Colegio de San Gabriel Arcangel

Area E, City of San Jose del Monte, Bulacan

Lesson Module

Course Title: Intermediate Accounting 3 Level: Second Year

Course Code: AE17 Lesson No.: 4
Lesson Hours: 3

Objectives:

At the end of this Module, the student will be able to:

1. To understand cash basis of accounting
2. To understand accrual basis of accounting
3. To describe the differences between cash basis and accrual basis of
accounting
4. To be able to prepare adjustments in converting the cash basis financial
statements to accrual basis financial statements

Subject Matter: Cash and Accrual Basis

Procedures:
A. Motivation

B. Lesson Presentation

Methods of Accounting

Cash Basis
Income is recognized when received regardless of when earned and expenses is
recognized when paid regardless of when incurred.

In other words, this approach does not recognized accounts receivable, accounts
payable, accrued income, deferred income, accrued expense and prepaid expense.

Accrual Basis
Income is recognized when earned regardless of when received and expense is
recognized when incurred regardless of when paid.

Thus the essence of this approach is the recognition of accounts receivable,

accounts payable, accrued income, deferred income, accrued expense and prepaid
expense.
 Cash basis versus Accrual basis

Item Cash basis Accrual basis

333Sales Cash sales + collection of Cash sales + sales on
trade receivables account
Purchases Cash purchases + Cash purchases +
payments to trade purchases on account
creditors
Income other than sales Items received are Items earned are
considered as income considered as income
regardless of when regardless of when
earned received
Expenses in general Items paid are treated as Items incurred are treated
expenses regardless of as expenses regardless
when incurred of when paid
Depreciation Depreciation is provided Depreciation is provided
normally normally
Bad debts No bad debts are Doubtful accounts are
recorded because trade treated as bad debts-
receivables are not
recognized

C. Application
EXERCISE 1-1
ABC Company reported the following data which constitute a condensed description
of the business for the first year of operations ending December 31, 2019

Cash sales 500,000

Sales on account 3,000,000
Collections from customers 2,800,000
Cash purchases 300,000
Purchases on account 2,000,000
Payments to trade creditors 1,600,000
Salaries paid 650,000
Office supplies paid 200,000
Other expenses paid 50,000
Interest received 40,000
Equipment 400,000

The equipment is acquired on January 1 and has estimated useful life of 10 years
with no residual value.

The following amounts are properly determined on December 31

Accrued salaries payable 70,000
Office supplies unused 50,000
Accrued interest receivable 10,000
Doubtful accounts 90,000
Ending inventory 400,000

Required:
Prepare a comparative income statement for ABC Company under cash basis and
accrual basis accounting

EXERCISE 2
Bacolod Company began operations on January 1, 2018. During the year ended
December 31, 2019, the accounting records have been on a double entry basis but
the cash basis of accounting has been employed. The entity provided the following
trial balance prepared from these records on December 31, 2019

Cash 1800,000
Land 730,000
Equipment 3,000,000
Purchases 3,000,000
Expenses 790,000
Interest expense 180,000
Note payable 1,500,000
Sales 5,500,000
Share capital 2,000,000
Retained earnings 500,000
Totals 9,500,000 9,500,000

Additional information

 Accounts receivable – 12/31/19 – P500,000; 12/31/18 – P350,000

 Included in sales was P100,000 deposited by a customer for merchandise to
be delivered in 2020
 Accounts payable – 12/31/19 – P450,000; 12/31/18 – P400,000
 Expenses include P30,000 one-year insurance dated May 1, 2019
 The note payable of P1,500,000 is a one-year note issued and discounted at
12% on November 1, 2019
 It is estimated that 5% of the outstanding accounts receivable on December
31, 2019 may prove uncollectible
 Accrued expenses – 12/31/19 – P75,000; 12/31/18 – P60,000
 Inventory – 1231/19 – P600,000; 12/31/18 – P450,000
 The equipment was acquired on January 1, 2018. The estimated life is 10
years

The entity decided to convert the accounting records to the accrual basis on
December 31, 2019

Required
Prepare the necessary adjusting entries to convert the financial statement to accrual
basis of accounting

Prepare the Income Statement and Statement of Financial Position