ACCN08B. Module 5- Cash and Accrual Basis PDF

Preview

Summary

MODULE 5 Intermediate Accounting 3 SESSION TOPIC 5 : Cash and Accrual Basis of Accounting LEARNING OUTCOMES: The following specific learning objectives are expected to be realized at the end of the session: 1. Know and explain the difference between cash and accrual basis accounting. 2. Prepare fina...

Description

MODULE 5 Intermediate Accounting 3 SESSION TOPIC 5 : Cash and Accrual Basis of Accounting LEARNING OUTCOMES: The following specific learning objectives are expected to be realized at the end of the session: 1. Know and explain the difference between cash and accrual basis accounting. 2. Prepare financial statements under accrual basis accounting from cash basis. KEY POINTS Cash basis

Accrual basis

CORE CONTENT Introduction: This module covers the discussion of the cash and accrual basis of recognizing business transactions and preparation of financial statements from cash basis to accrual basis of accounting. IN-TEXT ACTIVITY Cash and Accrual Basis There are two methods for recording accounting transactions such as cash basis and accrual basis. The main difference between these two comes down to timing of recording the business transaction. Cash Basis. Income is recognized when received regardless of when earned, and expense is recognized when paid regardless of when incurred. Example 1: On July 1, 202x, A Co. paid P5,000 to X Marketing Inc. for advertisements. In this example, since A Co. paid in cash, under cash basis accounting, the entity will recognize an advertising expense. Entry will be: Advertising Expense Cash

P5,000 P5,000

Example 2: On July 1, 202x, A Co. sold P12,000 worth of merchandise to B. Co on account. In this example, under cash basis accounting, no revenue will be recognized since no cash was received. Therefore, cash basis accounting does not recognize accounts receivable or accounts payable. Revenue is recorded when cash is received from customers, and expenses are recorded when cash is paid to suppliers and employees. Accrual Basis. Income is recognized when earned regardless of when cash is received, and expense is recognized when incurred regardless of when cash is paid. Example 1: On July 1, 202x, A Co. paid P5,000 to X Marketing Inc. for advertisements. In this example, under accrual basis accounting, the entry will be the same as under cash basis:

ACCN08B Intermediate Accounting 3| *For instructional purposes only*

1

Advertising Expense Cash

P5,000 P5,000

Example 2: On July 1, 202x, A Co. sold P12,000 worth of merchandise to B. Co on account. While in this example, under the accrual basis of accounting, the entity will recognize revenue. Entry will be: Accounts Receivable Sales

P12,000 P12,000

Therefore, accrual basis accounting recognizes accounts receivable or accounts payable. Revenue is recorded when earned and expenses are recorded when consumed. Cash basis to Accrual basis Conversion Many small businesses use cash basis of accounting because of its simplicity, and then adjust the records to accrual basis at the end of an accounting period when financial statements need to be produced. In general, the following cash to accrual conversion formulas can be used to convert each revenue and expense income statement account from the cash basis to the accrual basis of accounting.

Revenue= Receipts + Ending Accounts Receivable – Beginning Accounts Receivable Expense= Payments + Ending Accrued Expenses – Beginning Accrued Expenses

For additional complications, the following formulas may be used. Computation of Sales (Accrual Basis): Cash sales Sales on account: Trade accounts and notes receivable, end Collection of trade accounts and notes receivable Sales return, discounts, and allowances Accounts and notes receivable written off Trade notes receivable discounted (Notes Receivable directly credited) Total Less: Trade accounts and notes receivable, beginning Total sales-accrual basis

xx xx xx xx xx xx xx xx

xx xx

This computation adds back all items that decreased the trade accounts and notes receivable to the ending balance to come up with the actual trade accounts and notes receivable for the current period. Amount computed will then be added to the cash sales to get the total sales (cash and on account) for the current period.

Computation of Purchases (Accrual Basis): Cash purchases Purchases on account: Trade accounts and notes payable, end Payment of trade accounts and notes receivable Purchase returns, discounts, and allowances Total Less: Trade accounts and notes payable, beginning Total purchases-accrual basis

ACCN08B Intermediate Accounting 3| *For instructional purposes only*

xx xx xx xx xx xx

xx xx

2

This computation adds back all items that decreased the trade accounts and notes payable to the ending balance to come up with the actual trade accounts and notes payable for the current period. Amount computed will then be added to the cash purchases to get the total purchases (cash and on account) for the current period.

Computation of Income other than sales (Accrual Basis): Income received-cash basis Add: Deferred income, beginning Accrued income, ending Total Less: Accrued income, beginning Deferred income, ending Income for the current year-accrual basis

xx xx xx xx xx xx

xx xx

The deferred income beginning is added because this amount is received in the previous period and earned in the current period. Whereas the deferred income ending is deducted because this is received in advance in the current period and to be earned only in the next period. The accrued income beginning is deducted because this is already recognized as income in the previous period although it is received only in the current period. Whereas the accrued income ending is added because this is already earned in the current period although it is yet to be received in the following period.

Computation of expenses (Accrual Basis): Expenses paid-cash basis Add: Prepaid expenses, beginning Accrued expenses, ending Total Less: Accrued expenses, beginning Prepaid expenses, ending Expenses for the current year-accrual basis

xx xx xx xx xx xx

xx xx

The prepaid expense beginning is added because this amount is paid in the previous period and only incurred or expensed in the current period. Whereas the prepaid expense ending is deducted because this is paid in advance in the current period and to be expensed only in the next period. The accrued expense beginning is deducted because this amount is incurred in the previous period and paid only in the current period. Whereas the accrued expense ending is added because this is already incurred in the current period although it is yet to be paid in the following period.

Sample Problem: Love Marie Inc. maintains its books on a cash basis but prepares adjustments at the end of the accounting period to conform with accrual basis. The following account balances are provided for the year ended December 31, 2020: Cash

200,000

Accounts receivable

250,000

Inventory Land

150,000 300,000

Building

1,000,00

ACCN08B Intermediate Accounting 3| *For instructional purposes only*

3

Accumulated depreciation

0 200,000

Equipment Accumulated depreciation

400,000 40,000

Accounts payable

100,000

Share capital

1,500,00 0 345,000

Retained earnings Sales

Office expenses

2,000,00 0 1,200,00 0 255,000

Rent Insurance

240,000 50,000

Supplies expense

140,000

Purchases

Additional information: 1. Inventory on December 31, 2020 amounted to P230,000. 2. Accounts receivable: 

December 31, 2020

P290,000



December 31, 2019

250,000

3. It is estimated that P15,000 of the outstanding accounts receivable on December 31, 2020 may prove uncollectible. 4. Depreciation rate: 

Building

5%



Equipment

10%

5. Accounts payable: 

December 31, 2020

P130,000



December 31, 2019

100,000

6. Accrued rent on December 31, 2019 was unrecorded in the amount of P5,000. 7. Accrued rent on December 31, 2020 amounted to P10,000. 8. Prepaid insurance on December 31, 2019 in the amount of P7,000 was not recognized. 9. Prepaid insurance on December 31, 2020 amounted to P12,000. Adjusting entries prepared on December 31, 2020: 1. Inventory- December 31, 2020

P230,000

Profit and loss 2. Accounts receivable

230,000 290,000

Sales

ACCN08B Intermediate Accounting 3| *For instructional purposes only*

290,000

4

3. Doubtful accounts

15,000

Allowance for doubtful accounts 4. Depreciation

15,000 90,000

Accum. Depreciation-building

50,000

Accum. Depreciation-equipment

40,000

5. Purchases

130,000

Accounts payable 6. Retained earnings

130,000 5,000

Accrued rent payable 7. Rent expense

5,000 10,000

Accrued rent payable 8. Prepaid insurance

10,000 7,000

Retained earnings 9. Prepaid insurance

7,000 12,000

Insurance expense

12,000

Sales per book Add: Accounts receivable, end Total Less: Accounts receivable, beg. Total sales-accrual basis

P2,000,000 290,000 2,290,000 250,000 P2,040,000

Purchases per book Add: Accounts payable, end Total Less: Accounts payable, beg. Total purchases-accrual basis

P1,200,000 130,000 1,330,000 100,000 P1,230,000

Rent expense per book Add: Accrued rent, end Total Less: Accrued rent, beg. Total rent expense-accrual basis

P240,000 10,000 250,000 5,000 P245,000

Insurance expense per book Add: Prepaid insurance, beginning Total Less: Prepaid insurance, ending Total insurance expense-accrual basis Retained earnings per book Add: Unrecorded prepaid insurance, December 2019 Total Less: Unrecorded accrued rent, December 2019 Adjusted retained earnings, January 1, 2020

ACCN08B Intermediate Accounting 3| *For instructional purposes only*

P50,000 7,000 57,000 12,000 P45,000 P345,000 7,000 352,000 5,000 P347,000

5

Love Marie Inc. Income Statement Year ended December 31, 2020 ₱ 2,040,000.00

Sales Less: Cost of sales: ₱ 150,000.00 1,230,000 1,380,000

Inventory, beg. Purchases Goods Available for sale Inventory, ending Gross Income

230,000

Less: Expenses: Office expenses Rent expense

1,150,000 890,000

₱ 255,000.00 245,000

Supplies expense Insurance expense

140,000 45,000

Doubtful accounts Depreciation

15,000 90,000

790,000 ₱

Net Income

100,000.00

Love Marie Inc. Statement of Financial Position December 31, 2020 Assets Current assets: Cash Accounts receivable Inventory

₱ 200,000.00 (Note 1)

275,000 230,000

Prepaid Insurance Noncurrent assets: Land

12,000

₱

717,000.00

300,000

Building

(Note 2)

750,000

Equipment

(Note 3)

320,000

1,370,000 ₱ 2,087,000.00

Total Assets Liabilities and Equity Current liabilities: Accounts Payable

₱ 130,000.00

Accrued rent

10,000

₱

140,000.00

Equity: Share capital Retained earnings Total Liabilities and Equity

(Note 4)

1,500,000 447,000

1,947,000 ₱ 2,087,000.00

ACCN08B Intermediate Accounting 3| *For instructional purposes only*

6

Note 1: Accounts receivable Less: Doubtful accounts Net realizable value

₱

Note 2: Building Less: Accum. Dep.-Building Carrying amount

₱ 1,000,000.00 250,000.00 ₱ 750,000.00

₱

Note 3: Equipment Less: Accum. Dep.-Equipment Carrying amount

₱ ₱

Note 3: Retained earnings, Jan 1, 2020 Add: Net Income Retained earnings, Dec 31, 2020

₱ ₱

290,000.00 15,000.00 275,000.00

400,000.00 80,000.00 320,000.00

347,000.00 100,000.00 447,000.00

SESSION SUMMARY Business transactions maybe recorded using two methods namely, cash basis and accrual basis of accounting. Cash basis recognizes revenue and expense when cash is received and paid regardless of when earned or incurred. While accrual basis recognizes revenue and expense when earned and incurred regardless of when cash is received or paid. A company may use cash basis of accounting but will adjust the accounts to accrual basis at the end of the period for the preparation of the financial statements. SELF-ASSESSMENT Assignment:  Prepare the year end adjustments and prepare income statement and statement of financial position using accrual basis of accounting. REFERENCES Refer to the references listed in the syllabus of the subject. SELF-ASSESSMENT ASSIGNMENT: Hankies Company began business operations on January 1, 2020. During 2020, the accounting records are kept on a double entry system but on the cash basis of accounting. On December 31, 2020, the trial balance prepared from these records appeared as follows: Cash Purchase Expenses Notes Payable Sales Share Capital

P 840,000 4,200,000 560,000 P

P5,600,000

200,000 4,400,000 1,000,000 P5,600,000

ACCN08B Intermediate Accounting 3| *For instructional purposes only*

7

The management decided to use the accrual basis. The following data on December 31, 2020 are available: 1. Merchandise inventory on December 31, at cost, P500,000. 2. On December 31, accounts receivable amounted to P100,000 and accounts payable totaled P80,000. 3. Accrued expenses on December 31, P 20,000. 4. The purchases included merchandise in the amount of P10,000 bought for the president. The president had not reimbursed the company. 5. The sales included P25,000 deposit given by a customer for merchandise to be delivered in 2021. 6. It is estimated that 5% of the outstanding accounts receivable on December 31, may turn out to be uncollectible. 7. Expenses include the following: a. P 25,000 for office supplies of which P5,000 is used as of December 31. b. P100,000 for the purchase of equipment on July 1, 2020. It was estimated that this property would have an estimated useful life of 10 years without residual value. c. P20,000 for one-year insurance premium on a fire insurance policy dated October 1, 2020. 8. The notes payable comprise a noninterest-bearing note of P100,000, dated August 1, 2020, due on February 1, 2021 and a one-year note Of P100,000, dated September 1, 2020, bearing an interest of 12% payable at maturity. Required: 1. Adjusting entries on December 31, 2020 2. Income statement 3. Statement of financial position

ACCN08B Intermediate Accounting 3| *For instructional purposes only*

8...