1- Establish and Maintain Accrual Accounting System (1).pdf

FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 As you studied in previous financial services courses, there are different types of accounts to operate the company’s activities. These accounts are classified as foll...

FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 As you studied in previous financial services courses, there are different types of accounts to operate the company’s activities. These accounts are classified as following: Types of accounts 1. Asset accounts: the different types of economic resources owned or controlled by an entity. Common examples of asset accounts are cash, real estate, inventory, prepaid expenses, equipment, supplies, buildings, and accounts receivable. 2. Liability accounts: represent the different types of economic obligations of an entity, such as accounts payable, bank loans, bonds payable and accrued expenses. 3. Equity accounts: represent the residual equity of an entity (the value of assets after deducting the value of all liabilities). Equity accounts include common stock, capital, and retained earnings. 4. Revenue or income accounts represent the company's earnings and common examples include sales, service revenue and interest income. 5. Expense accounts represent the company's expenditures. Common examples are utilities, rents, depreciation, interest, and insurance. 6. Contra-accounts are accounts with negative balances that offset other balance sheet accounts. Examples are accumulated depreciation (offset against fixed assets), and the allowance for bad debts (offset against accounts receivable). To organize and classify all individual accounts within the general ledger there is an index or classification system known as the chart of accounts. A chart of accounts is a listing of the names of the accounts that a company has identified and made available for recording transactions in its general ledger. (Averkamp, 2016) There are a number of ways to establish the chart of accounts depends on the business size and nature. (e.g. three-digit codes, five-digit codes, seven- digit codes). FNA (805) 1|Page  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 Example of a company chart of account: Assets: 1000 to 1999. Liabilities: 2000 to 2999. Equity: 3000 to 3999. Revenues: 4000 to 4999. Expenses: 5000 to 5999. Example in chart of Account to establish debtors and creditors subsidiary ledgers: (Qamber & Ebrahim, 2010) FNA (805) 2|Page FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 Al Mahmood Trading Est. General Journal Date Explanation Ref Debit Credit May 01 Cash 20,000 Capital 20,000 Investment of additional cash 04 Account Receivable –Mariam 3200 Sales 3200 Sold goods on account 07 Equipment 6000 Account Payable - Almoaayed 6000 Bought equipment o account 15 Furniture 1800 Cash 1800 Bought furniture by cash 17 Account Recivable - Jamal 1700 Equipment 1700 Sold equipment on account 21 Account recivable –Nader 2900 Sales 2900 Sold goods on account 25 Sales return 800 Account recivable – Mariam 800 Goods returned from Mariam 26 Account payable – Almoaayed 1000 Cash 1000 Paid the part of the amount due to Almoaayed FNA (805) 3|Page  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 Using the same example above post the ledger Account Receivable and Account Payable: 1. Post them to the general ledger. (Subsidiary ledger) 2. Balance each general ledger account. FNA (805) 4|Page  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 What is invoice ? A commercial document that itemizes a transaction between a buyer and a seller. Types of invoices: SALES (debtors) PURCHASE (creditors) These are generally is the form These are invoices has been of invoices raised by a business received from a Creditor for and delivered to the customer goods or services provided to for payment within an agreed business and agree to pay within time frame. (Wikimedia time frame. Foundation, Inc., 2017) Account receivables Account payable Process and bank payment FNA (805) 5|Page  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 Invoice code: Invoice codes are necessary to ensure proper documentation of charges and income. The code should be present on each invoice issued, and should be numbered sequentially. The code could be a: Number (1000, 1001…) Number & letter (INB001, INB002, INB003…) It depends on the company policies and systems. Types of business document (source document) Invoice Cheque Receipt Memorandom Credit Notes Credit Cash Cash (Memo) Purchases Payments Receipts for Returns of of goods. for Revenue. Investment. goods or Expenses. assets sold Credit Sales Cash on of goods. Cash Receipts for account. Payments selling Drawings. for buying goods or Returns of goods or Assets. goods or Assets. assets Cash bought on Cash Receipts account. Payments from to Accounts Accounts Receivable Payable.. FNA (805) 6|Page  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 Summary of mostly important Journal Entries for Business Documents Transaction Document Journal entry Invoice Dr. purchases Credit purchases of goods (received ) Cr. accounts payable Invoice Dr. accounts receivable Credit sales of goods (issued) Cr. sales Dr. accounts payable Return of goods or assets Credit note Cr. purchases return or bought on account (received ) assets Return of goods or assets Credit note Dr. sales return or assets sold on account (issued) Cr. accounts receivable Example The following documents were received by the accountant of Nawal Cleaning Service during the month of September, 2013. You are required to enter these documents in the General Journal and post to Account Payable- Fahad Hypermarket FNA (805) 7|Page FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 FNA (805) 8|Page FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 GENERAL JOURNAL Date Explanation Debit Credit Sep 05 Account Receivable- Jassim 68 Service Revenue 68 Invoice #101 10 Cleaning supplies 1900 Account Payable- Fareed cold store 1900 Invoice #2030 18 Machine 720 Accounts Payable – Fahad Hypermarket 720 Invoice #5530 19 Account Receivable- Rashid Abdulla 60 Service Revenue 60 Invoice #102 21 Account Payable- Fahad Hypermarket 180 Purchase Return 180 Credit Note # 2502 FNA (805) 9|Page  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 Name of Account: Accounts Payable – Fahad Hypermarket.NO 201 Date Explanation PR Debit Credit Balance Sep. 18 720 720 21 180 540 Contra Account Overview: A contra account is an account found in an account ledger that is used to reduce the value of a related account. A contra account's natural balance is opposite of the associated account. The contra accounts in the balance sheet help the users of the financial statements to get complete information, relevant persons to manage contra deals may include Accountant, Debtors, and Owners. Examples of contra account procedures: Here are several examples of contra accounts, as they would be presented in the balance sheet: Accounts receivable $1,000,000 Less: allowance for doubtful accounts (50,000) Net accounts receivable $950,000 Updated debtor amount FNA (805) 10 | P a g e  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 Name of Account: Account Receivables account (General Ledger) Date Explanation PR Debit Credit Balance Balance 1,000,000 31 Dec. Allowance for 50,000 950,000 doubtful debts Introduction of Doubtful Debts: When a company directly grants credit to its customers, it expects that some customers will not pay what they promised. The accounts of these customers are uncollectible accounts and called Bad Debts. These accounts receivable that harder to be collected become the company’s Uncollectible Accounts Expense, or Bad Debts Expense. Methods of Uncollectible Accounts (Bad Debts) Any business firm should carefully evaluate a customer’s financial condition and credit history before selling to that customer on account. But in spite of the care taken before granting credit, occasionally there will be customers who cannot or will not pay their account. The two most common ways of accounting for uncollectible accounts are: 1- Direct write-off method The direct write-off method recognizes bad accounts as an expense at the point when judged to be uncollectible. 2- Allowance method The allowance method provides in advance for uncollectible accounts think of as setting aside money in a reserve account. In this standard, we will explain the allowance method. FNA (805) 11 | P a g e  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 Steps in allowance method: 1. Recording estimated uncollectible 2. Recording The write – Off of uncollectable account 3. Recovery of uncollectible Accounts First step: Recording estimated uncollectible An example: Assume that Bahrain furniture has Account receivables BD 200,000 at December 31 2016. The credit Manager estimated that BD 12000 of these account receivable will be uncollectible. The adjusting entry to record the estimated uncollectible is: Date Explanation Debit Credit 31 Dec 2016 Bad debts Expense 12000 Allowance for Doubtful Accounts 12000 Bad debts expense is reported in income statement as an operating expense. Allowance for Doubtful Accounts is reported in balance sheet as a contra account, it deducted from account receivable in the current assets section of the balance sheet as show: Bahrain Furniture Balance sheet Account receivable BD 200,000 Less : Allowance for doubtful debt 12000 Net Account receivable 188000 FNA (805) 12 | P a g e  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 Note: Net account receivable is the net amount expected to be received in cash." it exclude amounts that the company estimated it will not be collected Second Step: Recording the write – Off of uncollectable account There are different methods of collecting past-due accounts: Insure that the customer receives the invoice Follow-up calls – Determine reasons for nonpayment of invoice amount and appropriate follow-up action Sending demand letters. Legal action (The Research Foundation of State University of New York , 2005 ) When all means of collecting a past-due account have been exhausted and collection appears impossible the account should be written off. Each write -off should be formally approved by management. For Example: the manager of finance department on Bahrain Furniture authorized a write-off of BD500 balance owned by R.A Ware on March 1 2017. The entry to record the write -off is: Date Explanation Debit Credit 1 Mar 2017 Allowance for Doubtful Accounts 500 Account Receivable – R.AWare 500 FNA (805) 13 | P a g e  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 The entry to record write-off of an uncollectible account reduces both Account Receivable and allowance for Doubtful Accounts. After posting, the general ledger account will appear as follow: Allowance for Doubtful Account Receivable Accounts Jan1 Bal. Mar. 1 Mar 1 500 Jan 1 Bal. 200,000 500 12,000 Bal. 199,500 Bal. 11,500 Third step: Recovery of uncollectible Accounts A bad debt recovery: is business debt from a loan, credit line or accounts receivable that is recovered either in whole or in part after it has been written off or classified as a bad debt. Because it generally generates a loss when it is written off, a bad debt recovery usually produces income. (IAC (NASDAQ: IAC), ) Occasionally, a company collects from a customer after the account has been written off two entries are required to record the recovery of the bad debts: 1- The entry made in writing off the account is reversed to reinstate the customer's account 2- The collection is journalized in the usual manner FNA (805) 14 | P a g e  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 For example, On July 1 R.A Ware pays the BD 500 amount that had been Write –off on March 1. These entries: Date Explanation Debit Credit July 1 Account Receivable – R.AWare 500 Allowance for Doubtful Accounts 500 (to reverse the write-off of R.A ware account ) July 1 Cash 500 Account Receivable – R.AWare 500 (To record the collection from R.A Ware ) Note that the recoveries of bad debts, like the write-off of bad debts, affect only the balance sheet account FNA (805) 15 | P a g e  FNA Financial Services and accounting Establish and maintain an accrual accounting system 805 References Averkamp, H. (2016). Introduction to Chart of Accounts. Retrieved from AccountingCoach Website: http://www.accountingcoach.com/chart-of- accounts/explanation Bragg, S. (2013, March 9). What is Contra Account ? Retrieved March 14, 2017, from Accounting Tools: http://www.accountingtools.com/questions- and-answers/what-is-a-contra-account.html IAC (NASDAQ: IAC),. (n.d.). Bad Debt Recovery. Retrieved from INVESTOPEDIA: http://www.investopedia.com/terms/b/bad-debt- recovery.asp J.Weygandt, J., E.Kieso, D., & D.Kimmel, P. (2002). Accounting Principles. Canada: Johon Wiley & Sons , Inc. Qamber, E. A., & Ebrahim, A. A. (2010). PRINCIPLE OF ACCOUNTING. MANAMA: MINISTRY OF EDUCATION. Qamber, E., & Abdulwahab, A. (2010). Principles of Accounting. Kindom Of Bahrain: Ministry of Education. The Research Foundation of State University of New York. (2005 , June 24). Identifying and Collecting Past Due Accounts Receivable Invoices. Retrieved March 14, 2017, from RFSUNY: https://www.rfsuny.org/media/RFSUNY/Procedures/ar_identifying- collecting-past-due-accounts-receivable-invoices_pro.htm Wikimedia Foundation. (2017, February 21). Chart of accounts. Retrieved March 14, 2017, from Wikipedia: https://en.wikipedia.org/wiki/Chart_of_accounts Wikimedia Foundation,. (2017, March 6). Asset. Retrieved from Wikipedia: https://en.wikipedia.org/wiki/Asset Wikimedia Foundation, Inc. ( 2017, February 19 ). Invoice processing. Retrieved from Wikimedia : https://en.wikipedia.org/wiki/Invoice_processing All copyrights reserved to the owners of the indicated references FNA (805) 16 | P a g e