INTERMEDIATE ACCOUNTING 1A

7. Financial Statements
CHAPTER 1 8. Closing the books
9. Post-closing Trial Balance
THE ACCOUNTING PROCESS 10. Reversing Entries

ACCOUNTING RECORDS OF A BUSINESS ENTITY

Accounting
1. Business or Source Documents
 The process of identifying, measuring, and
communicating economic information to permit  the original source materials evidencing a
informed judgments and decisions by users of the transaction
information
 Sales invoices, official receipts, vouchers
Accounting Information System statement of account etc
 The system of collecting and processing
2. Books of Accounts
transaction data and disseminating financial
information to interested parties. AIS is a
 General Journal
subsystem of Management Information System
 General Ledger

Components of AIS

 Personnel directly involved in accounting work SYSTEMS OF RECORDING TRANSACTIONS

 Accounting policies and standards
 Procedures 1. Double-entry System
 Equipment and devices
 Records and reports  A system that requires two book entries - one
debit and one credit - for every transaction within
Management Information System a business

 A set of data gathering, analyzing, and reporting The double-entry system makes use of the following
functions designed to provide management with concepts:
the information it needs to carry out its function
 Duality - this concept views each transaction as
Components of MIS having a two-fold effect on values - a value
received and a value parted with, and each
 Accounting Information System or Financial transaction is recorded using at least two
Information System accounts
 Personnel Information System
 Logistics Information System  Equilibrium - this concept requires each
transaction to be recorded in terms of equal
debits and credits
THE ACCOUNTING CYCLE
2. Single-entry System

Represents the steps or procedures used in recording  Each transaction is recorded through simple
transactions and preparing financial statements. The narrative. Transactions are not analyzed in terms
accounting cycle implements accounting process. of debits and credits.

Steps in Accounting Cycle ACCRUAL BASIS CASH BASIS

1. Identifying and analyzing Income and expenses are Income and expenses are
2. Journalizing recognized when earned recognized when
3. Posting or incurred, regardless of received or paid,
4. Unadjusted Trial Balance when cash is received or regardless of when cash
5. Adjusting Entries paid is earned or incurred
6. Adjusted Trial Balance / Worksheet
preparation
 GENERAL JOURNAL GENERAL LEDGER

Also called the book of original entry is a formal record Also called the book of secondary entries or book of
where transactions are initially recorded final entries is a systematic compilation of group of
chronologically through journal entries. accounts

Journalizing Posting

- the process of recording transactions in the journal - the process of transferring data from the journal to
by means of journal entries the appropriate accounts in the ledger.

Types of Journals Types of Ledger

 General Journal  General Ledger

- contains all the accounts appearing in the
 Special Journal trial balance
- a book of original entry used to record
transactions of a similar nature  Subsidiary Ledger
- provides a breakdown of the balances of
a) Sales journal - used to record sales on acc controlling accounts
b) Purchases journal - used to record
purchases of inventory on account Controlling account (control account)
c) Cash receipts journal - used to record all - one that consists of a group of accounts with similar
transactions involving receipts of cash nature. The balance of the controlling account is
d) Cash disbursement journal - used to shown in the general ledger while the balances of the
record all transactions involving payment of accounts that comprise the controlling account are
cash shown in the subsidiary ledger

Types of Journal Entries For example:

a) Simple journal entry
- contains a single debit and a single credit Accounts Receivable - a controlling account
appearing in the general ledger. This account is
b) Compound journal entry supported by various subsidiary accounts in the
- contains two or more debits and credits subsidiary ledger, such as

c) Adjusting entries Accounts Receivable from Customer A, Accounts

- entries made prior to the preparation of Receivable from Customer B etc
financial statements to update certain accounts so
that they reflect correct balances as at the designated The sum of the subsidiary accounts should be equal
time to the balance of the related controlling account in the
general ledger
d) Closing entries
- entries made at the end of the accounting
period after all adjustments have been made to
zero-out balances of all nominal accounts and to
update the retained earnings account ACCOUNT

e) Reversing entries The basic storage of information in accounting.

- entries usually made on the first day of the
accounting period to reverse certain adjusting entries Example: Cash, Accounts receivable, Land, etc
in the immediately proceeding period

f) Correcting entries CHART OF ACCOUNTS

- entries made to correct accounting errors

g) Reclassification entries
- entries made to transfer an amount from one A list of all the accounts used by the entity.
account to another account that better describes the
nature of the transaction being recorded
 TYPES OF ACCOUNTS ERRORS REVEALED BY A TRIAL BALANCE
Real (Permanent) Account
- are accounts that are not closed at the end of 1. A debit without a credit, vice versa
the accounting period, but rather carried over to the 2. Recording one part of an entry at a diff amount
next accounting period. These accounts are shown in 3. Transplacement error, eg. a 1,000 amount is
the statement of financial position recorded as 100 or 10,000
4. Transposition error, digits in an amount are
 Nominal (Temporary) Account interchanged, eg. 5,652 is recorded as 15,625
- are accounts closed at the end of the
accounting period. These accounts include all income
and expenses accounts, drawings and dividends Concepts:
accounts, clearing accounts (eg. Income Summary
account) and suspense accounts ( eg. Cash storage  The effect of an error on the trial balance
or overage account) depends on the normal balance of the account
involved. So any understatement or
 Mixed accounts overstatement of eg. Cash affects only the
- are accounts that have both real and nominal debit side of the trial balance
account components.These accounts are subject to  An incorrect debit to an account with a normal
adjustment. Mixed accounts include unadjusted debit balance will overstate that account; an
prepayments and deferrals having both expired and incorrect credit will understate that account.
unexpired components.  Overstatement is corrected by deduction
 Understatement is corrected by addition
 Contra accounts  Correction is made on a per account basis
- are accounts that are deducted from a related
account. Eg. Accumulated Depreciation Understated and overstated are two terms that
describe the inaccuracy of accounting figures.
 Adjunct accounts Accountants use these terms primarily when
- are accounts that are added to a related reviewing financial statements. The terms also apply
account. Eg. Premium on bonds payable to other situations, however, often found in a
company’s general ledger or subsidiary journals
Validation accounts such as contra and adjunct
accounts are neither assets nor liabilities OVERSTATEMENT UNDERSTATEMENT
Accountants use this Understated amounts
TRIAL BALANCE term to describe an indicate a reported
incorrect reported amount is not correct
A list of general ledger accounts and their balances. It amount that is higher and the reported amount
is prepared to check the equality of total debits and than the true amount. is less than the true
credits in the ledger. The preparation of trial balance amount.
creates a starting point for the preparation of financial
statements.
ADJUSTING ENTRIES
TYPES OF TRIAL BALANCE
 Unadjusted Trial Balance Entries made prior to the preparation of financial
- this is prepared before adjusting entries. It statements to update certain accounts so that they
contains real, nominal and mixed accounts. reflect correct balances as of the designated time.
 Adjusted Trial Balance
PURPOSE OF ADJUSTING ENTRIES
- this is prepared after adjusting entries. It
contains real and nominal accounts.
a) To take up unrecorded income and expenses of
 Post-closing Trial Balance the period (eg. accruals for income and
- this is prepared after the closing process. It expenses)
contains real accounts only. b) To split mixed accounts into their real and
nominal elements (eg. adjustments to
prepayments and unearned income)
 METHODS OF INITIAL RECORDING

INCOME EXPENSES

Advanced collections of income may initially be Prepayments of expenses may initially be recorded
recorded using either: using either:

a) liability method or the b) income method a) asset method or the b) expense method
LIABILITY METHOD INCOME METHOD ASSET METHOD EXPENSE METHOD

Advanced collections of Advanced collections of Prepayment of expenses Prepayment of expenses

income are initially income are initially are initially debited to an are initially debited to an
credited to a liability credited to an income asset account. expense account.
account. account.
At the end of the period, At the end of the period,
At the end of the period, At the end of the period, the incurred portion (used the unused portion (not
the earned portion is the unearned portion is up or expired) is yet incurred or unexpired)
recognized as income recognized as a liability recognized as expense is recognized as asset
while the unearned while the earned portion while the unused portion while the incurred portion
portion remains as liability remains as income remains as expense remains as expense.

ILLUSTRATION 1 ILLUSTRATION 2

A business rents out its building. On April 1 20x1, the A business prepays one-year insurance for 120,000
business receives one year rent in advance of on October 1, 20x1. The prepayment of insurance is
120,000. The rent per month is 10,000. recorded as follows
ASSET METHOD EXPENSE METHOD
The receipt of the advance rent is recorded as follows Oct. 1, 20x1 Oct. 1, 20x1
LIABILITY METHOD INCOME METHOD
April 1, 20x1 April 1, 20x1 Prepaid Insurance 120,000 Insurance Expense 120,000
Cash 120,000 Cash 120,000
To record the To record the
Cash 120,000 Cash 120,000 prepayment of one year
prepayment of one year
Unearned rent 120,000 Rent Income 120,000 insurance insurance
To record the receipt of To record the receipt
1 year rent in advance. of 1 year rent in advance. Adjustment on December 31, 20x1
Adjustment on December 31, 20x1 BEFORE (Incurred portion - Expense)
ADJUSTMENTS: 30,000 (120,000 x 3/12)
(Earned portion - Income) Oct. 1 to Dec. 31, 20x2
BEFORE 90,000 (120,000 x 9 / 12)
ADJUSTMENTS: April 1 to Dec 31, 20x1 Mixed account
120,000 (Not yet incurred portion -
Mixed account One year prepaid insurance Asset)
120,000 (Unearned portion -
90,000 (120,000 x 9 / 12)
One year rent in advance Liability)
Jan 1 to Sept. 30, 20x1
30,000 (120,000 x 3/12)
Jan 1 to March 31, 20x2

The adjusting entries on December 31, 20x1

The adjusting entries on December 31, 20x1
ASSET METHOD EXPENSE METHOD
LIABILITY METHOD INCOME METHOD December 31, 20x1 December 31, 20x1
December 31, 20x1 December 31, 20x1
Insurance Expense 30,000 Prepaid Insurance 90,000
Prepaid Insurance 30,000 Insurance Expense 90,000
Unearned rent 90,000 Rent Income 30,000 To recognized the expired To recognized the unexpired
Rent income 90,000 Unearned Rent 30,000 portion of the one year insurance portion of the one year insurance
To recognized the To recognized the
earned portion of the one unearned portion of the
year rent in advance one year rent in advance
 WORKSHEET POST CLOSING TRIAL BALANCE

An analytical device used to facilitate the gathering of data The post closing trial balance is prepared in order to
for adjustments and the preparation of financial prove the equality of debits and credits in the ledger
statements and closing entries. after the closing process.

It contains statement of financial position accounts

FINANCIAL STATEMENTS
only because all the income statement accounts are
already closed.
The end products of the accounting process.
The post-closing trial balance contains the balances
The means by which the information accumulated and that are extended to the next accounting period.
processed in financial accounting is periodically
communicated to the users. REVERSING ENTRIES

Complete set of financial statements consists of: Reversing entries are entries usually made on the first
day of the accounting period to reverse certain
1. Statement of Financial Position adjusting entries in the immediately preceding period
2. Statement of profit or loss and other
comprehensive income Purposes of Reversing Entries
3. Statement of changes in equity
4. Statement of Cash Flows a. To facilitate recording of cash receipts and
5. Notes; a) comparative information disbursements in the next accounting period
6. Additional statement of financial position b. To promote convenience in recording the next
(required only when certain instances occur) period’s year end adjustments for accruals
c. To promote consistency of accounting
HEADING OF FINANCIAL STATEMENTS procedures

a. Name of the reporting entity Adjusting Entries that may be reversed:

b. Title of the financial statement
c. Reporting period 1. Accruals for income and expense
2. Prepayments initially recorded using the expense
1) Statement of As of (or As at) method
Financial Position December 31, 20x1 3. Advanced collections initially recorded using the
2) Statement of profit income method
or loss and other For the year ended
comprehensive December 31, 20x1
income
3) Statement of For the year ended
changes in equity December 31, 20x1
4) Statement of Cash For the year ended
Flows December 31, 20x1
5) Notes December 31, 20x1

CLOSING ENTRIES

Closing the books is the process of preparing closing

entries for nominal accounts and ruling and balancing
real accounts.

Closing entries are entries prepared at the end of the

accounting period to zero out all temporary or nominal
accounts in the ledger.

This is done so that the transactions in a period will

not commingle with the next period’s transactions.
 CHAPTER 2 POSTDATED CHECKS
CASH AND CASH EQUIVALENTS
 do not qualify as cash
CASH
 because postdated checks are not presently
available for immediate use.
Cash includes money or its equivalent that is readily
available for unrestricted use.  They will only be available for use at a future
date.
Money is the standard medium of exchange and the
basis of accounting measurements. Example:

Other negotiable instruments that can be used to December 31, 20xx

settle obligations and are readily available for
unrestricted use may form part of cash Cash on hand includes a 20,000 customer check
dated January 10, 20x2
Refers to undeposited
collections awaiting Cash on hand - 100,000
CASH ON HAND deposit and other current Postdated check - 20,000
funds held as of the Updated cash on hand = 80,000
reporting date
Refers to deposits in
UNUSED CREDIT LINE
banks that are available
CASH IN BANK for immediate
withdrawals and  not included as cash
unrestricted use
 but rather disclose only in the notes

EXAMPLES OF CASH:  It is the difference between the amount of line of

credit and the amount that was actually borrowed
1. Coins and currencies
2. Demand deposits (checking or current accounts) Line of credit - an amount of money a company is
and savings account allowed to borrow during a particular period of time
3. Checks - such as Cashier’s checks, Personal from one
checks, Manager’s checks, Traveler's check, and
Certified checks received from customers or other Example:
external parties
4. Bank Drafts - guarantees by bank to advance funds Line of credit of 100M. you borrowed 70M. The
on the demand by the party to whom the draft was difference, which is 30M is the unused credit line.
directed
5. Money orders - similar to bank drafts but are drawn UNRELEASED CHECKS DRAWN and
from post offices or other financial institutions POSTDATED CHECKS DRAWN
6. Cash funds set aside for use in current operations
such as:
a) Petty cash fund When checks drawn are either:
b) Revolving fund
c) Payroll fund  Unreleased or undelivered to the payee
 Postdated
d) Change fund
e) Dividend fund
No payment has actually made.
f) Tax fund
g) Travel fund
h) Interest fund Therefore, an adjusting entry is needed to return back
the unreleased check or postdated check to cash and
accounts payable.
Examples of items not included as cash:
Example:
1. Postdated checks - checks dated at a future date
2. IOUs or advances to employees
10,000 dated today but not yet to be delivered to
3. Cash funds not available for use in current
payee
operations such as sinking fund, plant expansion fund,
depreciation fund, insurance fund, etc
15,000 was delivered to payee today but the check is
4. Postage stamps
dated 100 years from now
 Initial Entry: CASH EQUIVALENTS

Accounts Payable 10,000 Short term, highly liquid investments that are readily
Accounts Payable 15,000 convertible to known amounts of cash.
Cash 25,000
Only debt instruments acquired within 3 months or
A. Since the check is still on hold less before their maturity date can qualify as cash
B. The check is postdated 100 years from now equivalents.

The amounts are reverted back to cash A. Treasury bills, notes, or bonds acquired 3 months
before maturity date
Adjusting Entry:
TREASURY BILL
Cash 25,000 - short term obligation issued by the government at a
Accounts Payable 10,000 discount.
Accounts Payable 15,000
- normally have a maturity of 90 days to less than a
year

STALE CHECKS TREASURY NOTES & TREASURY BONDS

- long term obligations issued also by the government
Checks delivered to payees that are not encashed
- Treasury notes, have a maturity of 1 year to less
within a long period of time, normally 6 months or
than 10 years
more.
- Treasury bonds, have a maturity of 10 years or more
Stale checks are reverted back to cash.
B. Money market instrument or commercial paper
acquired 3 months before maturity date

Summary: MONEY MARKET INSTRUMENTS

- investments in portfolios of short term securities

COMMERCIAL PAPERS
money or its equivalent that is readily available for - consists of short term, unsecured, notes payable
unrestricted use. issued in large denominations by large companies
CASH ON HAND CASH IN BANK WORKING FUND with high credit ratings
cash funds set
Avail for -Maturity date: normally less than 270 days and is
Undeposited cash aside for
immediate traded in money market, thus, highly liquid.
collections use in current
withdrawal C. 3 month time deposit
operations
Cash in checking TIME DEPOSITS
Coins and bills Petty cash fund
accounts - Time deposits are highly secured investment
Cash in savings accounts that allow your money to grow at a reliable
Customer checks Change fund
accounts interest rate.
Travelers checks Payroll fund
Managers checks Dividend fund - evidenced by a certificate of deposit.
Cashiers checks Tax fund
Bank drafts Interest fund EQUITY SECURITIES
Money orders Travel fund
(investments in stocks) cannot qualify as cash
Postdated check received from Excluded from equivalent because shares of stocks do not have a
customer cash maturity date.
Undelivered check drawn Included in cash REDEEMABLE PREFERENCE SHARES
Postdated check drawn Included in cash
Stale checks Included in cash
Acquired 3 months before their specified redemption
date can qualify as cash equivalents because
redeemable preference shares are debt instruments.
 MEASUREMENT OF CASH BPI 5,000,000 BPI 1M
BDO 4,000,000 BDO 1 400k
 Cash is measured at face amount / face value RCBC (overdraft) 100k BDO 2 (overdraft) (50k)

 Cash deposits in foreign currency are measured Cash in Bank - 9,000,000 Cash In Bank - 1,350,000
using the exchange rate in effect of the end of the
reporting period Current Liability - 100,000

 Cash maintained in a bank undergoing

bankruptcy is excluded from cash and presented INTERNAL CONTROLS OVER CASH
as receivable measured at realizable value

Realizable value is the net amount of money that you INTERNAL CONTROL
will to get from selling one of your assets. - any action or process effected by management that
is designed to help an entity achieve its objectives.

DEPOSIT IN FOREIGN BANKS A. Reliability of financial reporting

B. Effectiveness and efficiency of operations
C. Compliance with laws and regulations
 Unrestricted deposits in foreign banks that are
D. Safeguarding of assets
available for immediate withdrawal are included
Examples of internal controls over cash:
as cash at face amount translated at the current
exchange rate
Duties of:
COMPENSATING BALANCE
1. Segregation of A. Authorization
incompatible duties B. Execution
A minimum amount that must be maintained in an C. Recording
entity's bank account as support for funds borrowed D. Custody over cash
from the bank.
should be segregated
Compensating balance that are legally restricted as to
withdrawal by the borrower are excluded from cash
Requires all cash receipts
Compensating balance that are not legally restricted should be deposited intact
as to withdrawal are included in cash. 2. Imprest System and all cash disbursement
should be made through
BANK OVERDRAFT checks

- a negative (credit) balance in the cash in bank a document that compares

account resulting from overpayment of checks in the cash balance on a
excess of the amount of deposit 3. Bank Reconciliation company’s balance sheet to
the corresponding amount
- occurs when there is not enough money in an on its bank statement.
account to cover a transaction but the bank allows it
anyway. 4. Cash counts
5. Minimum cash balance
- payable on demand. presented as current liabilities 6. Lockbox accounts
7. Non-encashment of personal checks from petty
RULE ON OVERDRAFT cash fund
- should not be offset against other bank accounts
with debit balances An internal control over all
cash disbursements. Under
EXCEPTION TO THE RULE this system, a voucher is
- when an entity maintains two or more accounts in 8. Voucher system prepared for every cash
one bank, and one account results in an overdraft, disbursement in order to
such overdraft can be offset against other bank ensure that each
account with a debit balance disbursement is properly
authorized, made for valid
expenditure, and properly
recorded.
 LAPPING
ACCOUNTING FOR CASH SHORTAGES
AND OVERAGES

CASH SHORTAGE
When the cash count results to an amount less than the
balance per records

Initially debited to a suspense account called “Cash

shortage or overage” pending proper investigation of the
cause of shortage.

Cash shortage or overage xxx

Cash on hand xxx Using a bank lockbox system and segregation of duties can
help prevent it from happening
“Cash shortage or overage” account is closed to either a KITTING
nominal or real account.
Disbursement per book and receipt per book should
Suspense accounts should not appear in the financial be recorded in the same period.
statements.

A. Closed to a “Receivable” account if the shortage was Disbursement per bank and receipt per bank should
due to the fault of an employee be recorded in the same period.
B. Charged to “Loss” if the investigation was without merit.
Entry to close the suspense account:
Not kitting
Receivable from cashier/Loss on cash shortage xxx
Cash shortage or overage xxx

CASH OVERAGE
When the cash count results to an amount more than the
balance per records.
Kitting
Initially credited to a suspense account called “Cash
shortage or overage” pending proper investigation of the
cause of overage.
A. Closed to a “Payable” account if the overage was due to
cash belonging to an employee that was commingled with
the entity's cash
B. Charged to “Gain” if the investigation was without merit.

CONCEALMENT OF CASH SHORTAGES If the receipt is recorded in the current period

(December) but the Disbursement is recorded in the
Cash shortages are fraudulently concealed in: next period (January) the balance of cash as of
year-end (Dec 31) is overstated. This indicates Kiting.
LAPPING KITTING
a fraudulent practice that Occurs when cash If the receipt is recorded in the next period but the
involves an employee shortage is concealed by Disbursement is recorded in the current period the
altering accounts overstating the balance of balance of cash as of year-end is understated. This
receivables to hide stolen cash. indicates does not indicate kiting.
cash.
Kitting occurs when a
Using funds from today’s check is drawn against a
receipts to pay first bank and depositing
yesterday’s Accounts the same check in a
Receivable second bank to cover the
shortage in the latter
bank
 PETTY CASH
Summary: The PCF account is:
Petty cash fund is a small amount of money available DEBITED CREDITED
for paying small expenses without writing a check. When it is initially
established
For example, When the fund is not
replenished but adjusted
An entity may provide for a policy that all prior to the preparation of
disbursements amounting 5,000 or more should be financial statements
made through checks while disbursements below When it is subsequently When it is subsequently
5,000 may be made through petty cash fund increased (through a decreased (through a
board resolution) board resolution)
ACCOUNTING FOR PETTY CASH FUND Petty cash fund is unaffected when disbursements
are made out of the fund
A. Petty cash fund is established

Petty cash fund xxx

Cash in bank xxx
SHORTAGE IN PETTY CASH FUND
B. Disbursement out of the petty cash fund
Various expense accounts xxx
Cash shortage or overage xxx
NO ENTRY
Cash in bank xxx
OVERAGE IN PETTY CASH FUND
Petty cash payments are initially recorded in a petty
cash register (ex. Log book) and supported by signed
Various expense accounts xxx
petty cash vouchers.
Cash shortage or overage xxx
Cash in bank xxx
C. Replenishment of petty cash disbursements

The PCF is replenished when its balance becomes

PCF illustrations page 69 -73
low. This time a journal entry is made for
disbursements during the period that were initially
recorded in the petty cash register.

Various expense account xxx

Cash in bank xxx

D. Adjustment for unreplenished fund at reporting

date

Various expense accounts xxx

Petty cash fund xxx
E. Subsequent changes in ledger balance of PCF

To increase PCF balance

Petty cash fund xxx

Cash in bank xxx

To decrease the PCF balance

Cash in bank xxx

Petty cash fund xxx
 CHAPTER 3 A. Cash balance per books, 300,000
B. Cash balance shown on the bank statement - 430k
BANK RECONCILIATION C. Credit memo - 190,000
D. Debit memo - 30,000
E. Deposits in transit - 50,000
BANK RECONCILIATION STATEMENT F. Outstanding checks - 25,000 (including certified
checks of 5,000)
 is a report that is prepared for the purpose of
bringing the balances of cash (a) per records and
(b) per bank statement into agreement.

 Prepared on a monthly basis

 Required only for checking accounts

Bank statement - a report issued by the bank that

shows the deposits and withdrawals during the
period and the balance of a depositors bank account

RECONCILING ITEMS

Balance per book Balance per bank

Cash balance in your accounting book - 520,000
+ Credit Memos + Deposit in transit
Cash balance shown on the bank statement - 410,000
- are additions (bank - are deposits made
credits) made by the but not yet credited
A. 45,000 issued to supplier but not yet presented to
bank to the depositors by the bank to the
the bank for payment
bank account but not depositors bank
B. 205,000 check deposit, is not yet credited to your
yet recorded by the account.
account
depositor
C. A customer deposited 60,000 to you bank account.
 Collections
 Notes collected by forwarded to bank You have not yet recorded this collection of account
bank  Collections on receivable in your accounting books
 Proceeds of bank hand D. The bank paid 10,000 monthly mobile phone
loan charges directly out of your account
 Matured time
deposits A. Outstanding check - 45,000
 Interest income B. Deposit in transit - 205,000
earned by the C. Credit memo - 60,000
deposit D. Debit memo - 10,000
- Debit Memos - Outstanding Checks
- are deductions (bank - are checks drawn
debits) made by the and released to
bank to the depositors payees but not yet
bank account but not encashed with the
yet recorded by the bank
depositor
 Certified checks
 Bank service  Stale checks
charges
 No sufficient funds
checks
 Payment of loans
 Automatic debits
 Defective checks
+ Book errors + Bank errors
= Adjusted balance = Adjusted balance
 BANK ACCOUNT BANK STATEMENT
Debit Credit Balance

+ - - +

RECORDS OF THE BUSINESS RECORDS OF THE BANK

We have money in the bank – our
→ We have money in the bank – the bank
bank balance is favourable (debit
owes us the money (credit balance)
balance)
→ a Liability for the bank
→ an Asset for the business

We owe the bank money – our bank

→ We owe the bank money – we are a debtor
balance is in an overdraft (credit
to the bank (debit balance)
balance)
→ an Asset for the bank
→ a Liability for the business

Deposits are debits – they increase → Deposits are credits – they increase the
the Asset bank’s liability

Cheque payments are credits – they → Cheque payments are debits – they
decrease the Asset decrease the bank’s liability

RULES OF ERRORS

BOOK ERRORS
Nature of error Effect on Cash Bal, end Correction
Book credit (DISBURSEMENT)
Understatement Overstatement Credit (Deduct)
Overstatement Understatement Debit (Add)
Book debit (RECEIPTS)
Understatement Understatement Debit (Add)
Overstatement Overstatement Credit (Deduct)

BANK ERRORS
Nature of error Effect on Cash Bal, end Correction
Bank credit (RECEIPTS)
Understatement Understatement Credit (Add)
Overstatement Overstatement Debit (Deduct)
Bank debit (DISBURSEMENT)
Understatement Overstatement Debit (Deduct)
Overstatement Understatement Credit (Add)

ILLUSTRATION: ERRORS

 Cash balance per books, 560,000

 Cash balance per bank statement - 640,000
 Credit memo - 40,000
 Debit memo - 30,000
 Deposits in transit - 150,000
 Outstanding checks - 50,000
 Disbursement per book, overstated, 90,000
 Bank debits, understated, 80,000
 PROOF OF CASH

 An expanded bank reconciliation that includes proof of cash receipts and cash disbursements.

 Proof of cash is prepared only when needed - usually in fraud investigations involving cash

PER BOOK BEG BALANCE RECEIPTS DISBURSEMENTS END BALANCE

Book Balance
Book Debits
Book Credits
Credit Memos
Bank Charges
Book Errors
Adjusted Balance

PER BANK BEG BALANCE RECEIPTS DISBURSEMENTS END BALANCE

Bank Balance
Bank Debits
Bank Credits
Deposit in Transit
Outstanding Checks
Bank Errors
Adjusted Balance

31-Mar 30-Apr
Book balance 400,000 540,000
Book debits 180,000
Book credits 40,000
Bank balance 280,000 440,000
Bank debits 30,000
Bank credits 190,000
Credit memos 36,000 23,000
Bank charges 10,000 16,000
Deposit in transit 169,000 136,000
Outstanding checks 23,000 30,000
 ABNORMAL BALANCES IN ACCOUNTS
CHAPTER 4
CREDIT BALANCE IN ACCOUNTS
RECEIVABLE DEBIT BALANCE IN ACCOUNTS PAYABLE
Resulting from: Resulting from:
 Overpayments  Overpayments
 Advance payments  Advance payments
 Error  Error

Credit balances in customers accounts (Accounts Debit balances in suppliers accounts (Accounts
Receivable) are presented as current liabilities and Payable) are presented as part of current assets and
not offset against receivables. not offset against payables.

In daily transactions, Customers accounts in the In daily transactions, Suppliers accounts in the
subsidiary ledger are credited for all cash receipts subsidiary ledger are debited for all cash payments
(whether for collection of recorded receivables or (whether for the settlement of recorded payables or as
advance payment) advance payment for the future purchase of goods)

When a customers account is credited for the amount When a suppliers account is debited for an amount
exceeding the outstanding debit balance, a credit exceeding the outstanding credit balance, a debit
balance would result. balance would result.

For example, For example,

ABC Co. has an outstanding receivable of 10,000 ABC Co. has an outstanding payable of 12,000 from
from Customer A. Customer A remits 16,000 to ABC Supplier B. ABC Co. pays 17,000 to Supplier B
Co, representing payment for the existing receivable representing settlement of the existing payable and
and the excess as advance payment for the future the excess as advance payment for the future
delivery of goods. purchase of goods.

ABC Co. will record collection as follows: ABC Co. will record collection as follows:

Cash 16,000 Accounts Payable - Supplier B 17,000

Accounts Receivable - Customer A 16,000 Cash 17,000
Subsidiary ledger will have the following balance: Subsidiary ledger will have the following balance:

Adjusting journal entry to eliminate credit balance to Adjusting journal entry to eliminate debit balance to
customers As account. Supplier Bs account.

Accounts Receivable - Customer A 6,000 Advance to suppliers 5,000

Advance from customers 6,000 Accounts Payable - Supplier B 5,000
After posting the AJE, the credit balance is eliminated and the
accounts receivable from Customer A will have a zero After posting the AJE, the debit balance is eliminated and the
balance. The “Advances from customers” account is included account will have a zero balance. The “Advances to suppliers”
in current liabilities as part of non trade payables. account is included in current assets as part of non trade
receivables.
 Cash 1,000
TERMS OF SALE OF CONTRACT Accounts Receivable 1,000
To record settlement of Accounts Receivable

B. FOB Destination, freight prepaid

The terms of a sale contract are considered when
determining the timing if transfer of control over the Dec. 31, 20x1
goods sold.
Prepaid Freight 10
FOB SHIPPING POINT FOB DESTINATION Cash 10
Ownership over the Ownership is transferred To record prepayment of freight to the carrier
goods sold is transferred only when the buyer
Jan 2
to the buyer upon receives the goods.
shipment. Accounts Receivable 1,000
A seller ships goods on December 29, 20x1 and the Sales 1,000
customer receives the shipment on January 2, 20x2 To record sales on account
If the sales term is FOB If the sales term is FOB
SHIPPING POINT, DESTINATION, accounts Jan 2
accounts receivable and receivable and sales are
sales are recognized on recognized only on Freight out 10
December 29, 20x1 January 2,20x2 (date of Prepaid freight 10
(date of shipment) receipt of delivery) To charge prepaid freight to expense

The goods are excluded The goods in transit are Jan 5

from the sellers year end included in the sellers
inventory Dec 31, 20x1 inventory Cash 1,000
Accounts Receivable 1,000
To record settlement of accounts receivable
FREIGHT PREPAID FREIGHT COLLECT
Means the seller has paid Means the freight is not
C. FOB Shipping point, freight prepaid
the freight in advance yet paid upon shipment.
before shipment. The carrier will collect the Dec 31, 20x1
shipping cost from the
However, this does not buyer upon delivery. Accounts Receivable 1,010
mean the seller is the one Sales 1,000
who is supposed to pay However, this does not Cash 10
for the freight. mean the buyer is the one To record the sale on account and freight paid
who is supposed to pay on behalf of the buyer
for the freight.
The entity who owns the goods being shipped should Jan 5, 20x2
pay for the shipping cost
Cash 1,010
FREIGHT TERM WHO
SHOULD
WHO
ACTUALLY
Accounts Receivable 1,010
PAY PAY To record collection of account receivable
FOB DESTINATION - FREIGHT COLLECT SELLER BUYER inclusive of reimbursement for the freight paid
FOB DESTINATION - FREIGHT PREPAID SELLER SELLER
FOB SHIPPING POINT - FREIGHT COLLECT BUYER BUYER
FOB SHIPPING POINT - FREIGHT PREPAID BUYER SELLER D. FOB Destination, freight collect

On Dec. 27, 20x1, ABC Co. Received a sale order for a credit Jan 2, 20x2
sale of goods with selling price of 1,000 ABC Co. Shipped the
goods on Dec. 31, 20x1. The buyer received the goods on Accounts Receivable 990
January 2, 20x2. The related shipping costs amounted to 10. Freight out 10
ABC Co. Collected the receivable on January 5, 20x2 Sales 1,000
To record sale on account and freight
A. FOB Shipping point, freight collect accommodated by the buyer

Dec. 31, 20x1 Jan. 5, 20x2

Accounts Receivable 1,000 Cash 990

Sale 1,000 Accounts Receivable 990
To record sale on account To record collection of accounts receivable
net of reimbursement for the freight

Jan 5, 20x2
 TRADE DISCOUNTS CASH DISCOUNTS An entity sells inventory with a list price of 10,000 on
Reduction is given in the list Allowance is given to the account under credit terms of 20%, 10%, 2/10, n/30
price (catalogue price) of the customer by the seller on the GROSS METHOD NET METHOD
goods by the manufacturer to invoice price of the goods if
the wholesaler the payment is made
1. Sale on account
immediately Accounts Receivable 7,200 Accounts Receivable 7,056
Sales 7,200 Sales 7,056
Given as a result of common Given as an incentive for early
trade practices, especially or immediate payment
(10,000 x 80% x 90%) (10,000 x 80% x 90% x 98%)
where bulk deals take place
Given to promote sales Given to recover payments 80% = 100 - 20% trade discount 98% = 100 - 2% cash discount
quickly 90% = 100 - 10% trade discount

2. Assume collection is made within the discount period

Cash 7,056 Cash 7,056
ACCOUNTING FOR CASH DISCOUNTS Sales discounts 144 Accounts Receivable 7,056
Accounts Receivable 7,200
 PFRS 15 Revenue from Contracts with
Customers 144 = 7,200 x 2%
 Traditional GAAP 3. Assume collection is made beyond the discount period
Cash 7,200 Cash 7,200
TRADITIONAL GAAP Accounts Receivable 7,200 Sales discount forfeited 144
1. Gross Method 2. Net Method Accounts receivable 7,056
Accounts receivable and Accounts receivable and
sales are initially sales are initially PFRS 15
recorded at amounts recorded at amounts net An entity sells inventory with a list price of 10,000 on
gross of cash discounts. of cash discounts. account under credit terms of 20% , 10% , 2/10, n/30.
The entity estimates only 80% of the cash discount
Cash discounts are Cash discounts not taken will be taken .
recorded only when they by the buyer are credited
are taken by the buyer to the “Sales discounts Invoice amount (10,000 x 80% x 90%) 7,200
forfeited” account and Multiply by 2%
included as part of “other Total available discount 144
income” or “finance Multiply by: 80%
income” Cash discounts Discount expected to be taken: 115.80
taken by the buyer are
not accounted for. Invoice amount 7,200
An entity sells inventory with a list price of 10,000 on Less: discount expected to be taken (115.80)
account under credit terms of 20%, 10%, 2/10, n/30 Transaction price 7,084.80
20%, 10% 2/10 n/30
Page 164 -165
Deducted from the list 2/10 - means the buyer is
price when determining entitled of 20% cash ACCOUNTING FOR BAD DEBTS
the invoice price discount off the invoice
price if he pays within the
discount period of 10 ALLOWANCE METHOD DIRECT WRITE OFF
days METHOD
An allowance is Records bad debt
n/30 - means the buyer is recognized for bad debts expense only when an
given a credit period of up expense when the account is judged to be
to 30 days. Failure to pay collectability of accounts worthless
within 30 days renders become questionable
the account as past due. No entry is made for
Bad debt expense are accounts that are merel
recognized when they doubtful of collection
become probable so as
not to overstate Not acceptable for
receivables dinancial reporting
purposes.
When certain accounts
are worthless the Favored for taxation
accounts are written off purposes
 PERCENTAGE OF RECEIVABLES
ALLOWANCE METHOD DIRECT WRITE OFF 174 -177
1. Collectibility become doubtful AGING OF RECEIVABLES

Accounts receivable of 10,000 is found to be doubtful 1. Aging based on days outstanding

of collection
Bad Debt Expense 10k NO ENTRY
Allowance for bad debts 10k
2. Write off

The 10,000 doubtful account is deemed worthless and

needs to be written off
Allowance for bad debts 10k Bad debt expense 10k
Accounts Receivable 10k Accounts Receivable 10k
3. Recovery

The 10,000 account previously written off is

subsequently recovered
Accounts Receivable 10k NO ENTRY
Allowance for Bad Debts 10k

Cash 10k Cash 10k

Accounts Receivable 10k Gain on Recovery 10k

Net realizable value /Carrying amount

301,000 = (310,000 - 9,000)

ESTIMATING DOUBTFUL ACCOUNTS
2. Aging based on days past due

PERCENTAGE OF NET CREDIT SALES

Bad Debt Expense = Percentage x Net Credit Sales

To record bad debt expense:

Bad debt expense 9,900

Allowance for doubtful accounts 9,900

Net realizable value of AR

Accounts Receivable, Dec. 31 - gross 150,000

Allowance for doubtful accounts, Dec 31 (13,900)
Accounts Receivabale, Dec 31 - net 136,100