7.2 Deferral Adjustments
Key Takeaways
- Deferrals allocate prepaid expenses and unearned revenues across periods after cash has already been paid or received.
- TESDA exam-meta study tips explicitly require familiarity with both the asset/liability method and the expense/revenue method for recording deferrals.
- Under the asset method, prepayments start as assets and are adjusted to expense; under the expense method, the payment starts as expense and an asset is restored for the unused portion.
- Unearned revenues start as liabilities (liability method) or as income (revenue method); period-end adjustments move the earned or unearned portion to the correct statement.
7.2 Deferral Adjustments
Quick Answer: Deferrals adjust prepayments and unearned revenues so each period shows only the expired cost or earned income. TESDA exam-meta study tips tell candidates to know both the asset/liability method and the expense/revenue method. Same economic result at period-end; different original recording paths and different adjusting entries.
If accruals catch up with economics before cash, deferrals clean up economics after cash. Prepaid rent, prepaid insurance, office supplies on hand, and customer advances are classic Philippine MSME items. Assessors frequently specify which method the firm uses—or give an opening entry style that forces you to infer the method.
Two Methods — Why Both Appear on Assessment
Exam-meta study tips for Bookkeeping NC III include: Familiarize yourself with both the asset/liability and expense/revenue methods for recording deferrals. Training centers and practical packets vary. You must recognize the original entry, then write the correct adjusting entry for that method. Mixing methods mid-problem is a common fail.
Side-by-Side: Prepaid Expense (₱36,000 one-year insurance paid 1 Oct 2026)
Insurance covers 1 October 2026 – 30 September 2027. At 31 December 2026, three months have expired (Oct–Dec); nine months remain prepaid.
Expired cost = ₱36,000 × 3/12 = ₱9,000. Remaining asset = ₱27,000.
Asset / Liability method (asset method for prepayments)
Original entry on payment (1 Oct):
| Account Title | Debit | Credit |
|---|---|---|
| Prepaid Insurance | ₱36,000 | |
| Cash | ₱36,000 |
Adjusting entry 31 Dec (recognize expired portion):
| Account Title | Debit | Credit |
|---|---|---|
| Insurance Expense | ₱9,000 | |
| Prepaid Insurance | ₱9,000 |
After adjustment: Prepaid Insurance ₱27,000 (asset); Insurance Expense ₱9,000.
Expense / Revenue method (expense method for prepayments)
Original entry on payment (1 Oct):
| Account Title | Debit | Credit |
|---|---|---|
| Insurance Expense | ₱36,000 | |
| Cash | ₱36,000 |
Adjusting entry 31 Dec (restore unused portion as asset):
| Account Title | Debit | Credit |
|---|---|---|
| Prepaid Insurance | ₱27,000 | |
| Insurance Expense | ₱27,000 |
After adjustment: Insurance Expense left at ₱9,000; Prepaid Insurance ₱27,000. Same end balances as the asset method.
Comparison Table — Prepaid Expense
| Feature | Asset / liability method | Expense / revenue method |
|---|---|---|
| Initial debit when cash paid | Prepaid Insurance (asset) | Insurance Expense |
| What you adjust at period-end | Expired portion → expense | Unused portion → asset |
| Adjusting debit | Insurance Expense | Prepaid Insurance |
| Adjusting credit | Prepaid Insurance | Insurance Expense |
| Ending expense (3 months used) | ₱9,000 | ₱9,000 |
| Ending prepaid asset | ₱27,000 | ₱27,000 |
Unearned Revenue Deferrals
Side-by-Side: Customer advance ₱60,000 for 6 months of services starting 1 Nov 2026
At 31 December 2026, two months earned; four months still unearned.
Earned = ₱60,000 × 2/6 = ₱20,000. Still unearned = ₱40,000.
Liability method (asset/liability family)
Original entry when cash received (1 Nov):
| Account Title | Debit | Credit |
|---|---|---|
| Cash | ₱60,000 | |
| Unearned Service Income | ₱60,000 |
Adjusting entry 31 Dec:
| Account Title | Debit | Credit |
|---|---|---|
| Unearned Service Income | ₱20,000 | |
| Service Income | ₱20,000 |
Revenue method (expense/revenue family)
Original entry when cash received (1 Nov):
| Account Title | Debit | Credit |
|---|---|---|
| Cash | ₱60,000 | |
| Service Income | ₱60,000 |
Adjusting entry 31 Dec (defer unearned portion):
| Account Title | Debit | Credit |
|---|---|---|
| Service Income | ₱40,000 | |
| Unearned Service Income | ₱40,000 |
Ending Service Income ₱20,000; Unearned Service Income ₱40,000—same under both methods.
Comparison Table — Unearned Revenue
| Feature | Liability method | Revenue method |
|---|---|---|
| Initial credit when cash received | Unearned Service Income | Service Income |
| Period-end focus | Recognize earned portion | Defer unearned portion |
| Adjusting debit | Unearned Service Income | Service Income |
| Adjusting credit | Service Income | Unearned Service Income |
| Ending earned income (2 of 6 months) | ₱20,000 | ₱20,000 |
| Ending liability | ₱40,000 | ₱40,000 |
More Philippine Worked Examples
Prepaid rent — asset method
On 1 December 2026, a Quezon City café pays ₱45,000 for three months’ rent (Dec–Feb). Monthly rent = ₱15,000.
Original: Dr Prepaid Rent ₱45,000; Cr Cash ₱45,000.
31 Dec adjust: Dr Rent Expense ₱15,000; Cr Prepaid Rent ₱15,000.
Remaining prepaid for Jan–Feb: ₱30,000.
Office supplies — count at year-end
Supplies on hand per physical count ₱4,200. Unadjusted Supplies (asset) balance ₱11,500 (asset method).
Supplies used = ₱11,500 − ₱4,200 = ₱7,300.
| Account Title | Debit | Credit |
|---|---|---|
| Supplies Expense | ₱7,300 | |
| Supplies | ₱7,300 |
If the firm used the expense method and debited Supplies Expense for all purchases, the adjusting entry would debit Supplies (asset) for the ₱4,200 still on hand and credit Supplies Expense ₱4,200.
Magazine subscription revenue — liability method
A publisher receives ₱24,000 on 1 September for a 12-month subscription. By 31 December, four months earned = ₱8,000.
Adjust: Dr Unearned Subscription Revenue ₱8,000; Cr Subscription Revenue ₱8,000.
How to Identify the Method on Assessment Day
| Clue in the problem | Method in use |
|---|---|
| Trial balance shows Prepaid Insurance with a large debit and little/no Insurance Expense | Likely asset method; adjust expired portion |
| Trial balance shows Insurance Expense equal to the full annual premium and Prepaid Insurance zero/missing | Likely expense method; set up remaining prepaid |
| Unearned Service Income has a credit balance from customer advances | Liability method; recognize earned slice |
| Service Income already includes the full advance | Revenue method; remove unearned slice |
Always read the unadjusted trial balance and the narrative of the original cash entry before writing the adjustment.
Statement Effects (Either Method, After Correct Adjustment)
| Deferral | Correct end result |
|---|---|
| Prepaid expense | Asset = unused cost; Expense = expired cost |
| Unearned revenue | Liability = unearned cash; Income = earned portion |
Wrong method logic (for example, expensing the full prepaid under asset method with no adjustment) understates assets and overstates expenses.
Link to Accruals and the Cycle
| Family | Cash timing | Typical accounts |
|---|---|---|
| Accrual (7.1) | Cash later | Payable / Receivable |
| Deferral (7.2) | Cash already | Prepaid / Unearned |
Both families are adjusting journal entries posted before the adjusted trial balance. Practical projects often mix one prepaid, one unearned, and one accrual in the same December 31 package.
Common Errors
- Adjusting the wrong direction (crediting expense under asset method instead of debiting it).
- Using 12 months when coverage started mid-year.
- Applying revenue-method mechanics to an asset-method trial balance.
- Forgetting supplies physical count drives the asset-method adjustment.
- Treating customer deposits as income immediately under liability method with no year-end earning analysis.
Master both methods so the exam-meta tip becomes automatic: identify path → compute earned/expired pesos → journalize → post → move to Section 7.3 items (depreciation and bad debts) and then the adjusted TB.
TESDA Bookkeeping NC III exam-meta study tips specifically tell candidates to familiarize themselves with which pair of approaches for recording deferrals?
On 1 October a firm pays ₱36,000 for one year of insurance and debits Prepaid Insurance. At December 31, what adjusting entry is correct under the asset method?
The same ₱36,000 annual premium was originally debited entirely to Insurance Expense. What December 31 adjusting entry restores the unused nine months under the expense method?
A client paid ₱60,000 in advance for six months of services. The firm credited Unearned Service Income. After two months, the adjusting entry under the liability method is: