
adjusted trial
balance
7. Prepare
financial
statements
8. Coming next
chapter
9. Coming next
chapter
STEPS IN THE ACCOUNTING CYCLE
STEPS IN THE ACCOUNTING CYCLE
