Service Entity Accounting Module PDF

Table of Contents {#table-of-contents.TOCHeading} ================= [**Topic 1: Accounting Equation and Double-entry System** 1](#topic-1-accounting-equation-and-double-entry-system) [**Recognition and Derecognition principle** 2](#recognition-and-derecognition-principle) [Elements of Financial S...

Table of Contents {#table-of-contents.TOCHeading} ================= [**Topic 1: Accounting Equation and Double-entry System** 1](#topic-1-accounting-equation-and-double-entry-system) [**Recognition and Derecognition principle** 2](#recognition-and-derecognition-principle) [Elements of Financial Statements 2](#elements-of-financial-statements) [Exercises: Accounting Equation and Double-entry System 9](#exercises-accounting-equation-and-double-entry-system) [Topic 2: Accounting Cycle of Service Entity 12](#topic-2-accounting-cycle-of-service-entity) [Analyzing Transactions 12](#_Toc52764232) [Exercises: Analyzing Transaction 14](#exercises-analyzing-transaction) [Journalizing transactions 15](#journalizing-transactions) [Posting or Accumulating 18](#_Toc52764235) [Exercises: Journalizing and Posting 20](#exercises-journalizing-and-posting) [Preparation of Unadjusted trial balance 23](#preparation-of-unadjusted-trial-balance) [LOCATING ERRORS IN THE TRIAL BALANCE 24](#locating-errors-in-the-trial-balance) [Exercises: Unadjusted Trial Balance 26](#exercises-unadjusted-trial-balance) [Preparation of Adjustments 29](#preparation-of-adjustments) [ADJUSTING ENTRIES FOR ACCRUALS 30](#_Toc52764241) [ADJUSTING ENTRIES FOR DEFERRALS 33](#_Toc52764242) [Exercises: Adjustments 44](#exercises-adjustments) [Preparation of Financial Statements / Adjusted Trial Balance 48](#preparation-of-financial-statements-adjusted-trial-balance) [The WORKSHEET 48](#the-worksheet) [Exercises: Worksheet 53](#exercises-worksheet) [Components of Financial Statements 55](#components-of-financial-statements) [Exercises: Statement of Cashflow 62](#exercises-statement-of-cashflow) [Closing Entries 64](#closing-entries) [Exercises: Closing Entries 67](#exercises-closing-entries) [Post-closing trial balance 68](#post-closing-trial-balance) [Reversing Entries 68](#reversing-entries) [Key to Correction: Accounting Equation and Double-entry System 69](#key-to-correction-accounting-equation-and-double-entry-system) [Key to correction: Analyzing Transaction 71](#key-to-correction-analyzing-transaction) [Key to Correction: Journalizing and Posting 72](#key-to-correction-journalizing-and-posting) [Key to correction: Unadjusted Trial Balance 76](#key-to-correction-unadjusted-trial-balance) [Key to correction: Adjustments 78](#key-to-correction-adjustments) [Key to Correction: Worksheet 89](#key-to-correction-worksheet) [Key to correction: Statement of cashflows 91](#key-to-correction-statement-of-cashflows) [Key to Correction: Closing Entries 92](#key-to-correction-closing-entries) Unit 1: Accounting Cycle of Service Industry Introduction: This unit discusses - The basic concept of accounting for Service industry - The Accounting Cycle of Service industry - The Basic Accounting Equation Essential Questions - What are the components of the Financial Statements for Service Entity? - What is the step by step process in the Accounting Cycle? - What is Double-entry system? - What is the Basic Accounting equation? Intended learning outcome - Discuss the steps in the Accounting Cycle - Discuss the application of the Double-entry system - Discuss the Basic accounting equation - Discuss the components of Financial statements - Discuss the elements of Financial statements Topic 1: Accounting Equation and Double-entry System ==================================================== In order to better understand the concept accounting, one needs to grasp the concept of Accounting Equation first. The basic accounting equation is: **Assets = Liabilities + Owner\'s Equity** The expanded version is: +-----------------------------------------------------------------------+ | Current Asset | | | | \+ | | | | Non-Current Asset | +-----------------------------------------------------------------------+ **Assets = Liabilities + Owner\'s Equity** +-----------------------------------------------------------------------+ | Current Liabilities | | | | \+ | | | | Non-Current Liabilities | +-----------------------------------------------------------------------+ ----------------------------------------------------------------- Beginning Capital + Income + Additional Investment - Withdrawal ----------------------------------------------------------------- This equation is the fundamentals of every journal entry thus, the foundation of the Financial Statements. The Accounting Equation is the product of the usage of **Double Bookkeeping System**, which means that in every transaction there is always two or more account affected, there is always a debit and a credit, that is why in every journal entry there is always at least one debit and one credit. **Recognition and Derecognition principle** =========================================== Before we discuss the meaning of the Elements of Accounting Equation, let us first discuss the ***Recognition and Derecognition concept.*** **Recognition-** the process of capturing for inclusion in the Financial Statements an item that **meets the definition** of an asset, a liability, equity, income or expense. In simple words, before an item be included in the financial statements it must meet the definition of one of the accounting elements. **Derecognition --** is the removal of all or part of recognized asset or liability from an entity\'s statement of financial position. Derecognition occurs when an item **no longer meets the definition** of an asset or liability In simple words, you will recognize an item if it meets a definition of one of the accounting elements, and derecognize an item if it no longer meets the definition of asset or a liability. It means that knowing the definition of each of the Accounting elements are important. Having said that let us discuss the Accounting Elements one by one. Elements of Financial Statements ================================ 1. **Asset**s **-- resource controlled by the enterprise** as a **result of past events** and from which **future economic benefits** are expected to flow to the enterprise. - *Resource controlled by the enterprise* -- control means having the **right to use and dispose** the resources. Control is also evidence by having the right to restrict others to use the asset - *Result of Past event* -- there must be a past transaction that gives birth to the asset - *Future economic benefits are expected* -- In order to be an asset, a resource must have a future benefit or use to the entity. - **Current Assets-** an asset is considered current if they are held for the purpose of being traded, expected to be realized or consumed within 12 months after the end of reporting period or operating cycle which ever is longer. - Cash -- Normally current assets but if **restricted for non current purposes that cash will become Non current.** Example: Cash restricted to purchase a machinery, since machinery is non current therefore that cash is restricted for non current purpose making it non current as well. - Inventory -- Merchandise for sale of the entity. - Account receivable -- receivable resulting from selling of merchandise or service. - Notes receivable -- receivable with a written note promising to pay - Prepaid expense- advance payment of services or merchandise to be received in the future - **To be classified as current** **asset,** a **TRADE ASSET** must be **collectible** **within one year or operating cycle whichever is LONGER** - Property, plant and equipment -- tangible assets that are held for use in production or supply of goods or services - Intangible assets -- identifiable, non monetary assets without physical substance. - Sinking fund -- cash set aside for non current portion such as buying an equipment or paying long term debt. - **To be classified as current asset,** a **NON-TRADE ASSET** must be **collectible within one year** - **Non-current assets-** if an asset doesn\'t meet the criteria of current asset it is considered as non-current assets. - If an asset is a trade asset and the maturity is more than the operating cycle or 1 year whichever is longer, then it is considered to be non current assets. - If an asset is a non trade asset and the maturity is more than 1 year, then it is considered to be non current assets. Let us sum up the discussion using this information map. ------------ **Assets** ------------ 2. **Liabilities-** a **present obligation** of the entity **arising from past events,** the settlement of which is **expected to result in an outflow of economic resources** embodying economic benefits - *Present obligation* -- the entity is required to pay it - *Arising from past events*- there is a transaction that gives birth to the liability. - *Settlement is expected to result in an outflow of economic resources* -- asset is required as payment - **Current Liabilities -** A liability is considered current if it is due within 12 months after the end of the balance sheet date. In other words, they are expected to be paid in the next year. - - - - - - To be classified as current liability, a trade payable must be expected to be paid **within one year or operating cycle which ever is longer**. - Mortgage payable -- payables with a collateral of real property - Bonds Payable -- payables evidence by a Bond certificate - **Non-current liabilities-** if a liability doesn\'t meet the criteria of current liability it is considered as non-current liability. To sum up the discussion let us use this information map ----------------- **Liabilities** ----------------- 3. **Expense -- Decrease in economic benefit** or **incurrence of liability** that results in **decrease of equity other than the withdrawals of owners**. Usually incurred to generate an income. - *Decrease in economic benefit* -- decrease in asset - *Incurrence of liability* -- increase in liability - *Results in decrease of equity* -- there must be an adverse or negative effect to the entity - *Other than the withdrawals of the owner*- the decrease in asset or increase in liability must be a result of outside transactions. **Typical Account Titles Used** 4. **Income- Increase in economic benefit** or **decrease in liability that results in increase of equity** **other than the investments of the owners.** Usually earned as a result of incurring expenses. - *Increase in economic benefit* -- increase in asset - *Results in increase of equity* -- there must be a positive effect to the entity - *Other than the investments of the owners* - the increase in asset or decrease in liability must be a result of outside transactions. **Typical Account Titles Used** 5. **Owner's Equity-** Also known as *net assets* or *equity*, *capital* refers to what is left to the owners after all liabilities are settled. +-----------------------------------+-----------------------------------+ | ACCOUNT TITLE | | +===================================+===================================+ | Left side or\ | Right side or | | **Debi**t side | | | | **Credit** side | | ***Dr.*** | | | | ***Cr.*** | +-----------------------------------+-----------------------------------+ | | | +-----------------------------------+-----------------------------------+ Exercises: Accounting Equation and Double-entry System ====================================================== 1. Which of the following accounting equations are correct? 2. Which of the following is correct under the double entry system? a. Asset amount must be equal to liability account b. The change in asset must be compensated by a change in liability c. The change in a debit-side entry must be compensated by a change in credit-side entry d. An increase in asset must be compensated by a decrease in asset 3. Which of the following statements are correct? 4. Which of the following statements regarding the double-entry system is incorrect? 5. Which of the following is correct if the sole proprietor of an entity borrows P30,000 in the name of the entity and deposits it into the entity's bank account? 6. Which of the following transactions affects the total value of liabilities of a firm? 7. On May 1,2021, Chia Ohab sets up a business and brings office equipment of P50,000 and inventory of P30,000 to the business. Chia puts up P80,000 into the firm's cash box and P100,000 into the firm's bank account. Meanwhile, the firm lends P50,000 cash to BCD Company and borrows P200,000 from You Do Note bank to acquire a piece of premises. 8. If during the accounting period the assets decreased by P10,000, and equity increased by P2,000, then how did liabilities change? 9. If during the accounting period the assets increased by P14,000, and equity increased by P4,000, then how did liabilities change? 10. If during the accounting period the assets increased by 30,000 and Liabilities decreased by P8,000, then how did equity change? 11. Which of the following statements is incorrect? 12. Which of the following statements is incorrect? 13. Which of the following transactions will increase the total assets of the business? 14. An account has the following uses, except 15. Which of the following statements is incorrect? Topic 2: Accounting Cycle of Service Entity =========================================== [Definition of terms ] - Service Industry- a kind of business which provides services rather than tangible objects. - Merchandising Industry- is a kind of business that buys goods and then resells them, generally for a higher price than they were purchased. A buy and sell kind of business. - Manufacturing Industry- is a kind of business that is engage in the transformation of goods, materials or substances into new products. - Sole Proprietorship- a business with only one owner - Chart of Accounts- A listing of the accounts available in the accounting system in which to record entries - Accounting Cycle- The accounting cycle is a collective process of identifying, analyzing, and recording the accounting events of a company. - Double Entry System - Every transaction will involve at least two (2) accounts **[Accounting Cycle of Service Industry]** - Analyzing Transactions - Journalizing Transactions - Posting/Accumulating Transactions - Preparation of Unadjusted Trial Balance - Adjustments - Preparation of Financial Statements - Closing Entries - Post-Closing Trial Balance - Reversing Entries []{#_Toc52764232.anchor}**1. Analyzing Transactions-** the most important step in accounting cycle because it is the identification if whether a transaction is accountable or non-accountable event. *Accountable event*- Transactions that will be recorded in the Journal. *Non-Accountable event*- transactions that is not recorded in the Journal **Note**: All accountable events are required to be recorded in the Journal. Non accountable event is not necessarily ignored, some are required to be disclosed in the Notes to Financial Statements by the Accounting Standard. **Accountable event** -- Recorded in the Journal **Non accountable event** \- if the problem is SILENT just ignore the non accountable event The big question is how will you analyze a transaction? Let us use two simple words to explain how to analyze transactions *[Classifying]* -- Knowing the account titles that are affected by the transaction. *[Measuring]*- Knowing the monetary value of the transaction **Note**: Classification and Measurement must be both present in order for a transaction to be labeled as an accountable event. To further illustrate how to analyze a transaction let us use three example problems. **Problem 1**: On January 10,2021 ABC Company agreed to purchase a Land to be paid in cash from BCD Company. The price of the land was not agreed upon as of January 10. [Account titles affected]- Land and Cash [Monetary Value] -- None [Analysis]: **Non accountable event**. It is non accountable event because even though at least two account title are affected, the transaction lacks monetary value which is one of the requirements in order for a transaction to be an accountable event. **Problem 2:** On January 10,2021 ABC Company sign a contract to hire an accountant for a salary of P200,000. The accountant will start on the end of the month. [Account titles affected] -- None [Monetary Value] -- 200,000 [Analysis]**: Non accountable event**. It is non accountable event because no account title was affected, the expense for the accountant is not yet incurred nor paid because the accountant is yet to start at the end of the month. **Problem 3:** On January 10,2021 ABC Company paid 200,000 for the purchase of equipment from BCD Company. [Account titles affected]- Cash and Equipment [Monetary Value-] 200,000 [Analysis]- **Accountable Event.** It is accountable event because at least two account was affected by the transaction and there is monetary value assigned to it **As a conclusion,** +-----------------------------------------------------------------------+ | Two or more account was affected | | | | \+ | | | | Monetary Value | | | | **=** **Accountable Event** | +-----------------------------------------------------------------------+ +-----------------------------------------------------------------------+ | None or only one account was affected | | | | \+ | | | | Monetary Value | | | | **= Non - Accountable Event** | +-----------------------------------------------------------------------+ +-----------------------------------------------------------------------+ | Two or more account was affected | | | | \+ | | | | No Monetary Value | | | | **=Non-Accountable Event** | +-----------------------------------------------------------------------+ Exercises: Analyzing Transaction ================================ **Instruction:** Choose which of the following transactions are Accountable and Non-Accountable events. 1**.** The entity purchased an equipment amounting to P10,000,000 2\. An entity sign a contract amounting to P8,000,000 3\. An entity file a lawsuit to collect P5,000,000 for copyright violations 4\. An entity was awarded P5,000,000 for successfully defending a Patent 5\. ABC company offers to purchase a piece of land for P2,500,000 there is a high likelihood that the offer will be accepted 6\. An entity receives notice that its rentals for an office space will increase by P50,000 per month effective next month 7\. An entity receives its electricity bill for the last month amounting to P40,000. The bill is due for payment next month 8\. The entity purchase inventory amounting to P4,000,000. The payment is due next month 9\. ABC company paid P1,000,000 for land 10\. An entity received P50,000 for services to be rendered next month 2. Journalizing transactions ============================ - recording the accountable events to the Journal - The main reason why analyzing transaction is important is because not all transactions will be journalized, only those accountable events will be shown in the journals of the company. **Journal**- chronological record of entity\'s transactions [Two types of journal] - Special Journal- Journals that is used to record specific transactions. The purpose of these journals is to segregate specific transactions from others so they can be better handled and controlled. - Sales journal - Purchases journal - Cash receipts journal - Cash payment/disbursements journal - General journal- used to record transactions that is not recorded in the special journals. The big question is, how will you journalize an accountable event? Before answering that, let us first define some important words that will be used all throughout the discussion in journalizing transactions - Normal balance- the side of the entry where a specific account increase. - Debit- the left side of the journal entry - Credit- the right side of the journal entry - Elements of Financial Statements- Assets, Liabilities, Expense, Income, and Equity - Simple Journal Entry- Journal entry that involves two account titles - Compound Journal Entry- Journal entry that involves three or more account titles A common mistake of accounting students is memorizing that debit means increase and credit means decrease, it is important to understand that increasing an account is dependent solely on their normal balances, having said that let us discuss each accounting elements and their respective normal balances. +-----------------------------------+-----------------------------------+ | DEBIT | CREDIT | +===================================+===================================+ | Assets | Liabilities | | | | | Expense | Income | | | | | | Equity | +-----------------------------------+-----------------------------------+ Using the above table, it means that if you want to increase an asset you need to put the asset in its normal balance which is debit same goes with expenses, but if you want to increase liability , income and equity you need to put it in the credit side of your journal entry. Of course there are times that you need to decrease a certain account balance, if you want to decrease an account all you need to do is to put it on the other side of its normal balance, for example if you want to decrease an asset all you need to do is to put it on the credit which is the other side of its normal balance debit. Here are sample problems to help you in journalizing transactions January 10- Chia Ohab invested P1,000,000 in her business named World of Dragon Nest Company. January 25- Purchase of 300,000 worth of equipment January 31- Purchase of Land worth 700,000. Half of it was paid with cash. February 2 -- Debt amounting to 300,000 was paid February 5- The entity billed the tenants amounting to 500,000 for January\'s rent February 7- Half of the February 5 billing was paid +-----------------------------------------------------------------------+ | Chart of accounts | | | | [Account titles] [Posting Reference] | | | | Cash 110 | | | | Accounts Receivable 120 | | | | Equipment 150 | | | | Land 160 | | | | Accounts Payable 200 | | | | Ohab, Capital 300 | | | | Ohab, Drawing 310 | | | | Rent Revenue 410 | | | | Utilities Expense 510 | +-----------------------------------------------------------------------+ +-------------+-------------+-------------+-------------+-------------+ | Date | Account | P.R. | Debit | Credit | | | titles and | | | | | | Explanation | | | | +=============+=============+=============+=============+=============+ | January 10 | Cash | 110 | 1,000,000 | 1,000,0000 | | | | | | | | | Ohab, | 300 | | | | | Capital | | | | | | | | | | | | To record | | | | | | the initial | | | | | | investment | | | | +-------------+-------------+-------------+-------------+-------------+ | 25 | Equipment | 150 | 300,000 | 300,000 | | | | | | | | | Accounts | 200 | | | | | Payable | | | | | | | | | | | | Purchase of | | | | | | equipment | | | | | | on account | | | | +-------------+-------------+-------------+-------------+-------------+ | 31 | Land | 160 | 700,000 | 350,000 | | | | | | | | | Accounts | 200 | | 350,000 | | | Payable | | | | | | | 110 | | | | | Cash | | | | | | | | | | | | Purchase of | | | | | | Land | | | | +-------------+-------------+-------------+-------------+-------------+ | February 2 | Accounts | 200 | 300,000 | 300,000 | | | Payable | | | | | | | 110 | | | | | Cash | | | | | | | | | | | | Payment of | | | | | | liability | | | | +-------------+-------------+-------------+-------------+-------------+ | 5 | Accounts | 120 | 500,000 | 500,000 | | | Receivable | | | | | | | 410 | | | | | Rent | | | | | | Revenue | | | | | | | | | | | | To record | | | | | | billing of | | | | | | tenants | | | | +-------------+-------------+-------------+-------------+-------------+ | 7 | Cash | 110 | 250,000 | 250,000 | | | | | | | | | Accounts | 120 | | | | | Receivable | | | | | | | | | | | | To record | | | | | | the | | | | | | collection | | | | +-------------+-------------+-------------+-------------+-------------+ **Analysis** [January 10] Accounts affected: Increase in Cash and Increase in Equity Monetary Value: 1,000,000 Explanation: Since there is an increase in Cash which is an asset Cash should be debited, while Increase in Equity is always in the side of credit. Normal balance is really necessary in making proper journal entry. [January 25] Accounts affected: Increase in equipment and increase in Accounts Payable Monetary Value: 300,000 Explanation: Cash was not affected because it is not specified that the equipment was paid in cash, never assumed unless otherwise stated in the problem. The equipment was debited because purchasing equipment results in increasing equipment which is an asset. The accounts payable was credited because purchasing equipment without paying cash will result in increase in liability with a credit normal balance. [January 31] Accounts affected: Increase in Land, Increase in Accounts Payable and decrease in cash. Monetary Value: 700,000 Explanation: Land was debited because increase in land is an increase in asset and asset has a debit normal balance. The problem stated that half of the amount was paid in cash that is why cash was credited because cash in asset and if you want to decrease an asset you need to put it on the other side of its normal balance that is why decreasing cash should be recorded as credit. Lastly, accounts payable was credited because only half of the price was paid and the other half was a liability. [February 2] Accounts affected: Decrease in Liability and decrease in cash Monetary Value: 300,000 Explanation: The liability was paid and resulted in decrease of accounts payable which is a liability account that is why it is debited in the entry, paying liability requires an outflow of cash therefore decreasing the cash balance as well which is an asset account that is why cash was credited in the journal entry. [February 5] Accounts affected: Increase in Accounts Receivable and Increase in rent revenue Monetary Value: 500,000 Explanation: Rent for January is already earned that is why a revenue must be recognized even if there is no cash payment from the tenants. An increase in revenue is recorded as credit to rent revenue, and since there is no cash payment a debit to accounts receivable must be recorded [February 7] Accounts affected: Decrease in Accounts Receivable and Increase in cash Monetary value: 250,000 Explanation: Receipt of cash is recorded as debit to cash, and decrease in receivable is recorded in the opposite of its normal balance. In studying how to make journal entries you need to - Memorize the normal balance of each accounting element (Assets, Liabilities, Equity, Income, and Expenses) - Be familiar of different account titles under each of the accounting elements - Keep on practicing by answering a lot of journal entries problem to sharpen your analytical skills in identifying the right account titles affected in every transaction []{#_Toc52764235.anchor}**3. Posting or Accumulating**- transferring the amounts from the journal to the appropriate accounts in the ledger. It is called Accumulating because this is the time where in the company will accumulate all the transactions in a specific account to know the exact balance of each accounts. **Ledger** -- is the book use to compute the balance of each of the account titles. -also known as the book of final entry or book of secondary entry. [Two types of ledger] - General Ledger- set of master accounts where transactions are accumulated - Subsidiary Ledger- intermediary set of accounts linked to the general ledger as a supporting document Category General ledger Subsidiary ledger ------------------------------------- ---------------------------------------------------------------- ----------------------------------------------------------- Nature It is a group of accounts with difference characteristics It is a group of account with similar characteristics Use It is required to be used in recording the accounts It is optional in recording process Link to Trial balance Trial Balance is made using the General ledger Trial balance is not prepared using the Subsidiary ledger Relationship with each other General ledger controls the Subsidiary ledger Subsidiary ledger is part of the General ledger In case of conflict with the amount General ledger will follow the amount in the Subsidiary ledger Amount computed in the Subsidiary ledger will be used Using the previous Journal entry made, let\'s Post it in the Ledger. Account: **Cash** Account No**. 110** Date Explanation J.R. Debit Credit Balance ------------ ------------- ------ ----------- --------- ------------- January 10 1 1,000,000 1,000,000 31 3 350,000 650,000 February 2 4 300,000 350,000 7 6 250,000 **600,000** Account: **Accounts Receivable** Account No. **120** Date Explanation J.R. Debit Credit Balance ------------ ------------- ------ --------- --------- ------------- February 5 5 500,000 500,000 7 6 250,000 **250,000** Account: **Equipment** Account No. **150** Date Explanation J.R. Debit Credit Balance ------------ ------------- ------ --------- -------- ------------- January 25 2 300,000 **300,000** Account: **Land** Account No. **160** Date Explanation J.R. Debit Credit Balance ------------ ------------- ------ --------- -------- ------------- January 31 3 700,000 **700,000** Account: **Accounts Payable** Account No. **200** Date Explanation J.R. Debit Credit Balance ------------ ------------- ------ --------- --------- ------------- January 25 2 300,000 300,000 31 3 350,000 650,000 February 2 4 300,000 **350,000** Account: **Rent Revenue** Account No. **410** Date Explanation J.R. Debit Credit Balance ------------ ------------- ------ ------- --------- ------------- February 5 5 500,000 **500,000** Account: **Ohab,Capital** Account No. **300** Date Explanation J.R. Debit Credit Balance ------------ ------------- ------ ------- ----------- --------------- January 10 1 1,000,000 **1,000,000** The date is just copied from the Journal entries being posted. The J.R. means Journal Reference, in actual practice the pages of the journal are used as Journal reference, but since we only have 1 page the JR was according to the chronological order of the journal entry. Example: The January 10 transaction was posted to the Cash and Ohab, Capital. The JR is one because it is the first journal entry made by the entity. The debit to cash was posted to the account cash and the credit to capital was posted to the account capital. The P.R. means posting reference, it is used to easily post a journal entry, like for instance in January 10 we see that in journal entry there is a section for PR, for Cash 110 and for Ohab, Capital 300, you will then use that PR to easily look where to post the journal entry. Exercises: Journalizing and Posting =================================== Multiple Choice Instruction: Choose the best answer 1\. Posting refers to the process of transferring information from a\. a journal to the general ledger accounts b\. general ledger accounts to journal c\. source of documents to a journal d\. a journal to source documents 2.\_\_\_\_ refers to the process of transferring the debit and credit amounts from journals to ledger accounts. a\. Balancing off b\. transferring c\. Posting d\. Closing 3\. What is post reference? a\. Found initially in the chart of accounts b\. Use to easily know where to post a specific journal entry c\. Found in the heading of every ledger account d\. All of the above 4\. Which of the statements is false? a\. The ledger is the book of final entry because it is the final book done before making the Financial Statements b\. The ledger is used to make the Trial balance c\. The ledger is made before journal d\. The journal is made before the ledger 5\. Which of the following is true? a\. The balance computed in the ledger is the amount used in making the trial balance b\. When the general ledger and the subsidiary ledger has conflict in the amount, the latter prevails c\. General ledger is required accounting book, while subsidiary ledger is not required d\. Subsidiary ledger is more of a supporting document that is why it prevails in case of conflict with the general ledger e\. All of the above 6\. A journal entry that contains more than just two accounts is called a\. A posted journal entry b\. An adjusting journal entry c\. An erroneous journal entry d\. Compound journal entry 7\. A journal entry that contains two accounts is called a\. A simple journal entry b\. An adjusting journal entry c\. An erroneous journal entry d\. Compound journal entry 8\. A journal entry that contains one account is called a\. A posted journal entry b\. An adjusting journal entry c\. Simple journal entry d\. None of the above 9\. Which of the following transactions results in an increase in revenues? a\. Collection of cash on account b\. Receipt of cash form bank loan c\. Sale of land at cost for cash d\. Services rendered on credit 10\. Which of the following has a debit normal balance? Chart of accounts: Cash; Accounts Receivable; Plumbing supplies; Service Vehicle; Notes Payable; Accounts payable; Arc, Capital; Arc, Withdrawals; Plumbing revenues; Salaries expense; Rent expense; Telephone expense; and Miscellaneous expense Requirement: Prepare the necessary journal entry and post the transaction to the ledger 4. Preparation of Unadjusted trial balance ========================================== - Trial balance is a list of all accounts with their respective debit or credit balances. - it is done to verify the equality of debits and credits in the ledger. - it is done after the posting to the ledger because all of the balance computed in the ledger is being used in the preparation of the Unadjusted trial balance Procedures in the preparation of trial balance are as follow 1^st^ - List the account titles in numerical order (use the Posting reference) shown in the chart of accounts 2^nd^ - Obtain the account balance of each account from the ledger and enter the debit balance in the debit column and the credit balances in the credit column 3^rd^ - Add the debit and credit columns 4^th^ - Compare the total, the total of debit and credit must be the same. Sample problem +-----------------------------------------------------------------------+ | Chart of accounts | | | | [Account titles] [Posting Reference] | | | | Cash 110 | | | | Accounts Receivable 120 | | | | Prepaid Expense 130 | | | | Equipment 150 | | | | Land 160 | | | | Accounts Payable 200 | | | | Agase, Capital 300 | | | | Agase, Drawing 310 | | | | Rent Revenue 410 | | | | Utilities Expense 510 | +-----------------------------------------------------------------------+ After Posting, the entity shows the following balance of each account Land - P2,300,000 Cash- P3,200,000 Accounts Payable- P2,000,000 Accounts Receivable- P1,000,000 Utilities Expense- P300,000 Agase, Drawing - P100,000 Agase, Capital- P2,000,000 Rent revenue- P4,000,000 Equipment- P1,000,000 Prepaid expense- P100,000 Unadjusted Trial Balance -------------------------- --------------------- --------------- --------------- No. Account Title Debit Credit 110 Cash 3,200,000 120 Accounts Receivable 1,000,000 130 Prepaid Expense 100,000 150 Equipment 1,000,000 160 Land 2,300,000 200 Accounts Payable 2,000,000 300 Agase, Capital 2,000,000 310 Agase, Drawing 100,000 410 Rent Revenue 4,000,000 510 Utilities Expense 300,000 Total **8,000,000** **8,000,000** **Explanation:** Use the posting reference number as a way to know what account should go first in the list. After listing the account, just copy the balance computed in the Ledger in each account. After computing the debit and credit, can we say that your trial balance is absolutely correct if the debit and credits are equal? The answer is no because of - *Human Error*- unintentional wrong journal entries or posting to the ledger - *Fraud*- Intentional wrong journal entries or posting to the ledger Human error and fraud will result to 1\. Sliding error- the decimals of the monetary value were put in the wrong place Example: P2691.89 was recorded as P26918.9 2\. Transposition error- the figures were interchanged Example: P2691.89 was recorded as P2961.89 3\. Omission- the transaction was not recorded Example: P2691.89 was not recorded at all 4\. Transaction was recorded for more than once Example; P2691.89 was recorded as P2691.89 but recorded twice even if the transaction only happens once. 5\. Wrong account title was used Example: Purchase of Equipment in credit was recorded as purchase of equipment in cash. LOCATING ERRORS IN THE TRIAL BALANCE ==================================== An inequality in the totals of debits and credits would automatically signal the presence of an error. The following procedures are the ways to easily locate an error in case the Trial balance is not balance 1\. Recompute the columns. The first thing to do is to make sure that the inequality was not a mathematical error or a result of wrong input in your calculator 2\. If the inequality was not solved by recomputation, the next thing to do is **to determine the exact amount by which the trial balance is out of balance** - If the discrepancy is **divisible by 9**, this suggests either a **transposition error or a sliding error.** For example, assume that the Cash balance is P23,000 but for some reason you recorded it as P32,000 leaving a P9,000 overstatement which is divisible by 9 - Try dividing the discrepancy by 2, and scan the columns for an amount equal to the amount. Example, assume that the cash was 50,000 but it was erroneously recorded as credit, the result is a discrepancy of P100,000 3\. If after scanning the trial balance the inequality was still unsolved the next thing to do is to compare the trial balance with that in ledger. Be certain that no amount is omitted. 4\. Recompute the balance of the ledger accounts 5\. Trace all posting to the journal and make sure that no amount was recorded wrong The following error are not detected by a trial balance 1\. Omission of a journal entry 2\. Recording the same transaction more than once 3\. Recording an entry but the debit and credit has the same wrong amount 4\. Posting the right amount in the wrong account title 5\. Transposition, sliding, omission error in the Journal Entry The above example was the reason that even if your trial balance is balance there is no assurance that your trial balance is absolutely correct. As a conclusion, - if the trial balance is not balance there is an error that needs to be corrected - if the trial balance is balance it doesn\'t mean that your trial balance is absolutely correct Having said that, **trial balance is merely a control device that helps MINIMIZE accounting errors.** Exercises: Unadjusted Trial Balance =================================== **Multiple Choice** Instruction: Choose the best answer 1\. Without the use of a trial balance, \_\_\_\_\_\_\_\_\_ a\. double-entry system will not be applied in accounting b\. there are no other ways to identify whether there is any problem c\. accounting ratios cannot be calculated d\. inequality between debit and credit balances cannot be easily found 2\. What is the purpose of trial balance? a\. To ensure that your Financial statements are correct b\. To absolutely assure that your journal and posting is correct c\. To check the equality of debit and credit d\. None of the above 3\. Unadjusted Trial balance a\. A listing of the account with their respective balance before adjustments b\. Done to make sure that your posting is correct c\. If equal, means that all your journal entries are correct d\. Is not required to be equal because it is still unadjusted 4\. Which of the following situations will cause the total debit balance to be greater than the total credit balance? a\. The amount extracted from Accounts receivable is posted to the wrong side of the trial balance. b\. the amount extracted from the machinery account is posted wrongly as P4,000 instead of P40,000 c\. The amount extracted from Accounts Payable is posted in the wrong side of the trial balance d\. the sales of goods to a debtor, Mr K are recorded in the account of another debtor Mr. L 5\. Which of the following situations will cause total debit balance to be smaller than the total credit balance? a\. The amount extracted from a creditor\'s account is posted to the wrong side of the trial balance. b\. the amount extracted from the account of a debtor, Mr.K,is posted as P1,000 instead of P1,100 c\. Sales of goods are recorded as purchased of goods in the ledger accounts. d\. The purchased of fixture is recorded in furniture account. 6\. Which of the following will make the trial balance equal even if there is an error committed a\. P1234 debit in the Journal entry was posted as P1243 in the ledger b\. Wrong account title was used in making journal entry c\. A debit in the ledger was transfer to the trial balance as credit d\. A credit balance in the ledger was transfer to the trial balance as debit 7\. Which of the following error is untraceable in the trial balance a\. Transposition error in one account in the ledger b\. Transposition error in the journal entry c\. Transposition error in the trial balance d\. All transposition error is untraceable 8\. A sliding error a\. Is untraceable if committed in one of the accounts in posting b\. Is traceable if committed in the journal entry c\. Is a kind of error arising from wrong placement of decimal d\. Is untraceable If done in the journal entry e\. Both C and D 9\. Unadjusted trial balance a\. Is done before adjustments b\. Is done to ensure that debit and credits are equal c\. Cannot give an absolute assurance that your journal and ledger is correct d\. All of the above 10\. Unadjusted trial balance a\. Is used directly in making the Financial Statements b\. Is made to ensure that the debits and credits are correct c\. Is made to reduce the risk of error to zero d\. Is made just to check whether debits and credits are equal 11\. Which of the following is true? a\. If the trial balance is not balance it means that there is an error b\. If the trial balance is balance it means that there is no error c\. If the trial balance is balance it means that there is an error d\. Both a and b 12\. Which of the following is true about an imbalance trial balance? a\. If the discrepancy in trial balance is divisible by 9 it might be a a result of transposition or sliding error b\. Dividing the discrepancy by 2 might lead you to the source of error c\. An imbalance trial balance is a conclusive evidence of a presence of error d\. All of the above **Problem Solving** Instruction: Prepare the Unadjusted trial balance using the following data **Chart of Accounts** **Cash 110** **Accounts Receivable 120** **Notes Receivable 130** **Prepaid Expense 140** **Land 150** **Equipment 160** **Accumulated Depreciation 170** **Loans Receivable 180** **Accounts Payable 210** **Notes Payable 220** **Loans Payable 230** **Taray, Capital 310** **Taray, Withdrawal 320** **Rent Revenue 410** **Utilities Expense 510** **Telephone Expense 520** After posting, the entity reported the following in the Ledger Drawing 500,000 Rent revenue 5,000,000 Telephone expense 300,000 Utilities expense 400,000 Cash 3,000,000 Accounts Receivable 1,000,000 Loans Payable 4,000,000 Capital 3,500,000 Notes Payable 1,500,000 Equipment 4,000,000 Land 3,000,000 Accumulated depreciation 1,000,000 Loans receivable 2,000,000 Prepaid expense 1,000,000 Notes receivable 1,000,000 Accounts Payable 1,200,000 5. Preparation of Adjustments ============================= - After making the unadjusted trial balance the next thing to do is to make the Unadjusted trial balance Adjusted and it is only possible through adjustments. - done at the **end of reporting period** **Types of Adjustments** - [Reclassifying entries] - Entries done to correct a wrong account title in journal entry. The key word here is the word "classifying" the error is in the classification which means an error in account title. Example: On January 10, ABC company purchase an equipment costing 10,000,000. The entity made the following journal entry on January 10 Equipment 10,000,000 Cash 10,000,000 Cash 10,000,000 Accounts Payable 10,000,000 Note: The cash was wrongly reduced by 10,000,000 even if there is no outflow of cash so to correct it the cash was debited by the same amount, likewise Accounts Payable was not recorded even if there is a liability incurred as of January 10, so to increase it we need to record Accounts payable in credit. - [Correcting entries] - correcting any other error aside from wrong account title. - [Adjusting entries] - It is done to update the books with economic events that already happened but is not yet recorded - Every time you make an adjusting entries It **ALWAYS involves one Income Statement Account (Income or Expense account) and one Balance Sheet account (Asset or Liability account)** **The need for adjustments..** It is easy to understand why we need to make the reclassifying and correcting entries---to correct an error, the problem is in the Adjusting entries, why is it important for us, future accountants, to understand the adjusting entries? Adjusting entries are done to reflect in the accounts information on economic activities that have occurred but have not yet been recorded. Adjusting entries assign revenues to the period they are earned, and expenses to the period they are incurred. Adjusting entries ensures that the recognition and derecognition principles are properly applied - Recognition principle -- the process of including an item in Financial statements that meets the definition of asset, liability, expense, income and equity. - Derecognition principle- the process of removing an item in Financial statements that doesn\'t meet the definition of asset, and liability In making adjusting entries it is important to understand when to recognize Income and expense. [Recognition of Income] An income is recognized when there is an *INCREASE IN ASSET*, or *DECREASE IN LIABILITY* **OTHER THAN INVESTMENT FROM OWNERS**. It is important to note that in order for an income to arise the transaction must be between the business and other entity. [Recognition of Expense] An expense is recognized when there is a *DECREASE IN ASSET*, or *[INCREASE IN LIABILITY]* **OTHER THAN WITHDRAWALS FROM OWNERS**. It is important to note that in order for an expense to arise, the transaction must between the business and other entity. To further illustrate the relationship of recognition principle with adjusting entries let us move in the specific accounts that needs to be adjusted in financial statements. Let us divide the accounts into two parts the Adjusting Entries for Accruals and Adjusting Entries for Deferrals []{#_Toc52764241.anchor}**ADJUSTING ENTRIES FOR ACCRUALS-** Accrual means recording income when earned not when the cash was received and recording expense when incurred not when payment was given. In simple means, accrual is about recording the transactions when the transaction happens regardless even if there is no cash involvement. Accrual adjusting entries involves 1\. **Accrued Salaries**- Salaries are normally paid at regular intervals. It can be weekly, semi-monthly or monthly. Accounting problems arises when the book needs to be close but there is still unpaid salaries because the date of payment is not yet due. Adjusting entries are needed to record unpaid salaries as of the end of the period. Pro-porma Journal Entry Salaries Expense xx\-\-\-\-\-\--Income statement account Salaries Payable xx\-\-\-\-\-- Balance sheet account Example: ABC Company has 2 employees with a salary of 1,000 per day. The policy of the company is to pay the employee every 10^th^ day and 25^th^ day of the month. Assuming that the company uses calendar year. Make the proper adjusting entry. Analysis: Since the end of the year is December 31 Adjusting entry must be made during that day. As of December 31, the last payment of salary was December 25, from December 26 to 31 the employee was not paid therefore there is an unrecorded expense. Computation P1,000 per day X [ 6 days unpaid](December 26-December 31) P6,000 per employee X [ 2] employee **P12,000** unpaid salaries for 2 employees [ ] Accounts affected: Increase in Salaries Expense and Increase in Salaries Payable [Adjusting Entry] Salaries Expense 12,000 Salaries Payable 12,000 Explanation: After computing the monetary value of the transaction we should analyze the effect of the unpaid salaries. Since we are applying the concept of accrual which means we should record expense when incurred not when paid, the 2 employees already worked for the period December 26 to December 31 thus, expense was already incurred even if not paid. The expense was unrecorded as of December 31 because no payment was made that is why we need to debit salaries expense to increase the expense and also credit the salaries payable to increase the liability as of the end of the year because of the presence of unpaid salaries. 2\. **Accrued Interest Expense** -- Interest are normally paid with intervals. Accounting problems arises when the payment doesn't fall in the end of the year because there will be unpaid interest. The computation for interest is as follows **P x R x T** = Interest Expense **P**= Principal or the entire amount of liability **R**= interest rate **T**= Time, the unpaid period Note: Interest are expressed at annual rates, so if interest is computed for less than a year, the calculation must express time as a portion of a year [Pro-porma journal entry] Interest Expense xx\-\-\-\-\-\-\-\-\-- Income Statement Account Interest Payable xx\-\-\-\-\-\-\-\-\-\-\-\-- Balance sheet Account Example On December 1, an entity borrowed P100,000 ,12% loan from Metrobank payable after 1 year. Make the proper adjusting entry regarding the interest Analysis: Adjusting entry is done at the end of the reporting period, in this case on December 31 because the problem is silent that\'s why the assumption is that the company is using calendar year. From December 1 to December 31 there is 1-month unpaid interest as of the end of the reporting period. Computation Interest = Principal x Interest Rate x Length of time = 100,000 x 12% x 1/12 Interest = **1000** Accounts Affected- Increase in Interest Expense and increase in interest payable [Adjusting Entry] Interest Expense 1,000 Interest Payable 1,000 Explanation: As of December 31 , there is 1 month unpaid interest, so the right thing to do is to record it by increasing interest expense and interest payable. Expense needs to be increased because even though it is unpaid the expense was already incurred, and since it is unpaid the payable must also be increased. **3. Accrual for Uncollectible Account**- Entities often allow clients to purchase goods or avail services on credit. Some of these accounts will never be collected; hence there is a need to reflect these as charges or deduction against income in a form of expense. [Pro-forma Journal Entry] Doubtful Account Expense xx\-\-\-\-\-\-\-\-\-- Income statement account Allowance for Doubtful Accounts xx\-\-\-\-\-\-\-\-\--Balance sheet account There are different ways in computing estimated uncollectible accounts, but for simplicity we will use the Percentage of Sales. Example: Assume that the entity made credit sales of P1,000,000 in 2020 and prior experience indicated an expected 2% uncollectible account base on credit sales. Compute and make the proper adjusting entry. Computation 1,000,000\-\-- Credit Sales [X 2%] \-\-- rate of uncollectible **20,000** \-\-\-- Estimated uncollectible account [Adjusting Entry] Doubtful account expense 20,000 Allowance for doubtful accounts 20,000 Explanation: Uncollectible accounts are only estimated base on past experience regarding their credit sales. Since it is just estimation the journal entry involves increasing an expense and increasing a contra receivable account not directly deducting the amount to receivable. **Contra Account --** contra account is used to reduce the value of a certain account when they are netted together. Contra account\'s normal balance is the opposite of the associated account. For example, the allowance for doubtful account is a contra receivable account since receivable has a debit normal balance then Allowance for doubtful account\'s normal balance should be credit the opposite of the normal balance of the associated receivable account. **Note:** The key word is the word "Contra", since it is Contra or Against, its normal balance is always the opposite of the account that it is against. Normal balance of contra account Debit Credit ------------------ ---------------- Contra Liability Contra Asset Contra Equity Contra Expense Contra Income **Note**: Their normal balance is in the opposite side of the account that they are against to. **4. Accrued Interest Income** -- same concept and computation with Accrued Interest expense, the only difference is that you are the one that extends credit to other entity. [Journal Entry] Interest Receivable xx\-\-\-\-\-\-\-\-- Balance sheet account Interest Income xx \-\-\-\-\-\-\-\-\-- Income Statement account Explanation: Interest receivable was debited because as of the year end there is unrecorded interest from the customer having the credit. Interest income is credited because income is being recorded when earned and not when the cash payment was received. **Note:** Adjusting Entries involving accruals **increases BOTH a Balance sheet account (real account) and an Income statement account (Nominal account).** []{#_Toc52764242.anchor}**ADJUSTING ENTRIES FOR DEFERRALS --** Entities often make expenditures that benefit more than one period. They also often receive cash before the service or product was delivered to the customer. When those two scenarios happen there is a need for adjusting entries because those two transactions fall under the concept of deferrals. **Deferrals** happen when there is an Advance Payment or Advance Collection, in other words it happens when expense is paid before incurring it or when income payment is received before earning it. Adjustments for deferrals is done in order to make deferrals in to accruals. **1. Prepaid Expenses --** Some assets are paid in advance like rents and insurance. An accounting problem arises when the advance payments covered two or more reporting period. There is a need for adjusting entries to record the expire portion of the prepaid expenses when the advance payment covers two or more reporting period. Two methods of recording Prepaid Expense or Advance Payments of Expense - **Asset method --** the entire pre-payment is initially recorded as an asset. Expense is recognized in adjusting entry. - **Expense method-** the entire pre-payment is initially recorded as an expense. Asset is recognized in adjusting entry **Note**: Both method of recording is correct, but if the **problem is silent, use the Asset method** because it strictly adheres to the Accrual principle of recording expense when incurred not when paid. To illustrate the difference between the two let us use an illustrative problem On May 31,2020 ABC Company paid 600,000 to BCD Company for a 1-year insurance covering the date May 31,2020 to May 31,2021. Prepare the necessary entry using Asset Method and Expense method In recording advance payment, there three Important dates that you need to take note 1\. The date of transaction- the date that the entity paid the prepaid expense. In this case it is May 31,2020 2\. The date of adjustments- the end of the reporting period In this case it is December 31,2020 3\. The expiration of the contract -- the last day that the prepaid expense covers In this case it is May 31,2021 It is important to take note these three important dates because you need it in the computation. - **Date of transaction to Date of Expiration of contract = Total life of the prepaid** - **Date of transaction to Date of Adjustments = Expired Portion of the Prepaid** - **Date of Adjustments to Date of expiration= Unexpired portion of the Prepaid** **Date of transaction \-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-- Date of Adjustments\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-- Date of Expiration** **Total Life of the Pre-payment** Computation: Date of transaction to Date of Expiration of contract = Total life May 31,2020 to May 31,2021 = **12 months---Total life** Date of transaction to Date of Adjustments = Expired portion May 31,2020 to December 31,2020 = **7 months is already used** or expired as of December 31 Date of Adjustments to Date of Expiration = Unexpired portion December 31,2020 to May 31,2021 = **5 months is still unexpired** **Note: Total life of the pre-payment = Expired portion + Unexpired portion** 600,000/ 12 months = 50,000 insurance per month 50,000 x 7 months (Expired portion) = 350,000 expense to be recognized 50,000x 5 months (Unexpired portion) = 250,000 asset left as of the end of reporting period. **Entry** +-----------------------+-----------------------+-----------------------+ | Date | Asset method | Expense method | +=======================+=======================+=======================+ | May 31,2020 | Prepaid Insurance | Insurance Expense | | | 600,000 | 600,000 | | (Transaction Date) | | | | | Cash 600,000 | Cash 600,000 | | | | | | | Analysis: Since it is | Analysis: Since it | | | an asset method, the | the expense method, | | | entry should involve | the entry should | | | a recognition of | involve a recognition | | | asset. Cash is | of expense. Cash is | | | credited because | also credit because | | | there would be no | it is a prepayment. | | | advance payment | | | | without an outflow of | | | | cash | | +-----------------------+-----------------------+-----------------------+ | December 31 | Insurance Expense | Prepaid Insurance | | | 350,000 | 250,000 | | (Adjustments) | | | | | Prepaid Insurance | Insurance Expense | | | 350,000 | 250,000 | | | | | | | **Computation** | **Computation** | | | | | | | 600,000/ 12 months = | 600,000 / 12 months = | | | 50,000 per month | 50,000 insurance per | | | | month | | | 50,000 x 7 months = | | | | 350,000 expense to be | 50,000 x 7 months = | | | recognized | 350,000 expense to be | | | | recognized | | | Expense to be | | | | recognized 350,000 | Expense to be | | | | recognized 350,000 | | | Initial Recorded | | | | Expense | Initial recorded | | | | expense | | | | [(600,000)]{.underlin | | | Adjustments to | e} | | | expense 350,000 | | | | | Adjustments to | | | Analysis: Asset | expense (250,000) | | | method requires a | | | | recognition of | **Alternative | | | expense (its | Computation** | | | counterpart) in the | | | | adjusting entry. 7 | 600,000/12 months = | | | months was already | 50,000 per month | | | used by the entity, | | | | that is why it is | 50,000 x 5 months = | | | proper to recognize | 250,000 assets to be | | | an expense for that | recognized | | | expired period and | | | | since in Asset method | Analysis: Expense | | | the initial entry | method requires a | | | doesn\'t recognized | recognition of asset | | | expense the adjusting | (its counterpart) in | | | entry will have the | the adjusting entry. | | | recognition of the | 5 months is still | | | expense for the | unused as of the end | | | expired period. | of reporting period, | | | | that is why it is | | | As of the adjustment | proper to recognize | | | date, the effects to | an asset for that | | | the accounts are | unexpired period. We | | | | saw that in the | | | **Cash: (600,000)** | computation we get | | | | the 350,000 expense, | | | **Prepaid Insurance: | since in expense | | | 250,000** | method the initial | | | | journal entry | | | = 600,000 less | requires the | | | 350,000 | recognition of | | | | expense in the whole | | | **Insurance Expense: | prepayment, the | | | 350,000** | proper way to adjust | | | | it is by deducting | | | After adjustments the | 250,000 to the | | | entity has | initial 600,000 | | | | recorded expense | | | 1\. Outflow of | | | | 600,000 cash | As of the adjustment | | | | date the effects to | | | 2\. 350,000 expense | the accounts are | | | to be recognized in | | | | the Income | **Cash: (600,000)** | | | Statement | | | | | **Prepaid Insurance: | | | 3\. 250,000 Prepaid | 250,000** | | | Insurance in the | | | | Balance sheet | **Insurance Expense: | | | | 350,000** | | | | | | | | =600,000 less 250,000 | | | | | | | | After the adjustments | | | | the entity has | | | | | | | | 1\. Outflow of | | | | 600,000 cash | | | | | | | | 2\. 350,000 expense | | | | to be recognized in | | | | the Income | | | | Statement | | | | | | | | 3\. 250,000 Prepaid | | | | Insurance in the | | | | Balance sheet | +-----------------------+-----------------------+-----------------------+ | **Note:** The two | | | | methods should have | | | | the same results | | | | after one adjusting | | | | entries. After one | | | | adjustment, the | | | | Expense method will | | | | become like an Asset | | | | method. All the | | | | subsequent entries | | | | after the first | | | | adjusting entries | | | | will be the same | | | | regardless of method | | | | you use, that is the | | | | reason why the | | | | Standard of | | | | Accounting allows the | | | | usage of any of these | | | | methods in recording | | | | pre-payments. | | | +-----------------------+-----------------------+-----------------------+ | May 31,2021 | Insurance Expense | Insurance Expense | | | 250,000 | 250,000 | | (Expiration) | | | | | Prepaid Insurance | Prepaid Insurance | | | 250,000 | 250,000 | | | | | | | **Computation** | **Computation** | | | | | | | 600,000/ 12 months = | 600,000/12 = 50,000 | | | 50,000 per month | per month | | | | | | | 50,000 x 5= 250,000 | 50,000 x 5 = 250,000 | | | expense to be | expense to be | | | recognized in 2021 | recognized in 2021 | | | | | | | Expense to be | Expense to be | | | recognized 250,000 | recognized 250,000 | | | | | | | Initial recorded | Initial recorded | | | expense | expense | | | | | | | | | | | Adjustments 250,000 | Adjustments 250,000 | | | | | | | Analysis: The last | Analysis: After one | | | portion of expense is | adjusting entry, the | | | recognized and | Expense method will | | | prepaid expense | become like asset | | | became zero. Note | method, that's why | | | that the initial | the last entry is | | | recorded expense is | recognition of | | | zero because the | expense, an entry | | | 350,000 recognized | entirely the same | | | before was during | with the asset | | | 2020, expense is a | method. Note that the | | | nominal account which | initial recorded | | | means its balance | expense is zero | | | during the year will | because the 350,000 | | | not be carried out | is an expense | | | the next year that is | recognized in 2020, | | | why during 2021 the | expense is a nominal | | | initial recorded | account which means | | | expense is zero. | that its balance in | | | | 2020 will never reach | | | | the 2021 | +-----------------------+-----------------------+-----------------------+ | **Note:** The journal | | | | entry is the same | | | | because after one | | | | adjusting entry, the | | | | Expense method | | | | already recognized an | | | | asset making it like | | | | an asset method. | | | +-----------------------+-----------------------+-----------------------+ **2.Advance collection-**Some customers also pay in advance before receiving the service or goods from the entity. Adjusting entry is required because not all of the cash you received is an income, some of it is liability and some part of it is already income, therefore you need to adjust the book to reflect the actual amount of income you earned during the period and the right amount of liability you have from the undelivered goods or services. Adjusting entries for advance collection is done to follow the Accrual concept, that Income is recognize when earned and not when the cash is received. Two methods of recording Advance collections - **Liability Method-** the entire pre-collection is initially recorded as liability. Income is recognized in adjusting entry. - **Income Method- the** entire pre-collection is initially recorded as income. Liability is recognized in the adjusting entry. To further illustrate the difference between the two, let us use an illustrative problem On October 1 ,2021 the entity received P1,200,000 rent payment from a customer. The rent covers the period October 1, 2021 to October 1, 2022. Prepare the necessary entry using Liability method and Income method. In recording advance collection, there are three Important dates that you need to take note 1\. The date of transaction- the date that the entity received the advance collection In this case it is June 30,2021 2\. The date of adjustments- the end of the reporting period In this case it is December 31,2021 3\. The expiration of the contract -- the last day that the advance collection covers In this case it is June 30, 2022 It is important to take note these three important dates because you need it in the computation. - **Date of transaction to Date of Expiration = Total life of the pre-collection** - **Date of transaction to Date of Adjustments = Expired Portion of the Pre-collection** - **Date of Adjustments to Date of expiration= Unexpired portion of the Pre-collection** **Date of transaction \-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-- Date of Adjustments\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-\-- Date of Expiration** **Total Life of Pre-Collection** Computation: Date of transaction to Date of expiration of contract = total life October 1,2021 to October 1, 2022 = 12 months Date of transaction to Date of adjustments = Expired portion October 1,2021 to December 31,2021 = 3 months Date of Adjustments to Date of Expiration = Unexpired portion December 31,2021 to October 1,2022 = 9 months 1,200,000 / 12 months = 100,000 rent per month 100,000 x 3 months (expired period = 300,000 income to be recognized 100,000 x 9 months (unexpired period) = 900,000 liability left as of the end of the reporting period. **Entry** +-----------------------+-----------------------+-----------------------+ | Date | Liability method | Income method | +=======================+=======================+=======================+ | October 1,2021 | Cash 1,200,000 | Cash 1,200,000 | | | | | | (Transaction Date) | Unearned Rent Income | Rent Income 1,200,000 | | | 1,200,000 | | | | | Analysis: Under | | | Analysis: Liability | Income method, a | | | method requires a | recognition of Income | | | recognition of | is made upon the | | | liability in the | receipt of advance | | | initial entry because | collection from the | | | the cash received for | customer. | | | future service was | | | | treated as a | | | | liability. The word | | | | "Unearned" is used to | | | | set up a liability | | | | account. | | +-----------------------+-----------------------+-----------------------+ | December 31 | Unearned rent Income | Rent Income 900,000 | | | 300,000 | | | (Adjustments) | | Unearned Rent Income | | | Rent Income 300,000 | 900,000 | | | | | | | Analysis: The expired | Analysis: As of the | | | portion of the rent | end of the reporting | | | is 3 months. The | period the customer | | | customer already used | already used the | | | the property for 3 | 3-month rent. | | | months that is why it | Therefore, the income | | | is proper for the | should be reduced for | | | entity to record | only 3 months and a | | | income equivalent to | liability should be | | | the 3 months and to | recorded for the | | | remove the liability | unexpired portion | | | already used by the | | | | customer. | **Computation** | | | | | | | **Computation** | 1,200,000/12 = | | | | 100,000 rent per | | | 1,200,000 / 12 = | month | | | 100,000 rent per | | | | month | 100,000 x 3 = 300,000 | | | | income to be | | | 100,000 x 3 months = | recognized | | | 300,000 income to be | | | | recognized | Income to be | | | | recognized 300,000 | | | Income to be | | | | recognized 300,000 | Initial recorded | | | | Income [ | | | Initial recorded | 1,200,000]{.underline | | | income | } | | | | | | | | Adjustments (900,000) | | | Adjustments 300,000 | | | | | **Alternative | | | As of the adjustment | Computation** | | | date the effects to | | | | the accounts are | 1,200,000 /12 months | | | | = 100,000 rent per | | | **Cash: 1,200,000** | month | | | | | | | **Unearned Rent | 100,000 x 9 months ( | | | income: 900,000** | Unexpired portion) = | | | | 900,000 liability to | | | = 1,200,000 less | be recognized | | | 300,000 | | | | | Either way, you will | | | **Rent Income: | get the same P900,000 | | | 300,000** | adjustments | | | | | | | | As of the adjustment | | | | date, the effects to | | | | the accounts are | | | | | | | | **Cash: 1,200,000** | | | | | | | | **Unearned Rent | | | | Income: 900,000** | | | | | | | | **Rent Income: | | | | 300,000** | | | | | | | | = 1,200,000 less | | | | 900,000 | +-----------------------+-----------------------+-----------------------+ | **Note:** The two | | | | methods should have | | | | the same results | | | | after one adjusting | | | | entries. After one | | | | adjustment, the | | | | Income method will | | | | become like Liability | | | | method. All the | | | | subsequent entries | | | | after the first | | | | adjusting entries | | | | will be the same | | | | regardless of method | | | | you use, that is the | | | | reason why the | | | | Standard of | | | | Accounting allows the | | | | usage of any of these | | | | methods in recording | | | | pre-payments. | | | +-----------------------+-----------------------+-----------------------+ | October 1 ,2022 | Unearned Rent Income | Unearned Rent Income | | | 900,000 | 900,000 | | (Expiration) | | | | | Rent Income 900,000 | Rent Income 900,000 | | | | | | | **Computation** | **Computation** | | | | | | | 1,200,000 / 12 = | 1,200,000 / 12 = | | | 100,000 per month | 100,000 per month | | | | | | | 100,000 x 9 = 900,000 | 100,000 x 9 = 900,000 | | | income to be | income go be | | | recognized during | recognized during | | | 2022 | 2022 | | | | | | | Income to be | Income to be | | | recognized 900,000 | recognized 900,000 | | | | | | | Initial recorded | Initial recorded | | | income | income | | | | | | | | | | | Adjustments to income | Adjustments to income | | | 900,000 | 900,000 | | | | | | | Analysis: The initial | Analysis: The entry | | | recorded amount is | is entirely the same | | | zero because the | as the liability | | | 300,000 income was | method, because after | | | recorded on 2021, | one adjusting period | | | income is a nominal | the income method | | | account, therefore | already recognized a | | | its balance last 2021 | liability which makes | | | will not be included | it like the liability | | | in the computation of | method | | | income in 2022 | | +-----------------------+-----------------------+-----------------------+ | **Note:** The journal | | | | entry is the same | | | | because after one | | | | adjusting entry, the | | | | Income method already | | | | recognized a | | | | liability making it | | | | like a liability | | | | method. | | | +-----------------------+-----------------------+-----------------------+ **Important concepts that will help you in answering adjustments regarding deferral** **I. Pre-payment** - If the problem doesn\'t dictate the method to be used in recording, use the Asset method because it follows the Accrual concept of recording expense when incurred that is why the initial record of prepayment under this method involves a recognition of asset not expense - Remember that Asset method and Expense method are both allowed by the standard because after the adjusting entry the result of these two methods are the same - Remember the partnership of Asset and Expense method because it might be in handy to remember the adjusting entry for them. **If you use the Asset method then the adjusting entry will show a debit to expense**, and **if you use Expense method then the adjusting entry will show a debit to asset**. - Always remember how to compute for the expense using the dates given in the problem. **Remember that the expired portion is the expense, and the unexpired portion is always the asset of the entity,** that is true whether under Asset method or Expense method. - Remember that **after one adjusting entry the Expense method will become like the Asset method both in entry and analysis** because in the first adjusting entry the Expense method will start to record asset that is why it became like an asset method. It means that after one adjusting entry, the computation and journal entry under the two method will become the same. **II. Pre-collection** - If the problem doesn\'t dictate the method to be used in recording, use the Liability method because it follows the Accrual concept of recording income when earned that is why the initial record of pre collection under this method involves a recognition of liability not an income - Remember that Liability method and Income method are both allowed by the standard because after the adjusting entry the result of these two methods are the same - Remember the partnership of Liability and Income method because it might be in handy to remember the adjusting entry for them. **If you use the Liability method then the adjusting entry will show a credit to income, and if you use Income method then the adjusting entry will show a credit to liability** - Always remember how to compute for the Income using the dates given in the problem. **Remember that the expired portion is the income, and the unexpired portion is always the liability of the entity**, that is true whether the entity uses Liability method or Income method. - Remember that **after one adjusting entry, the Income method will become like the Liability method both in journal entry and analysis**, because after the first adjusting entry the Income method will start to record liability making it like the liability method. It means that after the first adjusting entry, the journal entry and analysis for both methods will become the same. **3. Depreciation --** When an entity acquires long-lived assets such as buildings, service vehicles, computers or office furniture, it is basically buying or prepaying for the usefulness of that asset. Since these kinds of asset are use for more than one period proper accounting requires the allocation of the cost of the asset over its estimated useful life. **Depreciation** means allocating the cost of the asset over service life or useful life of the asset Factors involve in computing depreciation - **Cost** -- The amount an entity paid to acquire the depreciable asset - **Estimated useful life** -- is the estimated number of periods that an entity can ma