Basis of Accounting

The basis of accounting refers to the methodology under which revenues and expenses are recognized
in the financial statement of a business. There are two main basis of accounting

(1) Cash
(2) Accrual accounting

- Cash accounting records revenue and expenses when they are received and paid.

- Accrual accounting records revenue when it is earned and expenses when it is incurred. (Accrual
accounting concept)

Revenue Earned
For example, a business rents part of its premises to another business for $10000 monthly. For
the month of March only $6000 was received. However, Cash received 6000 and cash to be
received $4000 is referred to as revenue earned. (Total amount $10000) The revenue earned in
a period should be included as income for that period irrespective of whether the money has
been received or is still owed.

Expenses Incurred
For example, a business electricity expense is $5000 for the month of March. Payment of $3000
was made for the month. When recording entries for electricity expense $5000 will be recorded.
That is, the $3000 paid and $2000 owing. (Total amount $5000) This is referred to as expenses
incurred. Therefore, expenses incurred in a particular period are charged against the profit for
that period whether or not they have been paid.

Most organizations use the accrual basis of accounting because this gives a true reflection of the
performance of the business.

Using the accrual concept, adjustments will be made to the financial statement for expenses and
revenue so that transactions that have not yet been included in the accounting record of a
business as of a specific date can be updated.

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 Adjustment for accrued expenses

- Accrued expenses: This represent expenses that are owing by the business

Peter Saul

Trial Balance (extract)

As at 31st March 2010

Debit Credit
Assets $10000

Capital $15000

Telephone exp $6000

Note

(a) Telephone expense of $2000 is outstanding

Require

(1) Prepare the ledger account to show the adjustment for the outstanding amount.
(2) Prepare the journal entry for the outstanding amount.
(3) Show the income statement extract for the outstanding amount.
(4) Show the statement of financial statement extract for the outstanding amount.
 Ledger Accounts

(1) Telephone expense a/c

2010 2010
March 31st Cash $6000 31st
March
March 31st Accrued telephone $2000
---------

Total $8000

Accrued telephone expense a/c

2010
31st March telephone expense $2000

General Journal
(2)

Date Details Debit Credit

2010
March 31st Telephone $ 2000
Accrued telephone $2000
Being entry to record
accrued telephone
expense
(3) Income Statement (extract)

Peter Saul

Income Statement

For the year ending 31st March 2010

Expense $6000
Add accrued telephone expense $2000
-----------
Total $8000

(4) Statement of Financial Statement

Peter Saul

Statement of financial position

As at 31st March 2010

Current Liability

Accrued telephone expense $2000

 Adjustment for Prepaid expenses

Prepaid expenses: This represent expenses that are paid in advance

(b)

Peter Saul

Trial balance (extract)

As at 31s1 March 2010

Debit Credit
Assets $8000

Capital $10000

Electricity $4000

Note

$1000 of the telephone expense is paid in advance

Require

(1) Prepare the ledger account for the prepaid amount

(2) Prepare the journal entry to record the prepaid amount.
(3) Show the income statement extract for the prepaid amount
(4) Show the statement of financial statement extract for the prepaid amount.

(1) Ledger Account

Electricity expense a/c

2010 2010
March Cash $4000 31st March prepaid electricity $1000
31st March Bal c/d $3000
------------
--------- $4000
$4000
1st April Bal c/d $3000

Prepaid electricity a/c

2010
31 March electricity $ 1000

(2) General Journal

Date Detail Debit Credit

2010
31 March Prepaid electricity exp $1000

Electricity expense $1000

Being entry to record electricity

paid in advance

(3) Income Statement

Peter Saul

Income Statement

For the month ending March 31, 2010

Expenses

Electricity $4000
Less prepaid expenses ($1000)

------------ 3000

(4) Statement of Financial Position

Peter Saul

Statement of Financial Position

As at 31st March 2010

Current assets

Prepaid electricity $1000

Adjustment for accrued revenue

Accrued Revenue: This is revenue that has been earned by providing a good or service, but for which
no cash has been received

Peter Saul

Trial Balance (extract)

As at 31 March 2010

Debit Credit
Capital $20000

Assets $12000

commission revenue $ 80000

Note

Rent revenue of $2000 is outstanding

Requires

(1) Prepare ledger account for the outstanding amount

(2) Prepare the journal entry for the outstanding amount
(3) Show the income statement extract for the outstanding amount
(4) Show the statement of financial position extract for the outstanding amount

(1) Ledger Account

Commission revenue a/c

2010
Cash $8000
31 March accrued commission revenue $2000
-----------
Total $10000
 Accrued commission revenue a/c

2010
31March commission revenue $2000

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(2) General Journal

Date Details Debit Credit

2010
31March Accrued commission revenue $2000

commission revenue $2000

Being entry to record

commission revenue
outstanding
 (3) Income statement

Peter Saul

Income statement (extract)

For the month ending 31 March 2010

Gross profit

commission revenue $8000

add accrued commission revenue $2000

-------------

10000

(4) Statement of Financial Statement

Peter Saul

Statement of Financial Position (extract)

As at 31 March 2010

Current Assets

Accrued commission revenue $2000

 7

Adjustment for revenue received

Revenue Received in advance: This is the revenue which should be earned in the future in an
accounting period but is already received in the current accounting period.

(c) Peter Saul

Trial Balance
As at 31st March 2010

Debit credit
Capital $8000

Assets $20000

Rent revenue $12000

Note

$4000 of the rent revenue is for the next period

Require

(a) Prepare the ledger account to record the amount received in advance
(b) Prepare the journal entry to record the amount received in advance
(c) Show the income statement extract for the amount received in advance
(d) Show the statement of financial position extract for the amount received in advance
1 Ledger Account

Rent Revenue a/c

2010 2010
31 March Advance rent revenue $4000 March Cash $12000
31 March Bal c/d $8000
----------
------------
$12000 $12000
1st March Bal b/d $8000

Advance rent revenue a/c

2010
1st March Rent revenue $400

2 General Journal

Date Details Debit Credit

2010
31st March rent revenue $4000

Advanced Rent revenue $4000

Being entry to record rent

revenue received in advance
 3 Income Statement Extract

Peter Saul

Income statement

For the year ending 31st March 2010

Gross profit

Rent revenue $12000

Less advance rent revenue ( $4000)

----------

$8000

4 Statement of Financial Position

Peter Saul

Statement of Financial Statement

As at 31st March, 2010

Current Liability

Advance rent revenue $4000