Chart of Accounts Example Gray Electronic Repair Services Chart of Accounts ASSETS (1000-1999)

Chart of Accounts Example
Gray Electronic Repair Services

Chart of Accounts
ASSETS (1000-1999)
1000 Cash
1010 Accounts Receivable
1011 Allowance for Doubtful Accounts
1020 Notes Receivable
1030 Interest Receivable
1040 Service Supplies
1510 Leasehold Improvements
1520 Furniture and Fixtures
1521 Accumulated Depreciation – Furniture and Fixtures
1530 Service Equipment
1531 Accumulated Depreciation – Service Equipment
LIABILITIES (2000-2999)
2000 Accounts Payable
2010 Notes Payable
2020 Salaries Payable
2030 Rent Payable
2040 Interest Payable
2050 Unearned Revenue
2060 Loans Payable
OWNER'S EQUITY (3000-3999)

3000 Mr. Gray, Capital
3010 Mr. Gray, Drawing
REVENUES (4000-4999)
4000 Service Revenue
4010 Interest Income
4020 Gain on Sale of Equipment
4999 Income Summary
EXPENSES (5000-5999)
5000 Rent Expense
5010 Salaries Expense
5020 Supplies Expense
5030 Utilities Expense
5040 Interest Expense
5050 Taxes and Licenses
5060 Depreciation Expense
5070 Doubtful Accounts Expense
Additional accounts can be added as the need arises. For bigger companies,
the accounts may be divided into several sub-accounts.
For example, employee salaries may have various accounts for different
departments and be included in the chart of accounts as:
5011 Salaries Expense – Administrative,
5012 Salaries Expense – Servicing,
5013 Salaries Expense – Marketing, etc.
Again, take note that the chart of accounts of one company may not be
suitable for another company. It all depends upon the company's needs. In any
case, the chart of accounts is a useful tool for bookkeepers in recording business
transactions.
JOURNAL ENTRY
Transaction #1: On December 1, 2017, Mr. Donald Gray started Gray Electronic
Repair Services by investing $10,000. The journal entry should increase the
company's Cash, and increase (establish) the capital account of Mr. Gray;
hence:
Date
Particulars Debit Credit
2017
Dec 1 Cash 10,000.00

Mr. Gray, Capital 10,000.00
Transaction #2: On December 5, Gray Electronic Repair Services paid

registration and licensing fees for the business, $370.
First, we will debit the expense (to increase an expense, you debit it); and then,
credit Cash to record the decrease in cash as a result of the payment.
5 Taxes and Licenses 370.00
Cash 370.00
Transaction #3: On December 6, the company acquired tables, chairs, shelves,

and other fixtures for a total of $3,000. The entire amount was paid in cash.
There is an increase in an asset account (Furniture and Fixtures) in exchange for
a decrease in another asset (Cash).
6 Furniture and Fixtures 3,000.00
Cash 3,000.00
Transaction #4: On December 7, the company acquired service equipment for

$16,000. The company paid a 50% down payment and the balance will be paid
after 60 days.
This will result in a compound journal entry. There is an increase in
an asset account (debitService Equipment, $16,000), a decrease in
another asset (credit Cash, $8,000, the amount paid), and an increase in
a liability account (credit Accounts Payable, $8,000, the balance to be paid
after 60 days).
7 Service Equipment 16,000.00
Cash 8,000.00
Accounts Payable 8,000.00
Transaction #5: Also on December 7, Gray Electronic Repair Services purchased

service supplies on account amounting to $1,500.
The company received supplies thus we will record a debit to increase supplies.
By the terms "on account", it means that the amount has not yet been paid; and
so, it is recorded as a liability of the company.
7 Service Supplies 1,500.00
Transaction #6: On December 9, the company received $1,900 for services

rendered. We will then record an increase in cash (debit the cash account) and
increase in income (credit the income account).
9 Cash 1,900.00
Service Revenue 1,900.00
Transaction #7: On December 12, the company rendered services on account,

$4,250.00. As per agreement with the customer, the amount is to be collected
after 10 days. Under the accrual basis of accounting, income is recorded when
earned.
In this transaction, the services have been fully rendered (meaning, we made
an income; we just haven't collected it yet.) Hence, we record an increase in
income and an increase in a receivable account.
12 Accounts Receivable 4,250.00
Transaction #8: On December 14, Mr. Gray invested an additional $3,200.00 into
the business. The entry would be similar to what we did in transaction #1, i.e.
increase cash and increase the capital account of the owner.
14 Cash 3,200.00
Transaction #9: Rendered services to a big corporation on December 15. As per

agreement, the $3,400 amount due will be collected after 30 days.
15 Accounts Receivable 3,400.00
Transaction #10: On December 22, the company collected from the customer in
transaction #7. We will record an increase in cash by debiting it. Then, we will
credit accounts receivable to decrease it. We are reducing the receivable
since it has already been collected.
17 Cash 4,250.00
Accounts Receivable 4,250.00

Actually, we simply transferred the amount from receivable to cash in the
above entry.
Transaction #11: On December 23, the company paid some of its liability in
transaction #5 by issuing a check. The company paid $500 of the $1,500
payable.
To record this transaction, we will debit Accounts Payable for $500 to decrease it
by the said amount. Then, we will credit cash to decrease it as a result of the
payment. The entry would be:
20 Accounts Payable 500.00
Cash 500.00
Accounts payable would now have a credit balance of $1,000 ($1,500 initial
credit in transaction #5 less $500 debit in the above transaction).
Transaction #12: On December 25, the owner withdrew cash due to an

emergency need. Mr. Gray withdrew $7,000 from the company.
We will decrease Cash since the company paid Mr. Gray $7,000. And, we will
record withdrawals by debiting the withdrawal account – Mr. Gray, Drawings.
25 Mr. Gray, Drawings 7,000.00
Cash 7,000.00
Transaction # 13: On December 29, the company paid rent for December, $
1,500. Again, we will record the expense by debiting it and decrease cash by
crediting it.
29 Rent Expense 1,500.00
Cash 1,500.00
Transaction #14: On December 30, the company acquired a $12,000 short-term

bank loan; the entire amount plus a 10% interest is payable after 1 year.
Again, the company received cash so we increase it by debiting Cash. The
company now has a liability. We will record it by crediting the liability account –
Loans Payable.
30 Cash 12,000.00
Loans Payable 12,000.00
Transaction #15: On December 31, the company paid salaries to its employees,
$3,500.
For this transaction, we will record/increase the expense account by debiting it
and decrease cash by crediting it. (Note: This is a simplified entry to present the
payment of salaries. In actual practice, different payroll accounting methods
are applied.)
31 Salaries Expense 3,500.00
Cash 3,500.00
There you have it. You should be getting the hang of it by now. If not, then you
can always go back to the examples above. Remember that accounting skills
require mastery of concepts and practice.
POSTING
The Posting Process
Let us illustrate how accounting ledgers and the posting process work using the
transactions we had in the previous lesson. Click here to see the journal entries
we will be using.
Take transaction #1 first.
Date
2017
Dec 1 Cash 10,000.00

Now, go to the ledger and find the accounts. Post the amounts debited and
credited to the appropriate side. Debits go to the left and credits to the right.
After posting the amounts, the cash and capital account would look like:
Cash Mr. Gray, Capital
10,000.00 10,000.00
Explanation: First, we posted the entry to Cash. Cash in the journal entry was
debited so we placed the amount on the debit side (left side) of the account in
the ledger. For Mr. Gray, Capital, it was credited so the amount is placed on the
credit side (right side) of the account. And that's it. Posting is simply transferring
the amounts from the journal to the respective accounts in the ledger.
Note: The ledger accounts (or T-accounts) can also have fields for account
number, description or particulars, and posting reference.
Let's try to post the second transaction.
5 Taxes and Licenses 370.00

Cash 370.00
After posting the above entry, the affected accounts in the ledger would look
like these:
Cash Taxes and Licenses
10,000.00 370.00 370.00
There was a debit to Taxes and Licenses so we posted that in the left side (debit
side) of the account. Cash was credited so we posted that on the right side of
the account.
Notice that after posting transaction #2, we now can get a more updated
balance for each account. Cash now has a balance of $9,630 ($10,000 debit
and 370 credit). Nice, right? Post all the other entries and we will be able to get
the balances of all the accounts.
General Ledger Example
A general ledger contains accounts that are broad in nature such as Cash,
Accounts Receivable, Supplies, and so on. There is another type of ledge which
we call subsidiary ledger. It consists of accounts within accounts (i.e., specific
accounts that make up a broad account).
For example, Accounts Receivable may be made up of subsidiary accounts

such as Accounts Receivable – Customer A, Accounts Receivable – Customer B,
Accounts Receivable – Customer C, etc.
Okay – let's go back to the general ledger. In the above discussion, we posted
transactions #1 and #2 into the ledger. If we post all 15 transactions
(click here to see the entries) and get the balances of each account at the end
of the month, the ledger would look like this:
ASSETS LIABILITES CAPITAL
Cash Accounts Payable Mr. Gray, Capital

10,000.00 370.00 500.00 8,000.00 10,000.00
1,900.00 3,000.00 1,500.00 3,200.00
3,200.00 8,000.00 9,000.00 13,200.00
4,250.00 500.00
12,000.00 7,000.00 Loans Payable Mr. Gray, Drawing
1,500.00 12,000.00 7,000.00
3,500.00
7,480.00
Service Revenue
4,250.00 4,250.00 4,250.00
3,400.00 3,400.00
3,400.00 9,550.00
Service Supplies Rent Expense

1,500.00 1,500.00
Furniture and Fixtures Salaries Expense

3,000.00 3,500.00
Service Equipment Taxes and Licenses

16,000.00 370.00
After all accounts are posted, we can now derive the balances of each
account. So how much Cash do we have at the end of the month? As shown in
the ledger above, the company has $7,480 at the end of December.
How about accounts receivable? Accounts payable? You can find them all in
the ledger.
Note: The above is a simplified and theoretical example of a ledger. In reality,

companies have a lot more than 15 transactions! They may have hundreds or
even thousands of transactions in one day. Imagine how lengthy the ledger
would be. Worse, imagine the work needed in posting that many transactions
manually.
Because of technological advancements however, most accounting systems

today perform automated posting process. Nonetheless, the above example
shows how a ledger works.
TRIAL BALANCE
To illustrate, here's a trial balance example. Based on the ledger we prepared in
the previous lesson, the trial balance would look like this:

Unadjusted Trial Balance
December 31, 2017
Account Title Debit Credit

Cash $ 7,480.00
Service Supplies 1,500.00
Furniture and Fixtures 3,000.00
Service Equipment 16,000.00
Accounts Payable $ 9,000.00
Mr. Gray, Drawing 7,000.00
Rent Expense 1,500.00
Salaries Expense 3,500.00
Taxes and Licenses 370.00
Totals $ 43,750.00 $ 43,750.00
The purpose of the trial balance is to test the equality between total debits and
total credits after the posting process. This trial balance is called an unadjusted
trial balance (since adjustments are not yet included).
There are two other types of trial balance: the adjusted trial balance which is
prepared after adjusting entries are prepared and posted, and the post-closing
trial balance which is prepared after closing entries. These two are prepared in
later steps of the accounting process.
Equal Doesn't Always Mean Correct
When the total debits and total credits are not equal, it is a clear indication that
a mistake has been committed in the journalizing and/or posting process. An
amount must have been entered incorrectly; hence, must be corrected.
However, the trial balance does not guarantee that the records are accurate
even if the total debits and total credits are equal. There are instances when this
happens such as:
when a transaction was not recorded or not posted (no debit and no credit),
when a transaction was recorded or posted twice (total debits and total credits
are both overstated by the same amount),
when an account was recorded instead of another account of the same
classification; for example, Supplies was debited instead of Equipment (the total
debits would still be correct since they are both asset accounts).
CORRECTING ENTRIES
A correcting entry is a journal entry whose purpose is to rectify the effect of an

incorrect entry previously made.
To illustrate how to prepare correcting entries, here are some examples.
On December 5, 2017, Gray Electronic Repair Services paid $370 registration

and licensing fees for the business.
The correct entry is:
Dec 5 Taxes and Licenses 370.00
Cash 370.00
Suppose the bookkeeper, for whatever reason, debited Transportation Expense
instead of Taxes and Licenses.
The entry made was:
Dec 5 Transportation Expense 370.00
Cash 370.00
Upon analysis, the Transportation Expense is overstated (higher than in should
be) because the bookkeeper recorded transportation expense but it was not
really a transportation expense.
Also, Taxes and Licenses is understated (lower than it should be). The amount
should have been recorded but was not recorded under this account.
To correct these errors, we should make an entry to offset the effects.
Transportation Expense is overstated therefore we should decrease it; Taxes and
Licenses is understated therefore we should increase it.
The Cash account was credited in the entry made. Was the entry made to Cash
correct? Look at the correct entry. Is it proper to have Cash credited? Yes.
Therefore, we have no problem with the Cash account.
Now, to increase Taxes and Licenses, we debit it. To decrease Transportation

Expense, we credit it. Remember that to increase/record an expense, we debit
it; to decrease an expense, we credit it. The correcting entry would then be:
Dec 31 Taxes and Licenses 370.00
Transportation
370.00
Expense
Note: The correcting entry is dated when the error is discovered. In this case, we
assumed that it was discovered and corrected on December 31.
If an explanation or annotation is required, it would be something like: "To

correct error made on taxes and licenses" or "To record correction of error on
entry made for taxes and licenses."
After making this entry, Transportation Expense will zero-out ($370 debit and $370
credit) and Taxes and Licenses will now have a balance of $370.00, thus making
our records correct.
Another Example
Let us assume the bookkeeper made another error.
On December 17, the company collected a receivable from a customer,

$1,650.00. Suppose the bookkeeper recorded it at $1,560.00 instead of $1,650.00.
This was the entry made:
Dec 17 Cash 1,560.00

What is the correct entry? The entry should have been:
Dec 17 Cash 1,650.00
How will we correct this? Cash is understated because the accountant

recorded $1,560 instead of $1,650. Accounts Receivable is also overstated
because it was reduced by $1,560 only but should have been reduced by
$1,650. We should then increase Cash and reduce Accounts Receivable by $90.
The correcting entry would be:
Dec 31 Cash 90.00
Accounts Receivable 90.00

Another way of doing it (and an easier one) is to look at the entry
made and correct entry. Upon analysis, you will see that the amount debited to
Cash is less that what should have been debited. The same goes for the amount
credited to Accounts Receivable. Cash should then be debited by $90 more
and Accounts Receivable should be credited by $90 more.
Recap: Steps in Making Correcting Entries
The steps in preparing correcting entries may be summed up as follows:

Determine the entry made. – What was the erroneous/wrong entry made?
Determine the correct entry. – What entry should have been made?
Analyze #1 and #2 to come up with the correcting entry.

Steps 1 and 2 may be interchanged. Nonetheless, you need to know the entry
made and the correct entry (should-be entry) before you can come up with the
correcting entry.
ADJUSTING ENTRY: ACCRUED INCOME
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, 2017, 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, 2018. The
transaction was not recorded in the books of the company as of 2017.
In this case, we should make an adjusting entry in 2017 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, 2017, 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, 2017. 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: ACCRUED EXPENSE
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 2017, Gray Electronic Repair Services used a total of
$1,800 worth of electricity and water. The company received the bills on
January 10, 2018. When should the expense be recorded, December 2017 or
January 2018?
Answer – in December 2017. 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, 2017. On December 31 of
the same year, 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, 2017.
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: UNEARNED REVENUE
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, 2017, 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, 2017, 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
60,000.00
Income
On December 31, 2017, 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

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

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
40,000.00
Income
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.
ADJUSTING ENTRY: PREPAID EXPENSE
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
600.00
Expense
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, 2017 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, 2017, 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.
ADJUSTING ENTRY: 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
6,000.00
Depreciation
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
$ 4,500
December)
2013 (entire year) 6,000
2017 (January to March) 1,500
Total for 5 years $ 30,000

ADJUSTING ENTRY: BAD DEBTS
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

xxx.xx
Debts
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

100.00
Debts
Again, you may use Doubtful Accounts. Just be sure to use a logical (and
uniform) pair every time. For example:
Doubtful Accounts
Dec 31 100.00
Expense
Allowance for
100.00
Doubtful 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
ADJUSTED TRIAL BALANCE
An adjusted trial balance is prepared after adjusting entries are made and posted to the ledger.
This is the second trial balance prepared in the accounting cycle. Its purpose is to test the equality
between debits and credits after adjusting entries are entered into the books of the company.
To illustrate how it works, here is a sample unadjusted trial balance:
Unadjusted Trial Balance
December 31, 2017
Cash $ 7,480.00
Service Supplies 1,500.00
Accounts Payable $ 9,000.00
Totals $ 43,750.00 $ 43,750.00
At the end of the period, the following adjusting entries were made:
Dec 31 Accounts Receivable 300.00
Service Revenue 300.00
31 Utilities Expense 1,800.00
31 Service Supplies Expense 900.00
31 Depreciation Expense 720.00
Accumulated Depreciation 720.00
After posting the above entries, the values of some of the items in the unadjusted trial balancewill
change. Take the first adjusting entry. Accounts Receivable is debited hence is increased by $300.
Service Revenue is credited for $300.
The balance of Accounts Receivable is increased to $3,700, i.e. $3,400 unadjusted balance plus $300
adjustment. Service Revenue will now be $9,850 from the unadjusted balance of $9,550.
Next entry. Utilities Expense and Utilities Payable did not have any balance in the unadjusted trial
balance. After posting the above entries, they will now appear in the adjusted trial balance.
Third. Service Supplies Expense is debited for $900. Service Supplies is credited for $900. The Service
Supplies account had a debit balance of $1,500. After incorporating the $900 credit adjustment, the
balance will now be $600 (debit).
And fourth. There were no Depreciation Expense and Accumulated Depreciation in the unadjusted trial
balance. Because of the adjusting entry, they will now have a balance of $720 in the adjusted trial
balance.
Adjusted Trial Balance Example
After incorporating the adjustments above, the adjusted trial balance would look like this. Just like in the
unadjusted trial balance, total debits and total credits should be equal.
Adjusted Trial Balance
December 31, 2017

Cash $ 7,480.00
Accumulated Depreciation $ 720.00
Utilities Expense 1,800.00
Service Supplies Expense 900.00
Depreciation Expense 720.00
Totals $ 46,570.00 $ 46,570.00

IS
Net income is equal to total revenues minus total expenses.
Income Statement
For the Year Ended December 31, 2017
Service Revenue $ 9,850

Less: Operating Expenses
Salaries Expense $ 3,500
Utilities Expense 1,800
Rent Expense 1,500
Service Supplies Expense 900
Depreciation Expense 720
Taxes and Licences 370 8,790
Net Income $ 1,060
Again, we drew a single line under 8,790 to indicate that a mathematical
operation was made. Two horizontal lines are drawn under the final amount
(1,060 net income). This is known as "double-rule" and is similar to enclosing the
final answers in a box or circle in your math test.
So there you go. The preparation is somewhat easy – you just need to be familiar
with the different revenue and expense accounts.
OE
Compute for the balance of the capital account at the end of the period and
draw the lines. One horizontal line means that a mathematical operation has
been performed. Two horizontal lines (double-rule) are drawn below the final
amount.
Statement of Changes in Owner's Equity
For the Year Ended December 31, 2017
Gray, Capital - beginning $ 0

Add: Additional Contributions 13,200
Net Income 1,060
Less: Gray, Drawings 7,000
Gray, Capital - ending $ 7,260
Conclusion
So there you have the preparation of a Statement of Changes in Owner's Equity.
It is a report that shows the items that affect the capital or equity account.
Simply, we are just presenting this formula in a formal report:
Capital, ending = Capital, beg. + Additional Contributions + Net Income -
Withdrawals
where: Net Income = Income - Expenses
BS

Balance Sheet
As of December 31, 2017
ASSETS
Current Assets:
Cash $ 7,480
Accounts Receivable 3,700
Service Supplies 600
Total Current Assets 11,780
Non-Current Assets:
Furniture and Fixtures $ 3,000
Service Equipment 16,000
Less: Accumulated Depreciation 720
Total Non-Current Assets 18,280
TOTAL ASSETS $ 30,060
LIABILITIES AND CAPITAL

Current Liabilities:
Accounts Payable 9,000
Utilities Payable 1,800
Total Current Liabilities 10,800
Non-Current Liabilities:
Loans Payable 12,000
Total Non-Current Liabilities 12,000
Total Liabilities 22,800
Gray, Capital - ending 7,260
TOTAL LIABILITIES AND CAPITAL $ 30,060
Total assets should be equal to total liabilities and capital. If they are not, then
something must have gone wrong during the process.
There you have it. The balance sheet we have just prepared is for a sole
proprietorship business. In a partnership, several capital accounts will have to be
presented – one for each partner. In a corporation, the capital portion is known
as stockholders' equity and is made up of capital stock, reserves, and retained
earnings.
CLOSING ENTRIES
Step 1: Close all income accounts to Income Summary
Date
2017
Dec 31 Service Revenue 9,850.00
Income Summary 9,850.00

In the given data, there is only 1 income account, i.e. Service Revenue. It has a
credit balance of $9,850. To close that, we debit Service Revenue for the full
amount and credit Income Summary for the same.
The Income Summary account is temporary. It is used to close income and
expenses. As you will see later, Income Summary is eventually closed to capital.
Step 2: Close all expense accounts to Income Summary
31 Income Summary 8,790.00
Utilities Expense 1,800.00
Service Supplies
900.00
Expense
Depreciation Expense 720.00

To close expenses, we credit the expense accounts and debit Income
Summary.
Now for the next step, we need to get the balance of the Income Summary
account. In step 1, we credited it for $9,850 and debited it in step 2 for $8,790. It
would then have a credit balance of $1,060.
Notice that the balance of the Income Summary account is actually the net
income for the period. Remember that net income is equal to all income minus
all expenses.
Step 3: Close Income Summary to the appropriate capital account
The Income Summary balance is ultimately closed to the capital account.
31 Income Summary 1,060.00

Step 4: Close withdrawals to the capital account
Note: This step is applicable only to sole proprietorships and partnerships.
In a sole proprietorship, a drawing account is maintained to record all
withdrawals made by the owner. In a partnership, a drawing account is
maintained for each partner. Drawing accounts are closed to capital at the
end of the accounting period.
Our example is a sole proprietorship business. Mr. Gray's withdrawals are
recorded in Mr. Gray, Drawing. To close the drawing account to the capital
account, we credit the drawing account and debit the capital account. Notice
that drawings decrease capital.
31 Mr. Gray, Capital 7,000.00

Conclusion
The purpose of closing entries is to prepare the temporary accounts for the next
accounting period. In other words, the income and expense accounts are
"restarted".
After preparing the closing entries above, Service Revenue will now be zero. The
expense accounts and withdrawal accounts will now also be zero. The balances
of these accounts have been absorbed by the capital account – Mr. Gray,
Capital, which now has a balance of $7,260 ($13,200 beginning balance +
$1,060 in step #3 - $7,000 in step #4).
POST CLOSING TRIAL BALANCE
Post-Closing Trial Balance Example
After incorporating the closing entries above, the post-closing trial balance
would look like this:
Post-Closing Trial Balance
December 31, 2017
Cash $ 7,480.00
Accumulated Depreciation $ 720.00
Totals $ 30,780.00 $ 30,780.00
The balances of the nominal accounts (income, expense, and withdrawal

accounts) have been absorbed by the capital account – Mr. Gray, Capital.
Hence, you will not see any nominal account in the post-closing trial balance.
And just like any other trial balance, total debits and total credits should be
equal.
REVERSING
The only types of adjusting entries that may be reversed are those that are
prepared for the following:
accrued income,
accrued expense,
unearned revenue using the income method, and
prepaid expense using the expense method.
Adjusting entries for unearned revenue under the liability methodand for
prepaid expense under the asset method are never reversed. Adjusting entries
for depreciation, bad debts and other allowances are also never reversed.
Reversing Entry for Accrued Income
Example: ABC Company is to receive $3,000 interest income at the end of
February 2018. It covers 3 months starting December 1, 2017. At the end of 2017,
the accountant properly made an adjusting entry for one month's worth of
accrued income.
Date
2017
Dec 31 Interest Receivable 1,000.00
Interest Income 1,000.00

At the beginning of 2018, the accountant can prepare this reversing entry:
Date
2018
Jan 1 Interest Income 1,000.00
Interest Receivable 1,000.00

The adjusting entry is simply reversed. Debit what was credited and credit what
was debited.
When the ABC Company receives the interest income at the end of February,
the accountant will then prepare this journal entry:
Feb 28 Cash 3,000.00

Notice that Interest Income is credited for 3,000. Now you might be asking this:
Under the concept of accrual, the interest income to be recognized in 2018
should be $2,000. Then why credit $3,000 Interest Income?
Very good. Well, in the reversing entry at the beginning of the period, Interest
Income was already debited for $1,000. So if we combine them ($1,000 debit
and 3,000 credit), then we'll end up with $2,000 Interest Income which is the
correct amount to be recognized in 2018.
We said that reversing entries are optional. If the accountant did not make a
reversing entry at the beginning of the year, the accountant will have this entry
upon collection of the income.
Feb 28 Cash 3,000.00
Interest Receivable 1,000.00

Note: Actually, if you combine the reversing entry and journal entry for
collection. You'll come up with the journal entry above.
Reversing Entry for Accrued Expense
Example: Suppose that ABC Company and its lessor agrees that ABC will pay
rent at the end of January 2018, covering a 3-month period starting November
1, 2017. The entire amount is $6,000.
At the end of December 2017, the accountant properly prepared this adjusting
entry for two months worth of rent expense (Nov 1 to Dec 31):
Date
2017
Rent Payable 4,000.00

At the beginning of 2018, the accountant can prepare this reversing entry:
Date
2018
Jan 1 Rent Payable 4,000.00

Again, notice that the adjusting entry is simply reversed.
When the company pays the entire rent, the accountant will then prepare this
journal entry:
Jan 31 Rent Expense 6,000.00
Cash 6,000.00
In effect, Rent Expense for 2017 is $2,000 even if the accountant debits $6,000
upon payment. This is because of the reversing entry which includes a credit to
Rent Expense for $4,000.
If the accountant did not make a reversing entry at the beginning of the year,
the accountant will have this entry upon payment of the rent.
Jan 31 Rent Payable 4,000.00
Cash 6,000.00
There you have the first two types of adjusting entries that can be reversed. If
you are having trouble understanding the process, don't worry. It requires some
time and a little effort for the concepts to sink in. In part 2, we'll take a look at
the other two types.
Reversing Entry for Unearned Income

If the income method is used in recording unearned income, reversing entries
can be prepared. Take note that adjusting entries for unearned income
recorded using the liability method are never reversed.
Example: ABC Company recorded customer advances amounting to $5,000 in
December 1, 2017. The company uses the income method in recording
unearned income.
Date
2017
Dec 1 Cash 5,000.00

At the end of 2017, the company rendered $2,000 worth of services. We need to
set-up the unearned income of $3,000 and bring Service Revenue to its correct
balance ($2,000). The adjusting entry would be:
Dec 31 Service Revenue 3,000.00
Unearned Revenue 3,000.00

At the beginning of 2018, the following reversing entry can be prepared:
Date
2018
Jan 1 Unearned Revenue 3,000.00

Notice that the adjusting entry is simple reversed.
At the end of 2018, Service Revenue will again be checked to see if there is any
unearned portion and if an adjusting entry is necessary.
Reversing Entry for Prepaid Expense
If the expense method is used in recording prepaid expense, reversing entries
can be prepared. Adjusting entries for prepaid expense under the asset
method are not reversed.
Example: On December 1, 2017, ABC Company paid $7,500 of rent for 3 months
starting December 1. The expense method was used in recording this
transaction.
Date
2017
Cash 7,500.00
At the end of 2017, 1 month worth of rent has already expired. Prepaid Rent
should be set-up for the remaining 2 months. The adjusting entry would be:
Dec 31 Prepaid Rent 5,000.00

At the beginning of 2018, the following reversing entry can be prepared:
Date
2018
Jan 1 Rent Expense 5,000.00
Prepaid Rent 5,000.00

Again, notice that the adjusting entry is simple reversed.
At the end of February, the entire rent paid has already expired. We do not
need to make an entry here since we already prepared a reversing entry.
Nonetheless, Rent Expense will be reviewed at the end of the year. Rent
Expense and all other expenses will be checked to see if there are any
unexpired portions which will require adjusting entries.

Chart of Accounts Example Gray Electronic Repair Services Chart of Accounts ASSETS (1000-1999)

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Chart of Accounts Example Gray Electronic Repair Services Chart of Accounts ASSETS (1000-1999)

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Chart of Accounts Example

Gray Electronic Repair Services

OWNER'S EQUITY (3000-3999)

Dec 1 Cash 10,000.00

Transaction #2: On December 5, Gray Electronic Repair Services paid

5 Taxes and Licenses 370.00

Transaction #3: On December 6, the company acquired tables, chairs, shelves,

6 Furniture and Fixtures 3,000.00

Transaction #4: On December 7, the company acquired service equipment for

7 Service Equipment 16,000.00

Accounts Payable 8,000.00

Transaction #5: Also on December 7, Gray Electronic Repair Services purchased

7 Service Supplies 1,500.00

Accounts Payable 1,500.00

Transaction #6: On December 9, the company received $1,900 for services

Service Revenue 1,900.00

Transaction #7: On December 12, the company rendered services on account,

12 Accounts Receivable 4,250.00

Service Revenue 4,250.00

Mr. Gray, Capital 3,200.00

Transaction #9: Rendered services to a big corporation on December 15. As per

15 Accounts Receivable 3,400.00

Service Revenue 3,400.00

Accounts Receivable 4,250.00

20 Accounts Payable 500.00

Transaction #12: On December 25, the owner withdrew cash due to an

25 Mr. Gray, Drawings 7,000.00

29 Rent Expense 1,500.00

Transaction #14: On December 30, the company acquired a $12,000 short-term

Loans Payable 12,000.00

31 Salaries Expense 3,500.00

Take transaction #1 first.

Dec 1 Cash 10,000.00

Mr. Gray, Capital 10,000.00

Let's try to post the second transaction.

5 Taxes and Licenses 370.00

General Ledger Example

For example, Accounts Receivable may be made up of subsidiary accounts

Cash Accounts Payable Mr. Gray, Capital

Service Supplies Rent Expense

Furniture and Fixtures Salaries Expense

Service Equipment Taxes and Licenses

Note: The above is a simplified and theoretical example of a ledger. In reality,

Because of technological advancements however, most accounting systems

Gray Electronic Repair Services

Account Title Debit Credit

Equal Doesn't Always Mean Correct

A correcting entry is a journal entry whose purpose is to rectify the effect of an

To illustrate how to prepare correcting entries, here are some examples.

On December 5, 2017, Gray Electronic Repair Services paid $370 registration

The correct entry is:

Dec 5 Taxes and Licenses 370.00

The entry made was:

Dec 5 Transportation Expense 370.00

Now, to increase Taxes and Licenses, we debit it. To decrease Transportation

Dec 31 Taxes and Licenses 370.00

If an explanation or annotation is required, it would be something like: "To

On December 17, the company collected a receivable from a customer,

Dec 17 Cash 1,560.00

What is the correct entry? The entry should have been:

Dec 17 Cash 1,650.00

Accounts Receivable 1,650.00

How will we correct this? Cash is understated because the accountant