Adjusting Entry for Depreciation Expense

 When a fixed asset is acquired by a company, it is recorded at cost (generally, cost is equal to the purchase price of
the asset). This cost is recognized as an asset and not expense.
 The cost is to be allocated as expense to the periods in which the asset is used.This is done by recording
depreciation expense.
 There are two types of depreciation – physical and functional depreciation.
 Physical depreciation results from wear and tear due to frequent use and/or exposure to elements like rain, sun and
wind.
 Functional or economic depreciationhappens when an asset becomes inadequate for its purpose or becomes
obsolete. In this case, the asset decreases in value even without any physical deterioration.

Understanding the Concept of Depreciation

There are several methods in depreciating fixed assets. The most common and simplest is the straight-
line depreciation method.
Under the straight line method, the cost of the fixed asset is distributed evenly over the life of the asset.
For example, ABC Company acquired a delivery van for $40,000 at the beginning of 2012. Assume that
the van can be used for 5 years. The entire amount of $40,000 shall be distributed over five years, hence
a depreciation expense of $8,000 each year.

Straight-line depreciation expense is computed using this formula:

Depreciable Cost – Residual Value
Estimated Useful Life
Depreciable Cost: Historical or un-depreciated cost of the fixed asset
Residual Value or Scrap Value: Estimated value of the fixed asset at the end of its useful life
Useful Life: Amount of time the fixed asset can be used (in months or years)
In the above example, there is no residual value. Depreciation expense is computed as:
= $40,000 – $0
5 years
= $8,000 / year
With Residual Value
What if the delivery van has an estimated residual value of $10,000? The depreciation expense then
would be computed as:
= $40,000 – $10,000
5 years
= $30,000
5 years
= $6,000 / year
How to Record Depreciation Expense
Depreciation is recorded by debiting Depreciation Expense and crediting Accumulated Depreciation. This
is recorded at the end of the period (usually, at the end of every month, quarter, or year).
The entry to record the $6,000 depreciation every year would be:
Dec 31 Depreciation Expense 6,000.00

Accumulated Depreciation 6,000.00

Depreciation Expense: An expense account; hence, it is presented in the income statement. It is

measured from period to period. In the illustration above, the depreciation expense is $6,000 for 2012,
$6,000 for 2013, $6,000 for 2014, etc.
Accumulated Depreciation: A balance sheet account that represents the accumulated balance of
depreciation. It is continually measured; hence the accumulated depreciation balance is $6,000 at the
end of 2012, $12,000 in 2013, $18,000 in 2014, $24,000 in 2015, and $30,000 in 2016.
Accumulated depreciation is a contra-asset account. It is presented in the balance sheet as a deduction
to the related fixed asset. Here's a table illustrating the computation of the carrying value of the delivery
van.
2012 2013 2014 2015 2016

Delivery Van - Historical Cost $40,000 $40,000 $40,000 $40,000 $40,000

Less: Accumulated Depreciation 6,000 12,000 18,000 24,000 30,000

Delivery Van - Carrying Value $34,000 $28,000 $22,000 $16,000 $10,000

Notice that at the end of the useful life of the asset, the carrying value is equal to the residual value.
Depreciation for Acquisitions Made Within the Period
The delivery van in the example above has been acquired at the beginning of 2012, i.e. January.
Therefore, it is easy to calculate for the annual straight-line depreciation. But what if the delivery van was
acquired on April 1, 2012?
In this case we cannot apply the entire annual depreciation in the year 2012 because the van has been
used only for 9 months (April to December). We need to prorate.
For 2012, the depreciation expense would be: $6,000 x 9/12 = $4,500.
Years 2013 to 2016 will have $6,000 annual depreciation expense.
In 2017, the van will be used for 3 months only (January to March) since it has a useful life of 5 years
(i.e. April 1, 2012 to March 31, 2017).
The depreciation expense for 2017 would be: $6,000 x 3/12 = $1,500, and thus completing the
accumulated depreciation of $30,000.
2012 (April to December) $ 4,500

2013 (entire year) 6,000

2014 (entire year) 6,000

2015 (entire year) 6,000

2016 (entire year) 6,000

2017 (January to March) 1,500

 Total for 5 years $ 30,000

Adjusting Entry for Bad Debts Expense

Companies provide services or sell goods for cash or on credit. Allowing credit tends to encourage more
sales.
However, businesses that allow credit are faced with the risk that their receivables may not be collected.
Accounts receivable should be presented in the balance sheet at net realizable value, i.e. the most
probable amount that the company will be able to collect.
Net realizable value for accounts receivable is computed like this:

Accounts Receivable (Gross Amount) $100,000

Less: Allowance for Bad Debts 3,000
Accounts Receivable (Net Realizable Value) $ 97,000

Allowance for Bad Debts (also often called Allowance for Doubtful Accounts) represents the estimated
portion of the Accounts Receivable that the company will not be able to collect.
Take note that this amount is an estimate. There are several methods in estimating doubtful
accounts.The estimates are often based on the company's past experiences.
To recognize doubtful accounts or bad debts, an adjusting entry must be made at the end of the period.
The adjusting entry for bad debts looks like this:

Dec 31 Bad Debts Expense xxx.xx

Allowance for Bad Debts xxx.xx

Bad Debts Expense a.k.a. Doubtful Accounts Expense: An expense account; hence, it is presented in
the income statement. It represents the estimated uncollectible amount for credit sales/revenues made
during the period.
Allowance for Bad Debts a.k.a. Allowance for Doubtful Accounts: A balance sheet account that
represents the total estimated amount that the company will not be able to collect from its total Accounts
Receivable.

What is the difference between Bad Debts Expense and Allowance for Bad Debts?
Bad Debts Expense is an income statement account while the latter is a balance sheet account. Bad
Debts Expense represents the uncollectible amount for credit sales made during the period. Allowance for
Bad Debts, on the other hand, is the uncollectible portion of the entire Accounts Receivable.
You can also use Doubtful Accounts Expense and Allowance for Doubtful Accounts in lieu of Bad Debts
Expense and Allowance for Bad Debts. However, it is a good practice to use a uniform pair. Some say
that Bad Debts have a higher degree of uncollectibility that Doubtful Accounts. In actual practice,
however, the distinction is not really significant.

Here's an Example
Gray Electronic Repair Services estimates that $100.00 of its credit revenue for the period will not be
collected. The entry at the end of the period would be:
Dec 31 Bad Debts Expense 100.00
Allowance for Bad Debts 100.00

Again, you may use Doubtful Accounts. Just be sure to use a logical (and uniform) pair every time. For
example:
Dec 31 Doubtful Accounts Expense 100.00
 Allowance for Doubtful
100.00
Accounts

If the company's Accounts Receivable amounts to $3,400 and its Allowance for Bad Debts is $100, then
the Accounts Receivable shall be presented in the balance sheet at $3,300 – the net realizable value.
Accounts Receivable (Gross Amount) $ 3,400
Less: Allowance for Bad Debts 100
Accounts Receivable - Net Realizable Value $ 3,300

Adjusting Entry for Accrued Expenses

Accrued expenses refer to expenses that are already incurred but have not yet been paid.
At the end of period, accountants should make sure that they are properly recorded in the books of the
company as an expense, with a corresponding payable account.
Here's the rule. If a company incurred, used, or consumed all or part of an expense, that expense or part
of it should be properly recognized even if it has not yet been paid.
If such has not been recognized, then an adjusting entry is necessary.

Pro-Forma Entry
The pro-forma adjusting entry to record an accrued expense is:
mmm dd Expense account* x,xxx.xx

Liability account** x,xxx.xx

*Appropriate expense account (such as Utilities Expense, Rent Expense, Interest Expense, etc.)
**Appropriate liability account (Utilities Payable, Rent Payable, Interest Payable, Accounts Payable, etc.)

For Example
For the month of December 2016, Gray Electronic Repair Services used a total of $1,800 worth of
electricity and water. The company received the bills on January 10, 2017. When should the expense be
recorded, December 2016 or January 2017?

Answer – in December 2016. According to the accrual concept of accounting, expenses are recognized
when incurred regardless of when paid. The amount above pertains to utilities used in December.
Therefore, if no entry was made for it in December then an adjusting entry is necessary.
Dec 31 Utilities Expense 1,800.00

Utilities Payable 1,800.00

In the adjusting entry above, Utilities Expense is debited to recognize the expense and Utilities Payable to
record a liability since the amount is yet to be paid.
Here are some more examples.

More Examples: Adjusting Entries for Accrued Expense

Example 1: VIRON Company entered into a rental agreement to use the premises of DON's building. The
agreement states that VIRON will pay monthly rentals of $1,500. The lease started on December 1, 2016.
On December 31, the rent for the month has not yet been paid and no record for rent expense was
made.

In this case, VIRON Company already incurred (consumed/used) the expense. Even if it has not yet been
paid, it should be recorded as an expense. The necessary adjusting entry would be:
 Dec 31 Rent Expense 1,500.00

Rent Payable 1,500.00

Example 2: VIRON Company borrowed $6,000 at 12% interest on August 1, 2016. The amount will be
paid after 1 year. At the end of December, the end of the accounting period, no entry was entered in the
journal to take up the interest.

Let's analyze the above transaction.

VIRON will be paying $6,000 principal plus $720 interest after a year. The $720 interest covers 1 year. At
the end of December, a part of that is already incurred, i.e. $720 x 5/12 or $300. That pertains to
interest for 5 months, from August 1 to December 31. The adjusting entry would be:
Dec 31 Interest Expense 300.00

Interest Payable 300.00

Expenses are recognized when incurred regardless of when paid. What you need to remember here is
this: when it has been consumed or used and no entry was made to record the expense, then there is a
need for an adjusting entry.

Adjusting Entry for Accrued Revenue

 Accrued income (or accrued revenue) refers to income already earned but has not yet been collected.
 At the end of every period, accountants should make sure that they are properly included as income, with
a corresponding receivable.
 When a company has performed services or sold goods to a customer, it should be recognized as income
even if the amount is still to be collected at a future date.
If no journal entry was ever made for the above, then an adjusting entry is necessary.

Pro-Forma Entry
The adjusting entry to record an accrued revenue is:
mmm dd Receivable account* x,xxx.xx

Income account** x,xxx.xx

*Appropriate receivable account such as Accounts Receivable, Rent Receivable, Interest Receivable, etc.
**Income account such as Service Revenue, Rent Income, Interest Income, etc.

Here's an Example
In our previous set of transactions, assume this additional information:
On December 31, 2016, Gray Electronic Repair Services rendered $300 worth of services to a client.
However, the amount has not yet been collected. It was agreed that the customer will pay the amount
on January 15, 2017. The transaction was never recorded in the books of the company.
In this case, we should make an adjusting entry in 2016 to recognize the income since it has already
been earned. The adjusting entry would be:
Dec 31 Accounts Receivable 300.00

Service Revenue 300.00

Here are some more illustrations.

More Examples: Adjusting Entries for Accrued Income
Example 1: Company ABC leases its building space to a tenant. The tenant agreed to pay monthly rental
fees of $2,000 covering a period from the 1st to the 30th or 31st of every month. On December 31,
 2016, ABC Company did not receive the rental fee for December yet and no record was made in the
journal.
Under the accrual basis, the rent income above should already be recognized because it has already been
earned even if it has not yet been collected. The adjusting journal entry would be:
Dec 31 Rent Receivable 2,000.00

Rent Income 2,000.00

Example 2: ABC Company lent $9,000 at 10% interest on December 1, 2016. The amount will be
collected after 1 year. At the end of December, no entry was entered in the journal to take up the
interest income.
Interest is earned through the passage of time. In the case above, the $9,000 principal plus a $900
interest will be collected by the company after 1 year. The $900 interest pertains to 1 year.
However, 1 month has already passed. The company is already entitled to 1/12 of the interest, as
prorated. Therefore the adjusting entry would be to recognize $75 (i.e. $900 x 1/12 ) as interest income:
Dec 31 Interest Receivable 75.00

Interest Income 75.00

The basic concept you need to remember is recognition of income. When is income recognized? Under
the accrual concept of accounting, income is recognized when earned regardless of when collected.
If the company has already earned the right to it and no entry has been made in the journal, then an
adjusting entry to record the income and a receivable is necessary.

Adjusting Entry for Unearned Revenue

 Unearned revenue (also known as deferred revenue or deferred income) represents revenue already collected but
not yet earned.
 Hence, they are also called "advances from customers".
 Following the accrual concept of accounting, unearned revenues are considered as liabilities.
 It is to be noted that under the accrual concept, income is recognized when earned regardless of when collected.
 And so, unearned revenue should not be included as income yet; rather, it is recorded as a liability. This liability
represents an obligation of the company to render services or deliver goods in the future. It will be recognized as
income only when the goods or services have been delivered or rendered.
 At the end of the period, unearned revenues must be checked and adjusted if necessary. The adjusting entry for
unearned revenue depends upon the journal entry made when it was initially recorded.
 There are two ways of recording unearned revenue: (1) the liability method, and (2) the income method.

Liability Method of Recording Unearned Revenue

 Under the liability method, a liability account is recorded when the amount is collected. The common accounts
used are: Unearned Revenue, Deferred Income, Advances from Customers, etc. For this illustration, let us use
Unearned Revenue.
 Suppose on January 10, 2016, ABC Company made $30,000 advanced collections from its customers. If the
liability method is used, the entry would be:

Jan 10 Cash 30,000.00

Unearned Revenue 30,000.00

 Take note that the amount has not yet been earned, thus it is proper to record it as a liability. Now, what if
at the end of the month, 20% of the unearned revenue has been rendered? This will require an adjusting
entry.
 The adjusting entry will include: (1) recognition of $6,000 income, i.e. 20% of $30,000, and (2) decrease
in liability (unearned revenue) since some of it has already been rendered. The adjusting entry would be:

Jan 31 Unearned Revenue 6,000.00

Service Income 6,000.00

We are simply separating the earned part from the unearned portion. Of the $30,000 unearned revenue,
$6,000 is recognized as income. In the entry above, we removed $6,000 from the $30,000 liability. The
balance of unearned revenue is now at $24,000.

Income Method of Recording Unearned Revenue

Under the income method, the accountant records the entire collection under an incomeaccount. Using
the same transaction above, the initial entry for the collection would be:

Jan 10 Cash 30,000.00

Service Income 30,000.00

If at the end of the year the company earned 20% of the entire $30,000, then the adjusting entry would
be:
Jan 31 Service Income 24,000.00

Unearned Income 24,000.00

By debiting Service Income for $24,000, we are decreasing the income initially recorded. The balance of
Service Income is now $6,000 ($30,000 - 24,000), which is actually the 20% portion already earned. By
crediting Unearned Income, we are recording a liability for $24,000.
Notice that the resulting balances of the accounts under the two methods are the same (Cash: $30,000;
Service Income: $6,000; and Unearned Income: $24,000).

Another Example
On December 1, 2016, DRG Company collected from TRM Corp. a total of $60,000 as rental fee for three
months starting December 1.
Under the liability method, the initial entry would be:
Dec 1 Cash 60,000.00

Unearned Rent Income 60,000.00

On December 31, 2016, the end of the accounting period, 1/3 of the rent received has already been
earned (prorated over 3 months).
 We should then record the income through this adjusting entry:
Dec 31 Unearned Rent Income 20,000.00

Rent Income 20,000.00

In effect, we are transferring $20,000, one-third of $60,000, from the Unearned Rent Income (a liability)
to Rent Income (an income account) since that portion has already been earned.
If the company made use of the income method, the initial entry would be:
Dec 1 Cash 60,000.00

Rent Income 60,000.00

In this case, we must decrease Rent Income by $40,000 because that part has not yet been earned. The
income account shall have a balance of $20,000. The amount removed from income shall be transferred
to liability (Unearned Rent Income). The adjusting entry would be:
Dec 31 Rent Income 40,000.00

Unearned Rent Income 40,000.00

Conclusion
If you have noticed, what we are actually doing here is making sure that the earned part is included in
income and the unearned part into liability. The adjusting entry will always depend upon the method
used when the initial entry was made.
If you are having a hard time understanding this topic, I suggest you go over and study the lesson again.
Sometimes, it really takes a while to get the concept. Preparing adjusting entries is one of the most
challenging (but important) topics for beginners.
Online resource for all things accounting. more ›

Adjusting Entries for Prepaid Expense

 Prepaid expenses (a.k.a. prepayments) represent payments made for expenses which have not yet been incurred.
 In other words, these are "advanced payments" by a company for supplies, rent, utilities and others that are still to
be consumed. Hence, they are included in the company's assets.
 Expenses are recognized when they are incurred regardless of when paid. Expenses are considered incurred when
they are used, consumed, utilized or has expired.
 Because prepayments they are not yet incurred, they are not recorded as expenses. Rather, they are classified
as current assets since they are readily available for use.
 Prepaid expenses may need to be adjusted at the end of the accounting period. The adjusting entry for prepaid
expense depends upon the journal entry made when it was initially recorded.

There are two ways of recording prepayments: (1) the asset method, and (2) the expense method.
Asset Method
Under the asset method, a prepaid expense account (an asset) is recorded when the amount is paid. Prepaid
expense accounts include: Office Supplies, Prepaid Rent, Prepaid Insurance, and others.
In one of our previous illustrations (if you have been following our comprehensive illustration for Gray Electronic
Repair Services), we made this entry to record the purchase of service supplies:

Dec 7 Service Supplies 1,500.00

Cash 1,500.00

Take note that the amount has not yet been incurred, thus it is proper to record it as an asset.
Suppose at the end of the month, 60% of the supplies have been used. Thus, out of the $1,500, $900
worth of supplies have been used and $600 remain unused. The $900 must then be recognized as
expense since it has already been used.

In preparing the adjusting entry, our goal is to transfer the used part from the asset initially recorded into
expense – for us to arrive at the proper balances shown in the illustration above.

The adjusting entry will include: (1) recognition of expense and (2) decrease in the asset initially
recorded (since some of it has already been used). The adjusting entry would be:
Dec 31 Service Supplies Expense 900.00

Service Supplies 900.00

The "Service Supplies Expense" is an expense account while "Service Supplies" is an asset. After making
the entry, the balance of the unused Service Supplies is now at $600 ($1,500 debit and $900 credit).
Service Supplies Expense now has a balance of $900. Now, we've achieved our goal.

Expense Method
Under the expense method, the accountant initially records the entire payment as expense. If the
expense method was used, the entry would have been:
Dec 7 Service Supplies Expense 1,500.00

Cash 1,500.00

Take note that the entire amount was initially expensed. If 60% was used, then the adjusting entry at
the end of the month would be:
Dec 31 Service Supplies 600.00

Service Supplies Expense 600.00

This time, Service Supplies is debited for $600 (the unused portion). And then, Service Supplies Expense
is credited thus decreasing its balance. Service Supplies Expense is now at $900 ($1,500 debit and $600
credit).
Notice that the resulting balances of the accounts under the two methods are the same (Cash paid:
$1,500; Service Supplies Expense: $900; and Service Supplies: $600).

Another Example
GVG Company acquired a six-month insurance coverage for its properties on September 1, 2016 for a
total of $6,000.
Under the asset method, the initial entry would be:
Sep 1 Prepaid Insurance 6,000.00

Cash 6,000.00

On December 31, 2016, the end of the accounting period, part of the prepaid insurance already has
expired (hence, expense is incurred). The expired part is the insurance from September to December.

Thus, we should make the following adjusting entry:

Dec 31 Insurance Expense 4,000.00

Prepaid Insurance 4,000.00

Of the total six-month insurance amounting to $6,000 ($1,000 per month), the insurance for 4 months
has already expired. In the entry above, we are actually transferring $4,000 from the asset to the
expense account (i.e., from Prepaid Insurance to Insurance Expense).

If the company made use of the expense method, the initial entry would be:
Sep 1 Insurance Expense 6,000.00

Cash 6,000.00

In this case, we must decrease Insurance Expense by $2,000 because that part has not yet been incurred
(not used/not expired). Insurance Expense shall then have a balance of $4,000. The amount removed
from the expense shall be transferred to Prepaid Insurance. The adjusting entry would be:
Dec 31 Prepaid Insurance 2,000.00

Insurance Expense 2,000.00

Conclusion
What we are actually doing here is making sure that the incurred (used/expired) portion is included in
expense and the unused part into asset. The adjusting entry will always depend upon the method used
when the initial entry was made.
If you are having a hard time understanding this topic, I suggest you go over and study the lesson again.
Sometimes, it really takes a while to get the concept. Preparing adjusting entries is one of the challenging
(but important) topics for beginners.
Online resource for all things accounting. more ›