Course Code and Title : BAEN 1 - Accounting Principles (BSBA)
Lesson Number : 8
Topic : Adjusting Entries - Part 2
Professor : Nordan P. Tompong, CPA, MMA
INTRODUCTION:
This module will be discussing the remaining two items that needed adjustments at the
end of the accounting period - that is the Uncollectible Accounts or Bad Debts and
Depreciation.
LEARNING OBJECTIVES:
At the end of this module, the learners are expected to:
1. Identify the methods in establishing the uncollectible accounts and depreciation
expense
2. Estimate the amount of bad debts and depreciation expense.
3. Prepare the adjusting entries for bad debts expense and depreciation expense.
4. Explain the effects of omitting the adjustments on the financial statements.
LESSON PRESENTATION:
To continue with the discussion on adjusting entries, we will be illustrating these two (2)
remaining accounts for adjustments. These are the uncollectible accounts or bad debts
expense and the depreciation expense.
A. UNCOLLECTIBLE ACCOUNTS / BAD DEBTS:
In any business entity selling on account to its customers, experience show that some
customers will not be able to pay their accounts as they fall due. Uncollectible accounts
or bad debts are accounts of customers who do not pay what they have promised to
pay.
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The company or business entity should provide allowance for uncollectible accounts and
recognize an expense or loss from these accounts. Other terms for uncollectible accounts
are Bad Debts or Doubtful Accounts.
There are also various ways wherein uncollectible accounts can be estimated based on
past experiences as follows:
1. By setting-up a certain percent (%) of uncollectible account based on the
outstanding receivable. This is also called the Balance Sheet Approach since bad
debts is directly related to accounts receivable.
- The percentage used under this method is based on company’s past experiences.
The percentage of uncollectible accounts based on past experiences is
multiplied by the outstanding balance of the accounts receivable to determine
the required balance of the allowance. This amount is compared with the ledger
balance of the allowance; the difference shall be adjusted thru a journal entry.
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2. By aging the accounts receivable.
- This is the most reasonable basis of calculating Uncollectible Account Expenses
based on classified past due accounts. It attempts to review each of the
customers’ accounts and age them to find out how long they have remained
outstanding. The longer they are outstanding, the more doubtful the accounts are,
and the higher will be the percentage provision for doubtful accounts. The
resulting computation based on the aging of accounts will represent the
required ending allowance. The beginning balance will then be deducted from
the required ending balance to arrive at the provision
for doubtful accounts.
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3. By setting-up a certain percent (%) of uncollectible account based on credit sales.
This is also called the Income Statement Approach since bad debts expense is
based on the sales made for the period.
- The method is simple to apply and emphasizes matching of expenses to
revenues since bad debts is directly related to sales. Estimating bad debts based
on sales is permitted if it is largely on credit.
A. Allowance Method:
Under this method, uncollectible account is being recognized in anticipation that a certain
amount or part of the Accounts Receivable cannot be collected. The doubtful accounts are
determined by estimation based on the company’s past experiences or the experience of other
companies within the same business industry. The Estimated Uncollectible Accounts is then
deducted from Accounts Receivable to arrive at the Estimated Realizable Value. The other term for
Estimated Uncollectible Account is Allowance for Doubtful Accounts.
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Illustration:
Let us assume that the business has an outstanding Accounts Receivable from various
customers in the amount of P100,000. At the end of its accounting period, it is estimated that 5%
of this, is doubtful of collection.
The anticipated loss due to this doubtful account is recorded at the end of the period by way of
an adjusting entry.
Uncollectible Accounts P 5,000
Estimated Uncollectible Accounts P
5,000 To set up a provision for doubtful accounts,
5% of the outstanding receivable
computed as follows:
Accounts Receivable P
100,000 x % of provision
5%
Uncollectible Accounts P 5,000
=======
The Estimated Uncollectible Accounts or the Allowance for Doubtful Accounts is a contra asset
account which is deducted from the principal account. Net Realizable Value is the difference
between the accounts receivable and the allowance for doubtful accounts.
EFFECTS OF ERROR/OMISSION ON FINANCIAL STATEMENTS:
If uncollectible account expense is not recorded, Expense Section of the Income Statement is
understated, and profit is overstated. In the Balance Sheet, this valuation account is understated
so that the Accounts Receivable is overstated. Owner’s Equity will be overstated because the
profit is closed to capital is also overstated.
FINANCIAL STATEMENT PRESENTATION
Uncollectible Account is an expense and will be presented in the Expense Section of the Income
Statement while the Estimated Uncollectible Accounts will be presented in the Balance Sheet as
reduction from the Accounts Receivable to arrive at its “Estimated Realizable Value” at the end of
the particular period as shown below:
Accounts Receivable P
Less: Estimated Uncollectible 100,000
5,000
Estimated Realizable Value P 95,000
======
===
B. DIRECT WRITE-OFF METHOD:
Under this method, the business adopts a policy of directly charging to Uncollectible
Account Expense / Doubtful Accounts Expense the account of a customer whom it believed
could not pay its balance anymore without providing an Estimated for Uncollectible / Doubtful
Accounts. This results in identifying the customer’s account that needs to be written-off.
This method is called the “Direct Write- Off Method.”
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Illustration:
Let us assume that Ms. Hanna Grace de Leon went abroad leaving an unpaid account
balance of P1,000.
To write-off the above account is by preparing a journal entry as
follows: Doubtful Accounts Expense P
1,000
Accounts Receivable P 1,000
To write-off the account of Ms. de Leon
With the direct write-off, the balance of the Accounts Receivable account will
automatically reduce from P100,000 to P99,000 (P100,000 - P1,000).
You noticed that the account credited was Accounts Receivable and not the Estimated
Uncollectible Accounts / Doubtful Accounts unlike what was done under the Allowance
Method.
B. DEPRECIATION EXPENSE:
Property and Equipment as defined by Philippine Accounting Standards (PAS No.16) are
tangible assets which are held by an enterprise for use in the production of supply of
goods and services for rental to others, or for administrative purposes, and are expected
to be used during more than one year period.
These include land, buildings, machineries, motor vehicles, furniture and fixtures,
equipment and improvement to leased facilities which are called depreciable assets
except land because it is expected to be useful to the business enterprise for an indefinite
period. The utility value (ability to yield service) will decrease over time because of wear
and tear, obsolescence (becomes outdated) and inadequacy (cannot cope up with
demands for more volume or better quality of service). Depreciation is therefore
recognizing part of the asset as an expense because of its decreasing utility value.
Property and Equipment are generally recorded at cost, less allowance for
depreciation. Cost is measured at the cash price equivalent. This is presented in the
Balance Sheet as Non-Current Assets.
The portion of the property and equipment that should be allocated over the number of
years and chargeable against expenses during the period. This is called depreciation
expense.
Methods of Computing Depreciation
There are various methods of computing depreciation. We will discuss only the most
common and simplest method of computing depreciation, the “straight-line method.”
There are three (3) factors that must be considered in determining depreciation. These
are:
1. Acquisition Cost - it is the amount paid or liability incurred when the asset is
acquired. It includes the purchase price and other incidental cost of its
acquisition.
2. Scrap Value - the estimated value of the asset at the end of its economic or useful
life. This is sometimes called salvage value or residual value.
3. Estimated Economic or Useful Life - the estimated length of time usually stated in
years that the asset can be of use.
ANNUAL Cost of the Asset - Salvage Value
DEPRECIATION = Estimated life of the asset in
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years
Based on the above formula, the computed depreciation represents the yearly
expiration of the fixed asset and is called Annual Depreciation Expense.
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Illustration 1:
A delivery equipment was purchased on January 3, 2018 for P600,000. It is estimated
that the vehicle’s salvage value at the end of 10 years is P50,000.
Cost of Asset - Scrap Value P600,000 - 50,000
Depreciation expense = = = P 55,000/year
Estimated Economic Life 10 years
The adjusting entry on December 31, 2018 will be:
Depreciation expense - Delivery Equipment P 55,000
Accumulated Depreciation - Delivery Equipment P
55,000
EFFECTS OF ERROR/OMISSION ON FINANCIAL STATEMENTS
Income Statement - if depreciation expense is not recorded or understated, Profit is
overstated. If depreciation expense is overstated, Profit is understated. If overstatement or
understatement of depreciation expense will occur in one period, it will continue to
overstate or understate profit in the subsequent periods until such time that the error is
discovered and corrected.
Balance Sheet - the overstatement or understatement of depreciation expense has the
effect of overstating its valuation account, the Accumulated Depreciation which has also the
effect of understating or overstating the Net Book Value of the property and equipment.
This “domino effect” of transactions and events will overstate or understate the non-
current asset section of the Balance Sheet. Owner’s Equity will also be affected depending
on what this error / omission will have in the Balance Sheet.
FINANANCIAL STATEMENTS PRESENTATION
Depreciation Expense is a nominal account which will be shown in the Expense section of
the Income Statement while the Accumulated Depreciation is a valuation, contra-asset or
asset-offset account which will be shown in the Balance Sheet as a reduction from the cost
of fixed assets as shown below:
Delivery Equipment P
Less: Accumulated 600,000
55,000
Net Book P
Value 545,000
The difference between the cost of Fixed Asset, Delivery Equipment of P 600,000 and the
related Accumulated Depreciation, P55,000 is called Net Book Value, Book Value or Carrying Value
of P545,000.
GENERALIZATION:
Adjusting entries are needed to ensure that the revenue recognition and
expense recognition principle are followed thus resulting to financial statements
reporting the effects of all transactions at the end of the accounting period.
Accountants make adjusting entries to reflect in the account information on
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economic activities that have occurred but not yet recorded. These entries are
needed to measure properly the profit for the period, and to bring related asset and
liability accounts to correct balances for the financial statements.
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REFERENCES:
college.cengage.com
Wild Financial / Managerial Accounting 6th Edition
Slideshare.net
accountingformanagement.com
principlesofaccounting.com
Suggested Textbook:
Lopez, Jr. Rafael M. (2018 Revised Edition) Basic Accounting for Non-Accountants: Simplified
Procedural Approach based on PAS: MS Lopez Printing & Publishing
Additional Materials:
Vera Cruz-Manuel, Zenaida (2017), 21st Century Accounting Process: Concepts and Procedures:
Raintress Trading & Publishing
Ballada, Win (2017), Fundamentals of Accounting: DomDane Publishers
Balatbat-Cabrera, Ma. Elenita (2019), Financial Accounting and Reporting: GIC Enterprises & Co., Inc.
Rante, Gloria, Fundamentals of Accounting, Millenium Books, Inc.
