Learning Objectives:

In this chapter, you should learn to;

1. compare cash basis of accounting and accrual basis
of accounting

2. Make adjusting journal entries for

a. bad debts
b. depreciation
c. prepayments
d. accruals
e. unearned income

3. Explain the importance of adjusting journal entries.

ACCRUAL BASIS
AND
CASH BASIS OF
ACCOUTING
 Accrual basis of accounting
basis dictates when transactions with third parties should be recognized.

determines the accounting periods in which they should be incorporated into

the financial statements

Under this concept the cash receipts from customers and payments to
creditors are replaced by revenue and expenses respectively

Revenue and expenses are derived by adjusting the realised operating cash
flows to take account of business trading activity that has occurred during the
accounting period, but has not been converted into cash receipts or payments
by the end of the period
 ACCOUNTING

CASH ACCRUAL
BASIS BASIS

Recognizes revenue or income in

Recognizes revenue or income when cash
accounting period in which it is earned
is received and recognized expense only
whether not cash has been received and
when cash is paid.
recognizes expenses in the accounting
period in which it is incurred whether or
not cash has been paid.
The following are indications that the accrual basis of accounting is in
use.
A. recognition of accounts receivable
B. recognition of accounts payable
C. recognition of bad debts expense or uncollectible accounts receivable
D. recognition of depreciation of property, plant and equipment
E. recogmtion of prepaid expenses
F. recognition of accrued expenses or expenses payable
G recognition of cash receipts for income not yet earned
A. Recognition of accounts receivable
 A. Recognition of accounts receivable
• Income/Revenue is recognized:
On account /On credit

Accounts Receivable xxx

Sales/Service Income xxx
To record income.

Collection:

Cash xxx
Accounts Receivables xxx
To record collection from customer.
 A. Recognition of accounts receivable
• Income/Revenue is recognized:
Cash Transaction

Cash xxx
Sales/Service Income xxx
To record income.
• IAS 18 Revenue in an attempt to identify when performance was
sufficient to warrant inclusion in the revenue for the period. It
stated that:

In a transaction involving the sale of goods, performance should be regarded as being

achieved when the following conditions have been fulfilled:

a) the seller of the goods has transferred to the buyer the significant risks
and rewards of ownership, in that all significant acts have been completed
and the seller retains no continuing managerial involvement in, or effective
control of, the goods transferred to a degree usually associated with
ownership; and
(b) no significant uncertainty exists regarding:
(i) the amount to be received for the goods;
(ii) the costs incurred or to be incurred in producing or purchasing the
goods.
Monthly sales, expenses and purchases for six months ended June 30 20X1
Sales Cash Purchases Expenses Cash Monthly realized operating cash flow
MONTH Invoice Received Invoiced Cash Paid Invoiced Paid
Jan Feb Mar Apr May Jun Total
January 15,000 7,500 16,000 3,400 3,100
February 20,000 17,500 19,000 16,000 3,500 3,400
March
April
35,000
40,000
27,500
37,500
29,000
32,000
19,000
29,000
3,800
3,900
3,500
3,800
Receipts from customers 7,500 17,500 27,500 37,500 40,000 42,500 172,500
May
June
40,000
45,000
40,000
42,500
33,000
37,000
32,000
33,000
3,900
4,000
3,900
3,900
Less: Payments from Suppliers 16,000 19,000 29,000 32,000 33,000 129,000
195,000 172,500 166,000 129,000 22,500 21,600 Expense-Creditors 3,100 3,400 3,500 3,800 3,900 3,900 21,600
Note: The following items were included under the following Expenses invoiced heading Rent 6,250 6,250
Expenses creditors-amount
Realised -1,850.00 -1,900.00 5,000.00 4,700.00 4,100.00 5,600.00 15,650.00
Wages 3,100 per month paid in the month
Commission 2% of sales invoice payable one month arrears

Deriveration of Expenses
Deriveration of Income
Materials Expenses
Cash Received 172,500 Cash Paid 129,000 21,600
Invoices Not paid 37,000 900
Invoices not paid (Sales invoiced-Cash Received) 22,500
Expenses=Total Invoiced
Revenue=Total invoiced 195,000 166,000 22,500
Statement of Comprehensive Income for the six months ended June 30 20X1
Opeating Cash Flow Adjust Cash Flow Business Activity
Revenue from the business entity 172,500 22,500 195,000
Less: Matching expenses
Transaction for materials 129,000 37,000 166,000
Transactions for services 21,600 900 22,500
Transaction with landlord 6,250 - 3,125 3,125

Operating Cash flow from business activity 15,650

Transactio NOT converted to cash -12,275
or relating to a subsequent period
PROFIT from business entity 3,375
Statement of Financial Position adjusted to accrual basis
B. Recognition of accounts payable
Purchase on account (Goods) Purchase on cash basis (Goods)

Purchases xxx Purchases xxx

Accounts Payable xxx Cash xxx
To record purchase of goods on credit. To record purchase of goods on cash.

Purchase on account (Supplies) Purchase on cash basis (Supplies)

Laboratory Supplies xxx Laboratory Supplies xxx

Accounts Payable xxx Cash xxx
To record supplies bought on account To record supplies bought on cash
 C. Recognition of bad debts
• The entity will find the best way of determining the probable uncollectible
amounts form customer :

Bad Debts Expense xxx

Allowance for Bad Debts xxx
To adjust for the uncollectible accounts.

Bad Debts Expense SCI

Allowance for Bad Debts SFP
 C. Recognition of bad debts
• Once particular or specific amount due to customer becomes definitely
uncollectible the same will be written off to Accounts Receivable

Allowance for Bad Debts xxx

Accounts Receivables xxx
To adjust for the write off of receivables which
are definitely uncollectible.
 D. Recognition of depreciation of plant and equipment
• Since the assets, plat and equipment will help create revenue over a
period beyond the year they are required, the application of their cost to
revenue should also be over a period beyond their year of acquisition
This is done through the process called Depreciation Accounting
Process of allocating the
cost of plant and
Depreciation Expense xxx equipment to the years
Accumulated Depreciation-___ xxx or periods expected to
To record depreciation. benefit from their use.

Building, Furniture, Office Equipment, Laboratory Equipment and

Transportation Equipment
 E. Recognition of Prepaid Expenses
• Two methods:

1. Asset Method- asset account is debited upon payment

Adjusting Entry: at the end of accounting period or

reporting period is the recognition of the expense portion by
debiting the expense account for the crease of expense and credit
to the asset account for the decrease in asset.
 E. Recognition of Prepaid Expenses
• Two methods:

1. Expense Method- expense account is debited

Adjusting Entry: the end of period adjustment is a debit to

the asset account for the unused portion and a credit to the
expense account.
 E. Recognition of Prepaid Expenses
The company paid a one year comprehensive insurance on the company
car. Payment on February 1, 20X1 is Php12,000.
The journal entries for the payment and the year-end adjustments are as
follows:

Asset Method Expense Method

20x1
Feb. 1 Prepaid Insurance 12,000 Insurance Expense 12,000
Cash 12,000 Cash 12,000
To record payment of insurance premium. To record payment of insurance premium.

20x1
Dec.31 Insurance Expense 11,000 Prepaid Insurance 1,000
Prepaid Insurance 11,000 Insurance Expense 1,000
To adjust for the 11-month expense. To adjust for the 1-month unused insurance premium.
 E. Recognition of Prepaid Expenses
On December 16, 20X1, the company purchased office supplies from
Goodwill Trading amounting to Php11,000. By December 31. 20X1 the
consumed office supplies amounted to Php 6,000 leaving an unused
portion of Php 5,000.
Recording of the purchase and the year end adjustment is as follows:

Asset Method Expense Method

20x1
Dec. 16 Unused Office Supplies 11,000 Office Supplies Expense 11,000
Cash 11,000 Cash 11,000
To record purchased of office supplies. To record purchased of office supplies..

20x1
Dec.31 Office Supplies Expense 6,000 Unused Office Supplies 5,000
Unused office Supplies 6,000 Office Supplies Expense 5,000
To adjust for used office supplies. To adjust for the unused office suppies. .
F. Recognition of accrued expenses or expenses payable
at the end of the accounting period
• The company may have availed of or incurred some expenses, payment ofr
which have not been made:
1. Salaries to employees
2. Professional fees to contractors
3. Electric Bills
4. Telephone Bills
5. Water Bills
 E. Recognition of Prepaid Expenses
On December 31, 20X1, the unpaid electric bills amounts to Php25,000.
The journal entry to adjust for this is:

20x1
Dec.31 Utilities Expense 25,000
Utilities Payable or
Accrued Expenses Payable 25,000.00
To adjust for unpaid electric bill for the month of Dec. 20x1

DR Utilities Expense increase in the expense

CR Utilities Payable or Accrued Expenses Payable increase in Liability
E. Recognition of Cash Received for income not yet earned.
Medilaboratory received Php15,000 from a client on December 1, 20X1 for
medical retainship for the months of December 20X1, January 20X2 and
February 20X2.
The are two ways of recording this cash receipt; one as a liability and other
as an income
Liability Method Income Method
20x1
Dec. 1 Cash 15,000 Cash 15,000
Unearned Service Income 15,000 Service Income 15,000
To record advance receipt of service fees. To record advance receipt of service fees.

20x1
Dec.31 Unearned Service Income 5,000 Service Income 10,000
Service Income 5,000 Unearned Service Income 10,000
To adjust for earned income for Dec 20X1 To adjust for unearned service income for January and
February 20X2.
To summarize, the illustrated adjusting entries at end of accounting or
report ing period are for the following:

A. Bad Debts Expense or Estimated Uncollectible Accotmts

B. Depreciation Expense
C. Prepaid Expenses
D. Accrued Expenses
E. Unearned Income
 Distinction between Accrual Basis of Accounting and Cash Basis of
Accounting
Basis Distinction Accrual Basis of Cash Basis Accounting
Accounting
 ACCOUNTING

CASH ACCRUAL
BASIS BASIS

ACCOUNTING
Hybrid or Mixed Basis
Under the hybrid system of accounting, incomes are recognized as
in Cash Basis Accounting i.e. when they are received in cash and
expenses are recognized on accrual basis i.e. during the
accounting period in which they arise irrespective of when they are
paid.
Mr. Anil Roy, a junior lawyer, provides the following particulars for the year ended
31st December, 2020:
`
Fees received in cash in 2020 60,000
Salary paid to Staff in 2020 8,000
Rent of office in 2020 14,000
Magazine and Journal for 2020 1,000
Travelling and Conveyance paid in 2020 3,000
Membership Fees paid in 2020 1,600
Office Expenses paid in 2020 10,000
Additional Information:-
Fees include 3,000 in respect of 2019 and fees not yet received is 7,000.
Office rent includes ` 4,000 for previous year and rent of ` 2,000 not yet paid.
Membership fees is paid for 2 years.
Compute his net income for the year 2020, under – (a) Cash Basis, (b) Accrual Basis
and (c) Mixed or Hybrid Basis.
 Mr. Anil
Statement of Income (Cash Basis)
for the year ended 31st December 2020

PARTICULARS AMOUNT AMOUNT

Fess Received 60,000.00
Less:
Salary 8,000.00
Office Rent 14,000.00
Magazine & Journal 1,000.00
Travellig & Conveyance 3,000.00
Membership Fees 1,600.00
Office Expenses 10,000.00 37,600.00
Net Income 22,400.00
 Mr. Anil
Statement of Income (Accrual Basis)
for the year ended 31st December 2020

PARTICULARS AMOUNT AMOUNT

Fess Received 60,000.00
Add: Accrued Fees for 2019 7,000.00
67,000.00
Less: Fees for 2019 received in 2020 3,000.00 64,000.00

Less:
Salary 8,000.00
Office Rent 14,000.00
Add: Outstanding Rent 2,000.00
16,000.00
Less: Rent 2019 paid 2020 4,000.00 12,000.00
Magazine & Journal 1,000.00
Travellig & Conveyance 3,000.00
Membership Fees 1,600.00
Less: Advance fee padi for 2021 800.00 800.00
Office Expenses 10,000.00 34,800.00
Net Income 29,200.00
 Mr. Anil
Statement of Income (Mixed or Hybrid)
for the year ended 31st December 2020

PARTICULARS AMOUNT AMOUNT

Fess Received 60,000.00 60,000.00

Less:
Salary 8,000.00
Office Rent 14,000.00
Add: Outstanding Rent 2,000.00
16,000.00
Less: Rent 2019 paid 2020 4,000.00 12,000.00
Magazine & Journal 1,000.00
Travellig & Conveyance 3,000.00
Membership Fees 1,600.00
Less: Advance fee padi for 2021 800.00 800.00
Office Expenses 10,000.00 34,800.00
Net Income 25,200.00