@ STATEMENT OF FINANCIAL POSITION Statement of Financial Position is a financial statement that shows the financial position of an enterprise as of a particular date. It measures and evaluates in terms of the enterprise’ liquidity, solvency, financial structure and capacity for adaptation, Liquidity is the stability of the enterprise to meet currently maturing obligations, Solvency is the availability of cash over the longer term to meet maturing obligations. Financial Structure is the source of financing for assets of the enterprise. It indicates how much is borrowed capital and how much is equity capital. Capacity for Adaptation is the financial flexibility of the enterprise to use the available cash for unexpected requirements and investment opportunities. The Statement of Financial Position, previously known as “Balance Sheet” shows the Assets, Liabilities and Owner's Equity which are called “ i ” These are being outlined below: a ASSETS - In layman’s language, these are the thi 5 and used by the business in th things of value or rights that are owned inventories, fumiture.anit aoe its operation such as cash, land, building a el i : etc. It also includes accounts colle by nd eauipment, Prepaid expenses, ti i f “Receivable”. This tells us how muck a de business which we termed a ne Business owns. 46LIABILITIES - In layman’s language, these are debts or financial obligations of the business that are payable in cash or in some kind of assets such as Accounts Payable, Notes Payable, Salaries Payable, Mortgage Payable, etc. This tells us how much the business owes. OWNER’S EQUITY - In layman’s language, this refers to money or value of property put by the proprietor in to the business to start with which refers to “Initial Investment”. Owner's Equity will be increased by profits or additional investment and decreased by withdrawal , expenses and losses. Most often, Owner's Equity is the residual interest in assets after deducting all the liabilities. It is expressed in the equation as Assets less Liabilities equals Owner’s Equity (A—L = OE). Thus if: the business owns (assets) P100,000 less what the business owes (liabilities) 70,000 equals what is left for the business (owner’s equity) P_30,000 Owner's Equity therefore, tells us how much is left for the business. Presented on the next page is a picture of the Statement of Financial Position of Davao Laundry Services “as of” March 31, 20A prepared under “Account Form”. An account form of Statement of Financial Position follows the “horizonta!” format wherein Assets are found at the left-hand side while Liabilities and Owner’s Equity at the right-hand side.are subject to the claim of the creditors at one hand and owner on the other hand. if there are no claims from outside creditors, then the owner has the sole right of the assets of business. @ STATEMENT OF COMPREHENSIVE INCOME Statement of Comprehensive income which is previously known as Income Statement is a financial statement that shows the "results of operations” of the business for a given period of time. It consists of three (3) sections which are the Revenue or Income, Expenses and Profit or Loss. The period covered by the statement may be: “For the month ended e “For the quarter ended Ae “For the six months period ended i “For year ended a Revenues or Income - denote money or proceeds from services rendered by a servicing company or income from use by other enti of the resources of the enterprise such as Rent Income, Royalties, etc. Servicing companies like Auto Repair Shop, Laundry Shop, Barber Shop, Beauty Parlor, etc. and Professional Income such as Auditing Fees, Legal Fees, Retainers Fees and others. Expenses - denote the benefit received by the business from its use which had helped in carrying out its operation, like salaries expense, rent expense, repairs and maintenance, taxes and licenses, etc. Profit (loss) — the excess of revenues over expenses is called “profit”, while the excess of expenses over revenues is “/oss”. Basically, the Statement of Comprehensive Income features the following: Revenue or Income Pxx - Expenses x = Profit Px | Presented on the next page is a picture of a Statement of Comprehensive Income of Davao Laundry Services prepared under the modified single-step format for the “month ended” March 31, 20A.ew or name of proprietor, 2. Title of the r 3. The period on t mprehen: statement of os i fed 31 March 20A For the mont! service Income Less: Operating Expenses 350 Uncollectible Account Expense P 3500 Depreciation Expense 10,000 Salaries Expense wets Rent Expense 13/000 Utilities Expense 2 a Laundry Supplies Expense ya Taxes and Licenses a ee ac ‘Advertising Expense is Operating Income Less: Finance Charges 000 Interest Expense 1008 for the month Profit The Statement of Comprehensive Income answers the following questions. 1. Does the business make profit? 2. Does the business incur loss? ” if the revenues earned are bigger than the expenses The business makes “profit are bigger than the revenues eared, incurred. Conversely, if expenses incurred there is a "loss". If the business makes profit, the following series of questions can be asked: 1. Can | afford to hire additional employees? 2. What costs can I cut-down to maximize profit? In the above Statement of Cor : P22,150, mprehensive Income, the business makes profit 4 The information presented = in a Statem considered the most i tatement of Comprehensi te usual st Important information provided oy franc accor cial 50‘Financia! suavenmstess because profitability is the paramount concern to those interested in the economic activities of the enterprise. @ STATEMENT OF CHANGES IN OWNER'S EQUITY Statement of Changes in Owner's Equity is a financial statement that summarizes the changes in equity for a given period of time. The beginning equity of the owner is increased by the additional investment and profit. Correspondingly, it is decreased by withdrawal and loss. Shown below is the Statement of Changes in Owner's Equity of Davao Laundry Services for the month ended March 31, 20A. Davao Laundry Services Statement of Changes in Owner's Equity For the month ended 31 March 20A S. Santos, Owner's Equity - March 1, 20A ] Add: Additional investment Profit for the month ij Total Less: Withdrawal S. Santos, Owner’s Equity - March 31, 204 The Statement of Changes in Owner's Equity answers the question: What cause the increase in Owner's Equity of S. Santos from P850,000 to 862,150? Looking at the Statement of Changes in Owner's Equity, we say that the beginning equity of Mr. S. Santos in the amount of P850,000 has increased to P862,150 caused by the results of operations. The amount of the increase is calculated as foilows: Owner’s Equity, end P862,150.00 Owner's Equity, beg. 850,000.00 Increase in Owner's Equity P_12,150,00ner's Equity by P12,150.0u '> acwwws * 52 1OHlOWs, eases in owner's equity) ner’s equity) P 22,150.09 The increase in Ow! 10,000.09) Pp Profit for the month (inc! je Less: Withdrawal (decrease in ow! Net Increase in Owner's Equity ner’s Equity because profit for the month of if is increase in Owt There is an inct 0 is bigger than the amount of his witha in the amount of P22,15¢ 10,000.00. The difference is P12,150.00. © STATEMENT OF CASH FLOWS ncial statement that provides information, Statement of Cash Flows is a fina’ les i the causes of change in an entity's cash balance from the beginning to the given period of time. These are classified into three (3) major activities: Operating Activities — these are cash inflows and outflows generated from n, operations or day to day transactions of the business such as: a. Cash Received (inflows) from sale of goods and services Cash Received (inflows) from rental of business property Cash Paid (outflows) to purchase of supplies and payment of oper expenses. Investing Activities - these are cash inflows and outflows generated from following transactions such as: a. Cash Received (inflows) from sale of property and equipment b. Cash Paid (outflows) to purchase of asset other than inventory Financing Activities — these are cash inflows and outflows generated fron following transactions: Cash Received (inflows) from cash investment by owner Cash Received (inflows) from loan obtained from bank a Paid (outflows) to payment of loan from bank and other led ‘ash Paid (outflows) to payment of owner’s withdrawals aocELEMENTS OF FINANCIAL STATEMENTS AND ACCOUNT TITLES USED The five (5) types of major accounts are considered the elements that are direg related to measurement of financial condition in the Statement of Financial Pos are the Assets, Liabilities and Owner’s Equity, while the elements directly relat to measurement of performance in the Statement of Comprehensive Incomes Income and Expenses. These accounting elements are given account name: account titles. 58‘finoncio! Statements. a ‘Account titles are identification or brief description of items that fall to the same kind, class or nature. STATEMENT OF FINANCIAL POSITION OR BALANCE SHEET ASSETS — Per International Financial Reporting Standards Framework, these are defined as “resources controlled by the enterprise as a result of past transactions and events and from which future economic benefits are expected to flow to the enterprise”. In layman’s term, assets are defined as things of value that are owned and used by the enterprise in its operations. Examples are cash, cash equivalents, building, land, machinery, furniture & fixtures, equipment, intangible assets, etc. It also includes inventories, prepaid expenses and a debt collectible by the enterprise from a customer which we termed as a Receivable. The following are the essential characteristics of an asset: the asset is controlled by the enterprise; the asset is a result of a past transaction or event; the asset provides future economic benefit; the cost of the asset can be reliably measured. aosa Current Assets - refer to all assets that are expected to be realized, sold or consumed within the enterprise’s normal operating cycle. Operating cycle is the interval of time from the date of acquisition of merchandise inventory; sell the inventory to customers and the ultimate collection of cash frorn the sale. When the normal operating cycle of the business is not clearly identifiable, it is assumed to be twelve (12) months. Per revised International Accounting Standards (IAS) No. 1, Assets are classified only into two (2): Current Assets and Non-Current Assets. An entity shall classify an asset as current when: a. it expects to realize the asset or intends to sell or consume it, in its normal operating cycle; b. it holds the asset primarily for the purpose of trading; ©. itexpects to realize the asset within twelve months after the reporting period;Fe ee eee ets Chapter 3 3 7) unless tt unless the aig d._ the asset is cash or a cash equivalent (as defined in IAS No. lity for at least is restricted from being exchanged or used to settle a liabil twelve (12) months after the reporting period Cash - the account title to describe money, either in paper oF in coins and substitutes like check, postal money orders, bank drafts and beoendd warr; When cash is within the premise of the business, the account title is Cash Hand and Cash in Bank if deposited in the bank. se are defined as cash equivalents as shoy dily convertible to known amoung ificant risk of changes in valug Cash Equivalents — Per IAS NO. 7 the: term, highly liquid investments that are rea of cash and which are subject to an insignil because of changes in interest rates. Petty Cash Fund — an account title for money that is separately placed insig the box and set aside for petty or small expenses. This usually happens when, company opens a bank account (savings or current) where it requires ; withdrawal slip or issuance of check every time it makes disbursements. Iti time consuming and it is not wise to make withdrawal slip or issue a check tp pay a small amount of expenses of let’s say P15.00 for jeepney fares. This funi is handled by a petty cashier who is accountable for its disbursements. The petty cashier is warned not to mix his or her personal money with the petty cas fund. Notes Receivable - this is a promissory note that is received by the busines from the customer arising from rendering of services, sale of merchandise, ett This can either be an interest bearing or non-interest bearing. Accounts Receivable - the account title for amounts collectible arising from services rendered to a customer or client on credit or sale of goods to customes ‘on accounts. This constitutes an oral or verbal promise to pay by a customer client. For example, your friend borrows from you the sum of P350.00 to bu! some bottles of beer during drinking session. In accounting parlance, thé means that You have an Accounts Receivable from him in the amount Estimated Uncollectible Accounts — this is an asset-offset or a contra-3* account. It provides for possible losses from uncollectible accounts. lth this is not actually an asset, it is classified as such because it is shown %! deduction from the Accounts Receivable which is a Current Asset Account.nani steserent example, the company has an amount collectible from various customers. Remember, not all customers are good payers. Thus, we provide a certain percent (%) of what we could not collect from them. This is called estimated uncollectible accounts or allowance for doubtful accounts which we previdusly termed as allowance for bad debts. The difference between Accounts Receivable and the related Estimated Uncollectible accounts is called Estimated Realizable Value. Advances to Employees - the account title for amounts collectible from employees for allowing them to make cash advances which are deductible against their salaries or wages. Inventories - Per IAS No. 2, these are assets which are (1) held for sale in the ordinary course of business; (2) in the process of production for such sale; or (3) in the form of materials or supplies to be consumed in the production process or in the rendering of services. These refer to grocery items such as sugar, canned goods, dairy products, toiletries, etc. Vegetable items such as tomato, eggplant, garlic, ginger, etc. Supplies Inventory or Unused Supplies — an account title for cost of stationery and other supplies purchased for use but are left on hand and still unused. The account title should be specified as to Unused Office Supplies if intended for the office, Unused Shop Supplies if intended for the shop, etc. Prepaid Expenses - account title for expenses that are paid in advance but are not yet incurred or have not yet expired such as Prepaid Rental, Prepaid Insurance, Prepaid Interest, Prepaid Advertising, etc. For example, we insure our vehicle. It is but normal that the insurance company will collect the premium in advance. The amount that we pay to the insurance company is what we call “prepayment”. The correct title however, is “Prepaid Insurance”. Accrued Income — account title for income that is already earned but it has not yet been collected. For example, a tenant is renting our building for P10,000 a month. His rental for the month of January will be paid in February. So, at the end of January we have a Rental Income Receivable from our tenant. The Correct account title however, is “Accrued Rental Income”. ‘These accounts are normally arranged according to liquidity (ready conversion to Cash) in the Statement of Financial Position.ae —~ Non-Current Assets: t - the International Accounting Standards (Ias) ‘ Property and beseartaath ipment as tangible assets which are held by an ente,, aaa ao d services, for rental to others, i, heals Pe Ee sort a re parted to be during more thor h ‘administrative purposes, and which ai used period such as: if building used as office or st 2 itle for the site where the f aa € OF Sto, te nd is reserved for future use, it is classified as “invest id. If tan es ee Land is not subject to depreciation because it is expected to be Uy for an indefinite period of time. Building - account title for a finished construction owned by the business whe operations and transactions took place. Equipment - include calculators, typewriters, adding machines, compute, steel filing cabinets and the like. If these are used in the office, the account ti, is Office Equipment and if used in the store, Store Equipment. Trucks, jee vans, automobiles and other kinds of motor vehicles are used exclusively delivering goods, the account title is Delivery Equipment. Furniture & Fixtures - include chairs, tables, counters, y cases and thelit If these are used in the office, the account title is Office Furniture & Fixturesat if these are used in store, the account title is Store Furniture & Fixtures. The cost of property and equipment include purchase price, freight on shipmet installation cost, trial-run expenses, etc. in order for it to become ready tow Expenditures incurred which extend the useful life of the asset, increase! productivity or enhance the quality of the product that will yield benefit beyondt current period are called “capital expenditures” and therefore, treated as an as# Accumulated Depreciation - this is an asset-offset or contra-asset account. is shown as a deduction from proj i h perty and equipment. Each property equipment should be provided with their individual valuation account. The i d The sierence between cost of property and the related accumulit® lepreciation is called “carrying value” or “net book value”. Intangible Assets — Per international Accor id are identifiable, non-monetary assets without physical substance. An asset 62 unting Standards (IAS) No. 38, te?: in standards (IAS) y t- the International nero pare held by an Bites 4 caneat ‘ Property and ea arr equipment as a7 vices, for rental to others, on defines property an an goods and SEMCES 1 during more thon in production or supply 2 cted to o Aaa ‘es, and which are exP© administrative purposes, es re the building used as Office oF stoy, it is classified as “invest ‘ e itis expected to be Uses, ite whe! Land - an account title for the by whi constructed. If land is reserve cation ecaus property”. Landis not subject to dep! i time. n indefinite period of tim: o itle fora finished construction owned by the business whe, Building - account title for operations and transactions took place. i i chines, compute, lipme! in yewriters, adding ma : ee ne soothe i ee are used in the office, the account ti, ing cabinets and the like. I 4 sea ing aes if used in the store, Store Equipment. TTUcks, je a Se emoties and other kinds of motor vehicles are used exclusively jy vans, delivering goods, the account title is Delivery Equipment. Furniture & Fixtures - include chairs, tables, counters, display cases and the lite If these are used in the office, the account title is Office Furniture & Fixtures ay if these are used in store, the account title is Store Furniture & Fixtures. The cost of property and equipment include purchase price, freight on shipmen installation cost, trial-run expenses, etc. in order for it to becor Expenditures incurred which extend the useful life of the asset, increase é Productivity or enhance the quality of the product that will yield benefit beyondt! Current period are called “capital expenditures” and therefore, treated as an asé ready to us Accumulated Depreciation - this is is shown as a deduction from equipment should be Provided an asset-offset or contra-asset account. eae and equipment. Each property # with their individual valuation account. The difference -between Cost fates t of i depreciation is called “carry vale” or pet got we related accumula? value”. Intangible Assets - Per Internat al 2 are identifiable, non-monetary meen, Meounting Stan if dard: ; 3, the Without physical is (IAS) No. 3 al substance. An asset”. ‘, \ resource controlied by an entity as a result of past events and from which future eonomic benefits are expected to flow to the entity. These include goodwill, patent, copyrights, franchise, trademarks, brand names, etc. Most of the intangible assets are not amortized but subject to test for impairment at least annually. Limes — Per International Financial Reporting Standards Framework, these are defined as “present obligations of an enterprise arising from past transactions or events, the ‘settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits". In layman's language, liabilities denote financial obligations of the business to its creditors. It represents the claim of the creditors over the assets of the enterprise. ABI The following are the essential characteristics of a liability: a. The liability is the present obligation of a particular enterprise. This means that the enterprise’ liability must be identified; b. The liability arises from past transactions or events. This means that the liability is not recognized until it is incurred; c. The settlement of the liability requires an outflow of resources embodying economic benefits. This means that the obligation of the enterprise is to transfer cash and non-cash resources or provide services at some future time. prise which are (a) expected Current Liabilities - are financial obligations of the enter (b) due to be settled within to be settled in the normal course of the operating cycle; one year from the Statement of Financial Position date. bilities are classified only Per revised International Accounting Standards (IAS) No. 1. Lial An entity shall classify a into two (2): Current Liabilities and Non-Current Liabilities. liability as Current when: it expects to settle the liability in its normal operating cycle; b. itholds the liability primarily for the purpose of trading; ¢. the liability is due to be settled within twelve (12) months after the reporting Period; or d. the entity does not have an unconditional right to defer settlement of the liability for at least twelve (12) months after the reporting period. 63rvice Income - In general, this is the account title ri all ty si ee dt i rendering of services. era i; ies SOU ived fri cin un ar eee svn Other specific income accor ¥ is Service e ; nerally used by Professionay Professional income - the account title Ber . € fr “ practice of their profession or ee : led as ae Ae ees Income for Accountants, Legal oe re awyers, a ack Dentists, Medical Fees Income for i d on buildings, space or Other ft - for income earne BS, : her, ood band by the business as the main line of its activity Owned an i ived by the business arisin tt Income — for income recei on borrowed by a customer and usually covered by This is typical in lending institutions. B from an, a Promiss,, Miscellaneous income - for income earned by the business Which isp main line of its activity and could not be clearly classified, EXPENSES- are the “gross outflow of economic benefit ts during the Period gp the course of ordinary activities of an enterprise when those Outflow re decrease in equity, other than those telating to distribution to owners". Be are salaries expense, rent expense, stationery and supplies expense, uncol. accounts, depreciation, taxes and licenses, etc, Losses represent ecreasesin, or increases in liabilities arising from that Activities or Ordinary course of business Opi events that are Outsig eration. Examples are the loss from Sale of pr and equipment, loss due to theft or pilferage, disaster such as fire and flood, Profit (Loss) ~ the excess of revenues expenses exc Over expenses is Called "Prof eed the revenues, it is Called a "Loss." Supplies Expense — consumed that bears expense, shop Supplie: this represents, SPECific titles a. S expense, etc, Cost of Supplies that were use! S Office s Upplies expense, store si" Repairs and Mainten, buildings, Machi business, nance - for expenses incurred in repairing or serviait ineries, Vehicles, €quipment etc which are owned 5 66ae sos EE aries Expense - for compensation given to employees of a business. It may = specified as Office Salaries, Salesmen’ 's Salaries, etc. uncollectible Accounts - for the anticipated loss that the business may incur arising from uncollectible accounts. pepreciation Expense - for the portion of the cost of property and equipment or fixed assets that has expired based on rational and systematic allocation procedure. Taxes and Licenses - for the amount paid for business permits, licenses and other government dues except the Income Tax paid which is not allowable by law as a deduction. Insurance Expense - account title for the expired portion of the insurance premium paid. Utilities Expense - the account title for telephone, light and water bills. Interest Expense - an expense incurred from borrowed money. This is separately shown as a deduction from Profit before finance charges to arrive at Profit. Miscellaneous Expense - any amount paid as expense which is not significant enough to warrant a particular classification. Gas & Oli — the account titie for gasoline, diesoline, lubricants, grease, fluids, lube oils, etc. for use by company vehicles.CURLING PROCESS the Journal is called “SOURNALIZING” which is the first Step of the accout Process. The entry that is made in the Journal is called “OURNAL ENTRY”. AN OPENING ENTRY ft The first entry made in the general journal is called an “Opening ex constitutes either the recording of the initial investments of a OE na engaged in the business for the first time or the recording of the begin! of accounts in Preparation for the next annual accounting period. is chapte"”, The opening entry is illustrated on Page 139 (with SE mon te! the initial investments of Mr. Severo Santos was recorded on Ma!POSTING TO THE GENERAL LEDGER (2nd Step of the Accounting Process) After the transaction has been recorded in the Journal, the entries in the Journal will then be transferred to another book cailed “Ledger” for final recording. The process oftransferring entries from the journal to the Ledger is what we call “Posting” which is the second step of the accounting process. Posting simply means updating the ledger accounts due to the effects of the transactions recorded in the journal. The transfer of entries from the Journal to the ledger is actually the sorting process Which means putting each value in a certain place according to its kind, class or nature, This refers to “Classifying”, which is the second phase of accounting. hh : . cree accounting systems, this can be a tedious and time-consuming process; ie ee systems, it is usually done instantly and automatically. In \ Computerized posting greatly reduces the risk of errors.FOOTING THE LEDGER After posting the journal entries to the ledger, the amounts of debit and credit are being totaled and usually done at the end of each month. This is called “footing”. Footing is the process of adding vertically each of the two amount columns of an account or item in the general ledger and finding their balances thereof while cross-footing is the process of adding horizontally the figures to check the correctness of the footing that was done. In footing the account, a well-sharpened pencil should be used in writing the total of the amount and the account balance. If an account is a debit balance (debit total isbigger than the credit total), the amount of difference is placed on the “particular” Column of the debit side. If the account, on the other hand is a credit balance (credit total is bigger than debit total), the amount of difference is placed on the ‘articular’ column of the credit side. If there is only one entry in any side of an ccount in the ledger, no footing is done and the entry is left “as is”.TRIAL BALANCE PREPARATION (3rd Step of the Accounting Process) The preparation of a trial balance is the 3rd step of the accounting process. It is merely copying carefully of what has been footed in the ledger. Remember, 2 trial balance does not prove that transactions have been correctly analyzed and recorded in the proper accounts. This proves only one aspect of the ledger, that is the equality of debits and credits. This report summarizes the debit and credit entries of each account in the Gerieral Ledger. Atrial balance is of two (2) forms. One is the trial balance of balances and the other \s the trial balance of totals. When you are required to prepare a trial balance and nomention was made of its form, it is understood to be a trial balance of balances. 1. Tiial Balance of Balances — Under this form of a trial balance, listings of the debit or credit balances of each account in the general ledger that are emaining open after footing has been done.Chapter 6 iit sl ; i result 2 trial balance to i Some errors and omissions committed that wil \ balance” are as follows: n the journal; (omission) i 1. Atransaction may not have been recorded te ea red in ts 2. A journal entry may not have been post ns (omission) wrong account; error) hich was debited to Accounts wi ieee posted to Accounts Payable ley was erroneous! 3. Posting a correct amount toa Example: The correct amount of Receivable je try and was carried to 4. Wrong charging of account title in the journal entry ne i ledger; (error) in the ledger; (« t, it was erroneously debited t, iter was bough! : : ee t instead of Office Equipmen, ? t Example: When a typ’ accoun' Office Supplies Expense i il trial balance to be “, Some errors and omissions committed that will result a be e, balance” are as follows: sbit and credit columns of the trial balance is wrong; (en, 1. The footing of the del 2. Anaccount with “open balance” in the balance; (omission) 3. The footing of the account balance in the General Ledger is wrong; (error) General Ledger was not listed in they, 4. Posting the amount of an item to the wrong side of the account or ley (error) Example: An amount of P 200 which was debited to account “Cash” wo posted to the credit side of the said account 5. Omission in postir it it it ir Posting of either debit or credit entry in the journal; (omission) Example: In a jc Ae pre: Ina journal entry debiting Cash and crediting Accounts Recei® Posting was made for C ‘ash but n Accounts Receivable account. }0 posting was made for theig of or) rial ger, unt ig 9 ~ gxample of an error in Sete eo ans written as 1,258. Sliding j. 'SPOSition j: 19 is ay sition is th, Like for example, P 10.00 is cnr” lacing th figure 1,528 ig i = is incor 19 the deci; incorrectl and the like. rectly written ne ecimal point of a figure. liberate or an intentional en a del entional act j is “in-balance” is done ing | jance eS poe ec atthough actually “out eee it appear that the trial i eco ee hare the amount of the eee the amount ference, the trial “ag pratice- 7 T, Ci i. xaminatiO" of books of accounts,” ‘an be di iscovered during an “audit” or \ocATING ERRORS IN THE TRIAL BALANCE Ilowing procedures is suggest w fol iggested to locate the errors or omissions committed caused the trial balance to be “out of balance.” 2" step Go over with the listed account balances and check whether they are all in its normal balances. A step 3” step Get the amount of difference between the debit and credit totals. Add again the debit and credit columns of the trial balance. If out ofbalance then, debit item might have been listed in the credit column and vice versa. If found correct and the trial balance is still “out of balance,” then, ifthe amount of difference is 1, 10, 100, or 1,000, it might be an error. in addition; the orders of figures written tf the amount of difference is 9 or a multiple of 9, 38 was written as 83. This is ‘ate reversed; for example, 25 was written as 520r ‘transposition error; ight be an error in listing the # i the amount of difference is divisible by 2 it mt he credit column of the trial ne balance. A debit amount was listed in t ince and vice versa; e divided by 9) it indicates as the amount of difference is divisible by 9 (can b le, P50 is incorrectly written its bi is placement of decimal point. For examp! 35 as P2.35, This is a sliding error.Chapter. REASONS WHY ADJUSTING JOURNAL ENTRIES ARE PREPARED? It is our primary objective to present a correct financial esl ta are tu, “test-meters” of the financial condition of the business. si 2 ms ang the results of operation at the end of the accounting perioe wing reasons: Generally, adjusting entries are prepared for the follo accounts updated a) to bring records or balances of ‘enses during the period b): to properly match revenues against exp WHAT ARE REAL AND NOMINAL ACCOUNTS? atement of Financial Position ang ate i ‘ ti Real accounts are accounts listed in the S i i considered “Permanent Accounts”. This statement a rm aire radi isted in nt of il inal accounts are accounts. lls a Sheet”, while Nominal Ss riporary. Accounts” of Owner, i idere Comprehensive Income and are consi J 3 Equity. This statement was previously known as Income Statement”. TYPES OF ADJUSTING ENTRIES The following are the usual items which require adjusting entries at the end of an accounting period: 1. Accruals a. Accrued Income b. Accrued Expenses 2. Deferrals a) Pre-collection of Income b) Prepayment of Expenses 3. Provision for Depreciation of Property and Equipment or Fixed Asset 4. Provision for Estimated Uncollectible Accounts (Bad Debts) 5. Unused Supplies inventory Adjustment 6. Adjustment on Inventories — this is typical in merchandising and manufacturing concern.RIES ARE PREPARED? JOURNAL ENT! carowrer 2 REASONS iris our pri mpest-mmeters the results of operation at ul WHY ADJUSTING a correct financial statements which a, n of the business as of 2 particular dat, N, period. em mary objective to present » of the financial conditio he end of the accounting Generally, adjusting entries are prepared for the following reasons: counts upda' ted a) to bring records or balances of acc ; t expenses during the period b) to properly match revenues agains! WHAT ARE REAL AND NOMINAL ACCOUNTS? Real accounts are accounts listed in the Statement of Financial Position and i, considered “Permanent Accounts”. This statement previously known as “Balance Sheet”, while Nominal accounts are accounts. listed in the Statement ¢ Comprehensive Income and are considered “Temporary Accounts” of Owner; Equity. This statement was previously known as “Income Statement”. TYPES OF ADJUSTING ENTRIES The following are the usual items which require adjusting entries at the end of accounting period: 1. Accruals a. Accrued Income b. Accrued Expenses 2. Deferrals a) Pre-collection of Income b) Prepayment of Expenses Provision for Depreciation of Property and Equipment or Fixed Asset Provision for Estimated Uncollectible Accounts (Bad Debts) Unused Supplies Inventory Adjustment Adjustment on Inventories - this is typical in merchandising 24 manufacturing concern. OAPwpesos Bs ws ACCRUALS (ACCRUED INCOME AND ACCRUED EXPENSE ADJUSTMENTS) counting, the term “accrual” means to recognize revenue or income earned in atjjess of when it is collected and to record expense incurred whether paid or 108" not ued Income — it is an income that is already earned but not yet collected when accounting period ends. The purpose of the adjusting entry is to record the income earned and recognize the corresponding asset account (receivable). i ied Expense — it is an expense that is already incurred but not yet paid when the accounting period ends. The purpose of the adjusting entry is to record the expenses incurred and recognize the corresponding liability account (payable). Joillustrate: A building owned by Metro Davao Hotel was partly rented by Allied Banking corporation for PS0,000 per month payable every 5" day of the following month. The rental for the month of December 20A will be paid on January 5, 20B. Analysis: 20A and 20B are two different and separate accounting periods. On the part of Metro Davao Hotel, the revenue was already earned in 20A but collection will be received in 20B. On the part of Allied Banking Corporation, the rental expense was already incurred in 20A but payment will be made in 20B. Metro Davao Hotel should record the income earned although not yet received by debiting Accrued Rent Income and crediting Rental Income. On the other hand, Allied Banking Corporation should record the expense incurred although not yet paid by the debiting Rent Expense and crediting Accrued Rent Expense on December 31,20A for both. Accrued Rent Income has semblance of a receivable account or it can be substituted x Rent Receivable while Accrued Rent Expense has a semblance of a payable | “*ount or can also be substituted by Rent Payable. | M eto Davao Hotel records Accrued Rent Income which is a Receivable account and Alig cok Corporation records Accrued Rent Expense which is a PayableDEFERRALS (PRE-COLLECTED INCOME AND PREPAID EXPENSE ADJUSTMENTS) PRECOLLECTION OF INCOME Pre-collected Income — this is an income that is already collected but na earned. This is exactly the opposite of accrued income. There are two method approaches that can be used in recording pre-collections, namely: 1. Income Method — an income account is credited upon collection or recep cash. This method is also called “nominal approach” because an incom 184osafsrepetiod Adustments statement of Comprehensive Income account and Statement of Comprehensive Income accounts are also called nominal accounts. . Liability Method ~ a liability account is credited upon collection or receipt of cash. This method is also called “real approach” because a liability is @ Statement of Financial Position account and Statement of Financial Position accounts are also called real accounts. Toillustrate: On October 1, 20A, Cordillera Realty Co. collected P12,000 from a tenant Tepresenting an advance collection from building rental for one year. The accounting period ends on December 31, 20A. The above transaction is recorded in a comparative journal entry showing both the Income and Liability methods of recording pre-collections: tear reeceEFFECTS OF ERROR/OMIISSION ON FINANCIAL STATEMENTS Under Income Method Under Liability Method \f adjusting entry is not prepared on December 31, 20A, the whole amount of 12,000 will be charged to Income when in fact P9,000 is unearned portion or Liability. Since the liability portion could not be recorded without the said adjusting entry, Income is overstated because the profit that is closed to Owner's Equity is overstated. Therefore: Statement of Comprehensive Income — Profit is overstated. Statement of Financial Position — Liability is understated and Owner's Equity is overstated. if adjusting entry is not preparey iS December 31, 20A, the whole amoun 12,000 will be charged to Liability whe, fact, P3,000 is earned portion or ty Since the income portion could not recorded without the said adjusting e Liability is overstated because the Prof thy is closed to Owner’s Equity is understated, Therefore: Statement of Comprehensive Income - Profit is understated. Statement of Financial Position - Labi) is overstated and Owner's Equity 6 understated,Guide in Preparing Adjusting Journal Entries on Pre-collection 1. fan Income account is credited upon receipt of cash (Income Method), the ad entry must recognize the Liability Account. Therefore, you go for the opp “credit the Liability and debit the income”. 2. Ifa Liability account is credited upon receipt of cash (Liability Method), the a, entry must recognize the Income Account. Therefore, you go for the Oppose “credit the Income and debit the Liability”. PREPAYMENT OF EXPENSES Prepaid Expense — this is an expense that is already paid but not incurred. Th exactly the opposite of accrued expense. There are two methods or appro that can be used in recording prepayments, namely: 1. Expense Method - under this method or approach, an expense account is’ upon payment of the prepaid expense. This method is also called approach” because an expense is an Income Statement accounts Statement accounts are also called nominal accounts.tte priodAcustnnts asset Method - an asset account is debited upon payment of the prepaid or Tf ® ‘his method is also called “real approach” because an asset is 2 Statement © Financial Position account and Statement of Financial Position accounts are called real account. qo illustrate: on september 1, 20A, Rajah Buayan Commercial paid an insurance Pe covering the period from September 1, 20A to September 1, 208 in the amount of 3,600. The accounting period ends on December 31, 20A. qhe transaction is recorded in a comparative journal entry showing both the gxpense and Asset methods of recording prepayments: COMPARATIVE JOURNAL ENTRIES pon EXPENSE METHOD ‘ASSET METHOD payment | Insurance Expense —_P3,600. Prepaid Insurance P 3,600 ‘on Cash 3,600) Cash P3,600 Sept. 1, To record insurance To record insurance 20A. premium paid. premium paid. Analysis: Under Expense Method, Insurance Expense account has been debited upon payment on Sept. 1, 20A which means charging to expense the whole amount of P3,600 while under Asset Method, Prepaid Insurance account has been debited which means charging to asset the whole amount of P3,600. This is what will happen if the adjusting entry is not prepared. Regardless of which method is used in recording prepayment, the P3,600 becomes a “mixed account” or a mixture of both expense and asset elements at the end of the Period broken down as follows: Expense or Expired portion computed as follows: 3,600 12 mos. (Sept. 1, 20A to Dec. 31, 20) = P300 x 4Amonths = P 1,200 Asset or Unexpired portion computed as follows: 3,600 P3,600 = 12 mos. P300. x Smonths = 2,400 Gan. 1, 208 to Sept. 1, 20B) Total prepayment —————> _P._ 3,600a EFFECTS OF ERROR/OMISSION ON FINANCIAL STATEMENTS [ Under Expense Method | Under Asset Method epared on Dec. 31, If adjusting entry is not prepared op, te 4 if adjusting entry is not pr 20A, the whole amount of P3,600 will be | charged to Expense when infact, P2,400 is the prepaid portion or Asset. Since the asset portion could not be recorded without the said adjusting entry, Expense is overstated and Asset is understated. If expense is overstated, then Profit is understated. Owner's Equity is also understated because the amount of Profit that is closed to | ‘Owner's Equity is understated. Therefore: | | Statement of Comprehensive Income — Expense is overstated and Profit is understated. | Statement of Financial Position ~ Asset is understated and Owner's Equity is also understated. 20A, the whole amount of P3699 |. charged to Asset when in fact,P1,20)" & expired portion or Expense. Since expense portion could not be the without the said adjusting entry, Expense understated and Asset is overstateg is) Expense is understated, then Profit overstated. Owner's Equity is also oversty is} because the amount of Profit that is closeq, | Owner's Equity is overstated. Therefore: Statement of Comprehensive Income . Expense is understated and Profit il overstated. | Statement of Financial Position ~ Asset i, overstated and Owner's Equity is ako) overstated. Guide in Preparing Adjusting Journal Entries on Prepayments 1. If an Expense account is debited upon payment (Expense Method), the adjusting entry must recognize the Asset Account. Therefore, you go for the opposite: “credit the Expense and debit the Asset”. an Asset account is debited upon payment (Asset Method), the adjusting ry must recognize the Expense Account. Therefore, you go for the Opposite: “credit the Asset and debit the Expense”. :as ..0—0—000O OO (5" Ste; hescpneatiad p of the Accounting Process) heet or working paper is a columnar sheet used as a tool or bridge connectin the Trial Balance and Financial Statements. \ts purpose is to ceonine te mance oF results of the operation and financial condition of the enterprise in a fastly manner even before adjusting and closing entries can be recorded in the General Journal. Aworksheet can be a 6-column, an 8-column or a 10-column worksheet. vides a pair of column for Unadjusted Trial Balance, A 6-column worksheet pro’ e Income and Statement of Financial Position. This is Statement of Comprehensiv called a “Simple Worksheet”. of columns for Unadjusted Trial Balance, A 10-column worksheet provides a pair Comprehensive Income and Adjustment, Adjusted Trial Balance, Statement of Statement of Financial Position. 217er . FINANCIAL STATEMENTS (6" Step of the Accounting Process) ol w have come to the very Purpose of acco, the proprietor of what happened to the Capi to gh the financial statements. The Preparati went step of the accounting process. unting which is to “communicate” ital that he put into the business ion of financial statements is the As mentioned earlier, the worksheet will hel statement of Comprehensive Income and the Statement of Financial Position. The statement of Comprehensive Income section of the worksheet shows all the ‘Nominal Accounts” while the Balance Sheet shows all the “Real Accounts”. At this point, it is worthy to mention as a reminder that the Income Statement or the Nominal Accounts are the temporary accounts of Owner's Equity comprising of Income and Expenses while the Statement of Financial Position or Real Accounts are permanent accounts comprising of Assets, Liabilities and Owner’s Equity. This justifies why the period covered in the: Statement of Comprehensive Income is worded “for the period ended” which can either be a monthly, quarterly, semi- annually or annually while that of the Statement of Financial Position is worded “as of which means, it is prepared on specific or particular date. Pp facilitate the preparation of the Therefore, if we are to prepare an Statement of Comprehensive Income, we just ‘ake a look at of the Statement of Comprehensive Income section of the worksheet. Litewise, if we are to prepare a Statement of Financial Position, we just take a look tof the Statement of Financial Position section of the worksheet. All we have to do Stofollow the standard format of these statements.3, page 5U. STATEMENT OF FINANCIAL POSITION Statement of Financial Position is a statement that shows the “financial, Position®y the enterprise as of a given date. A statement of financial position is of two fom “Account Form” and “Report Form”. The Account Form of a statement of financial position is patterned after ty Accounting Equation, Assets = Liabilities + Owner’s Equity wherein the Assets a: shown at the left side and Liabilities and Owner's Equity at the right side. The thre accounting elements are arranged in “horizontal order”. This form of a statement of financial position is used when there are plenty of accounts involved. This wa already shown on Chapter 3, page 48 of this book. The “Report Form” of a statement of financial position, assets are shown first av followed by liabilities and owner's equity in a “vertical order”. This form of? statement of financial position is used when there are only few accounts involved. Shown on the next page is the “Report Form” of a Statement of Financial Position? Davao Laundry Services as of 31 March 20A. 226STATEMENT OF CHANGES IN OWNER’S equity that occurred in Statement of This statement summarizes the changes Equity. It is arrived at by determining the Beginning pee ean Which ig 4, in the general ledger plus Additional araiielpae d ae is Statement of Comprehensive Income and the a wick oe ‘S Equity ,.* reconciled with the balance of this statement an what is appearing ing. Statement of Financial Position. x Statement of Changes in March 20A. Owner's Equity of Davao Shown below is the Services for the month ended 31 Davao Laundry Services Statement of Changes in Owner's Equity For the month ended March 31, 208 S. Santos, Capital - March 1, 204 P 850, 000 ‘Add: Additional investment Pp Profit 22,150 22,150 Total P 872, 150 Less: Withdrawal 10, 000 P 862,150 S. Santos, Capital ~ March 31, 20A he same Statement of Changes in Owner's Equity that was alr resented in t already presented i STATEMENT OF CASH FLOWS As previously discussed in Chapter 3, pages 52-54. maa BCUSSE , , , we learned tha’ Nice) McRae con about sources of cash Saat a eevee cane eo iean whether there are increases or decreases inc zach infos Cotod he eginning and ending at the end of a given period. Eahuintois oe c ma outflows, there is an increase in cash. C ef : lows, there is a decrease, ee Remember, there are 4 three (3) maj operating, investi major operating cash fl ; eine ee Ing and financing activities, Th ows of an entity. These ae pared with cash outflows, !@ cash inflows of every activity ® Per International A i ‘ccounting Stand; be lard: " je cash flow from Operating aa ms) irect method is also acceptable. ae 228 N ; 7, enterprises are encouraged” sing the direct method. How?aes CLOSING ENTRIES th (7 Step of the Accounting Process) The works of an accountant does Not end after the preparation of financial statements. While the information relative to the performance or results of business operations and. financial conditions were already relayed to the owner and other potential users, he has still to make a compliance of an accounting requirement which is the “closing of the books of accounts” signaling the end of an accounting period and the preparation of “post-closing trial balance” to ensure the aithmetical accuracy and correctness of the balances of accounts after closing entry 237REASONS WHY ADJUSTING JOURNAL ENTRIES ARE PREPARED? i It is our primary objective to present a correct financial statements whi “test-meters” of the financial condition of the business as of a particy the results of operation at the end of the accounting period. ich are ‘hy lar date : ‘Generally, adjusting entries are prepared for the following reasons: a) to bring records or balances of accounts updated b) to properly match revenues against expenses during the period WHAT ARE REAL AND NOMINAL ACCOUNTS? Real accounts are accounts listed in the Statement of Financial Position and a considered “Permanent Accounts”. This statement previously known as “Balang Sheet”, while Nominal accounts are accounts. listed in the Statement ¢ Comprehensive Income and are considered “Temporary Accounts” of Owner’ Equity. This statement was previously known as “income Statement”. TYPES OF ADJUSTING ENTRIES The following are the usual items which require adjusting entries at the end of@ accounting period: 1. Accruals a. Accrued Income b. Accrued Expenses 2. Deferrals a) Pre-collection of Income b) Prepayment of Expenses Provision for Depreciation of Property and Equipment or Fixed Assé* Provision for Estimated Uncollectible Accounts (Bad Debts) Unused Supplies Inventory Adjustment Adjustment on Inventories — this is typical in merchandising and manufacturing concern. oss eS a Ae anewa Fat rene gra eee ACCRUALS (ACCRUED INCOME AND ACCRUED EXPENSE ADJUSTMENTS) fn accountings feet seeeuer Means to recognize revenue or income earned regaraess of lected and to record expense incurred whether paid OF not. pocrued Income - it is an income that is already earned but not yet collected when the accounting period ends. The purpose of the adjusting entry is to record the income earned and recognize the corresponding asset account (receivable). Accrued Expense alt is an expense that is already incurred but not yet paid when the accounting period ends. The purpose of the adjusting entry is to record the expenses incurred and recognize the corresponding liability account (payable). Toillustrate: A building owned by Metro Davao Hotel was partly rented by Allied Banking Corporation for P50,000 per month payable every 5" day of the following month. The rental for the month of December 20A will be paid on January 5, 20B. Analysis: 20A and 20B are two different and separate accounting periods. On the part of Metro Davao Hotel, the revenue was already earned in 20A but collection will be teceived in 20B. On the part of Allied Banking Corporation, the rental expense was already incurred in 20A but payment will be made in 20B. Metro Davao Hotel should record the income earned although not yet received by ebiting Accrued Rent Income and crediting Rental Income. On the other hand, Alied Banking Corporation should record the expense incurred although not yet tad by the debiting Rent Expense and crediting Accrued Rent Expense on December 31,208 for both. Accrued Rent Income has semblance of a receivable account or it can be substituted Rent Receivable while Accrued Rent Expense has a semblance of a payable *count or can also be substituted by Rent Payable. stro Davao Hotel records Accrued Rent Income which is a Receivable account and a Banking Corporation records ‘Accrued Rent Expense which is a Payable unt. eehas been done ili a and to facilitate the preparation of the next or ni period. — em account, If you remember, we have classified the accounts into two, namely: the Homing, statement of comprehensive income accounts and real or statement of fina, position accounts. The nominal accounts are closed at the end of the accoun period while the real accounts are not closed and are held open. 2 By closing, this means that a nominal account which has an open balance Will be reduced to “Zero” balance. Thus, a nominal or income statement account with; debit balance will be credited in the closing entry by an amount equal to its deti, Conversely, a nominal or income statement account with a credit balance will debited in the closing entry by an amount equal to its credit.DEFERRALS (PRE-COLLECTED INCOME AND PREPAID EXPENSE ADJUSTMENTS) PRECOLLECTION OF INCOME Pre-collected Income — this is an income that is already collected but Tot earned. This is exactly the opposite of accrued income. There are two methods, approaches that can be used in recording pre-collections, namely: 1. Income Method — an income account is credited upon collection or receipti cash. This method is also called “nominal approach” because an incomes 184Statement of Comprehensive ; 'ncome account and Statement of Comprehensive Income accounts are also called Nominal accounts 2. Liability Method -a liability account is credited upon collection or receipt of cash. This method is also called “real approach” because a liability is a Statement of Financial Position acc: ‘Ount and Statement of Financial Position accounts are also called real accounts.= POST-CLosing TRIAL BALANCE (8" Step of the Accounting Process) ater closing all the Nominal or Stat sive | nother trial balance 's prepared to prove the equality of debit and credit amount af accounts remaining “open” in the General Ledger”. The open talances” in the ledger after closing are the ri acounts. The post-closing trial balance therefore, contains the list of Statement of financial Position accounts with open balances and is being defined as a “statement offinancial position in a trial balance form”. ‘ment of Comprehen: shown below are the General Ledgers with each of the real or statement of financial position account which are with open balance: ASSETS dry Supplies (4) Cash in Bank (1) Loney Supplies (4) _____taundry 10 90,000 3/31 P 20,00 Me P850,000] 3/3 P150,000 8/2 oe ro pofe REVERSING ENTRY (9th” Step of the Accounting Process) Reversing Entry is a journal entry that is being recorded in the General Journal and is done at the beginning of the accounting period after the preparation of the opening entry. For a company to operate for the first time, there will be no reversing entry at the beginning of the period. It will only take place from the start of the second year of operation but never at the beginning of the first year of operation. The purpose of this is to facilitate the recording of subsequent transactions. 245av es ‘What Accounts are to be Reversed? Basically, all adjusting entries on accruals are reversed. For deferred ity adjustments, only deferrals whose original entries follow the nominal approach y recording prepayment and pre-collection are reversed and that is when: Expense account is debited upon prepayment of expenses. b. Income account is credited upon receipt of pre-collected income. As a tule, all accrued and deferred item adjustments that recognized or setups Statement of Financial Position accounts are reversed. The normal balance of » asset account is a debit while the liability account is a credit. ‘SIMPLE GUIDE OR TECHNIQUES IN DETEMIINING WHEN ARE ADJUSTING ENTRIES REVERSED. When an adjusting entry involves an asset account and said account is at its norm balance of a debit, the adjusting entry must be reversed, When an adjusting entry involves a liab! ¥ ility account and said account is at its nom alance of a credit, the adjusting entry must be reversed. ADI JUSTING ENTRY ON ACCRUEN FyDEnces——TWhen an adjusting entry involves a liability account and said account is at its n, balance of a credit, the adjusting entry must be reversed. omy ADJUSTING ENTRY ON ACCRUED EXPENSES _ __ EXPLANATION —-—~ Rental Expense P xx Accrued Rental Expense is a Statemen, ‘Accrued Rental Expense P xx | Financial Position account and i normal balance of a credit being , liability account. This must be reversed ADJUSTING ENTRY ON ACCRUED INCOME _| EXPLANATION Accrued Interest Income is a Statemey Accrued Interest Income Pxx | of Financial Position account and in Interest Income Pxx | normal balance of a debit being: Receivable account. This must bk | reversed. ADJUSTING ENTRY ON PREPAID EXPENSE 7 EXPLANATION (Original Entry is Expense Method) | Prepaid Insurance Pxx | With the two accounts involved in ti Insurance Expense Pxx | adjusting entry, Prepaid Insurance 6? To record the unexpired Statement of Financial Position accov* portion of the insurance Since it is in its normal balance of a dé Premium. this must be reversed. 2an—{pIUSTING ENTRY ON PREPAID Expense (original Entry is Asset Method . enka a a ipurance EXPENSE Pxx repaid insurance to record the expired portion of the insurance payment. ‘pIUSTING ENTRY ON PRECOLLECTED INCOME (Original Entry is Income Method) Pxx Rental Income P xx Unearned Rental Income Torecord the earned portion of the rental collected in advance. Pxx TOSTING ENTRY ON PRECOLLECTED IC JCOME (Original Entry is Liability Method) Unearned Rental Income Px Rental Income To record the earned portion of the rental collected in advance. ga re EXPLANATION In this adj pia) aahusting entry, the Statement of pees Position account is the Prepaid creanee being an Asset. Since i is ited and not in its normal balance, this must not be reversed. : EXPLANATION In this adjusting entry, the Statement of Financial Position account is Unearned Rental Income being a Liability. Since it is in its normal balance of a credit, this must be reversed. EXPLANATION In this adjusting entry, the Statement of Financial Position account is Unearned Rental Income being a Liability. Since itis not in its normal balance of a credit, this must not be reversed.