Basic Financial Accounting & Reporting Adjusting the Accounts Learning Objectives After studying this chapter, you should be able to: Explain accrual accounting and state how it improves financial statements. Explain the importance of periodic reporting and time period assumption. Explain the recognition and derecognition process. Identify the types of adjustments and their purposes. Ilustrate how accounting adjustments link to financial statements. Use the same steps learned in-analyzing transactions. Prepare and explain the adjusting entries. Interpret the effects of omitting adjustments on the financial statements. Develop skills in preparing adjusting entries using T-Accounts. Summarize the adjustment process showing the type of adjustment, the effect of omitting the adjusting entry on the financial statements and the adjusting entry. 11. Prepare an adjusted trial balance. 12. Explain the alternative methods of recording deferrals ACCRUAL BASIS The financial statements, except for the cash flow statement, are prepared on the accrual basis of accounting in order to meet their objectives. Under the accrual basis, the effects of transactions and other events are recognized when they occur and not as cash is received or paid. This means that the accountant records revenues as they are eamed and expenses as they are incurred. The timing of cash flows is relatively immaterial for determining when to recognize revenues and expenses. Financial statements prepared on the accrual basis inform users not only of past ‘rnsactions involving the payment and receipt of cash, but also of obligations to pay Cash in the future, and of resources that represent cash to be received in the future. Generally accepted accounting prin !°5 require that a business use the accrual basis,4-2 | Bosc Financial Accounting ond Reporting by Prof. WiN Boles | cash basis accounting, however, the accountant does not record a transactio cash is received or paid. Generally, cash receipts are treated as revenues Payments as expenses. Cash basis income is the difference betwer OPE stingy receipts and disbursements, These cash flows necessarily exclude investments B distributions to the owner in the computation of income. oracay Island P7,000 on April g May 13, 2019. Under accrual ba venues when the busines Mlustration. A client paid the Sea Wind Resort in for a one-day super deluxe accommodation on accounting, the receipt of P7,000 will be considered a5 Fev rendered its services on May 13. cognize revenues on April 8, ‘don May 13. Suppose a fin basis, no revenue or expense w I be reported but the re} Observe that the accrual In contrast, if cash basis is used, the hotel will re related to this revenue transaction will be incurre report is prepared at the end of April, under accrual reported; under cash basis, revenues of P7,000 wil expenses will be recognized when incurred on May 13. provided a better measure of the results of transactions. PERIODICITY CONCEPT “The only way to know how successfully a business has operated is to close its doo allits assets, pay the liabilities and return any excess cash to the owners. This proc going out of business is called liquidation, This, however, Is not a practical measuring business performance. ‘Accounting information is valued when it is communicated early enough to be usee economic decision-making. To provide timely information, accountants have divi the economic life of a business into artificial time periods. This assumption is toas the periodicity concept. ‘Accounting periods are generally a month, a quarter or a year. The most accounting period is one yeor. Entities differ in their choice of the accounting fiscal, calendar or natural. A fiscal year is a period of any twelve consecutive mont ‘colendar year is an annual period ending on December 31. A natural business ye twelve-month period that ends when business activities are at their lowest level of ‘annual cycle. A period of less than a year is an interim period. Some even adop annual reporting period of 52 weeks. Businesses need periodic reports to assess their financial condition and perfo The periodicity concept ensures that accounting information is reported at intervals. It interacts with the recognition and derecognition principles to undet lise of accruals. To measure profit in a fair manner, entities update the incof txpense accounts immediately before the end ofthe period.Adjusting the Accounts | 4-3 OGNITION AND DERECOGNITION 2018 Conceptual Framework, recogni Nn is the process of capturing for inclusion in statement of financial position or the statement(s) of financial performance an that meets the definition of an asset, a liability, equity, income or expenses. amount at which an asset, a liability or equity is recognized in the statement of ncial position is referred to as its “carrying amount”. statement of financial position and statement(s) of financial performance depict an y's recognized assets, liabilities, equity, income and expenses in structured aries that are designed to make financial information comparable and iderstandable. cognition links the elements, the statement of financial position and the statements) financial performance. The statements are linked because the recognition of one 2m (or a change in its carrying amount) requires the recognition or derecognition of fe or more other items (or changes in the carrying amount of one or more other ms). For example: ) the recognition of income occurs at the same time as (i) the initial recognition of an asset, or an increase in the carrying amount of an asset; or (ithe derecognition ofa liability, or a decrease in the carrying amount ofa liability. ) the recognition of expenses occurs at the same time as: (i) the initial recognition of a liability, o an increase in the carrying amount of a liability: or (i) the derecognition of an asset, or a decrease in the carrying amount of an asset. initial recognition of assets or liabilities arising from transactions or other events lay result in the simultaneous recognition of both income and related expenses. For sxample, the sale of goods for cash results in the recognition of both income (from the cognition of one asset—the cash) and an expense (from the derecognition of another sset—the goods sold). The simultaneous recognition of income and related expenses sometimes referred to as the matching of costs with income. fecognition is appropriate if it results in both relevant information about assets, liabilities, equity, income and expenses and a faithful representation of those items, jecause the aim is to provide information that is useful to investors, lenders and other editors. Derecognition is the removal of all or part of a recognized asset or liability from an entity's statement of financial position. Derecognition normally occurs when that item ‘no longer meets the definition of an asset or ofa liability: (a) for an asset, derecognition normally occurs when the entity loses control of all or part of the recognized asset; and (b) for a lability, derecogntion normally occurs when the entity no longer has a present obligation forall or part of the recognized liability.4-4 | Basic Financial Accounting and Reporting by Prof. Wi THE NEED FOR ADJUSTMENTS Accountants make adjusting entries to reflect inthe accounts informa” OF “onan activities that have occurred but have not yet been recorded. Acltitng Hic astgn revenues to the period in which they are earned, and expenses fo 1T2 BET whi they are incurred, These entries are needed to measure properly {06 pee period, and to bring related asset and liability accounts to correct balances for the financial statements In short, adjustments are needed to ensure that the recagition and deresoain principles are followed thus resulting to financial statements reporting ofall ‘transactions at the end of the period, Adjusting entries involve changing account balances at the end of the period from what is the current balance of the account to what is the correct balance for proper finance) reporting. Without adjusting entries, financial statements may not fairly show the solvency of the entity in the balance sheet and the profitability in the income statement, The General Journal End of the period—adjusting entries recorded in the General Journal y Posting to the Ledger Prepaid SY epee ne N Unearned RevenuesAdjusting the Accounts | Adjusted Trial Balance Adjusted Trial Balance is prepared Assets Liabilities Owner's Equity Revenues Expenses DEFERRALS AND ACCRUALS Accountants use adjusting entries to apply accrual accounting to transactions that cover mmore than one accounting period. There are two general types of adjustments made at theend of the accounting period—deferrals and accruals. Each adjusting entry affects a balance sheet account (an asset or a liability account) and an income statement account (income or expense account). Deferral is the postponement of the recognition of “an expense already paid but not yet incurred,” or of “revenue already collected but not yet earned”. This adjustment deals with an amount already recorded in a balance sheet account; the entry, in effect, decreases the balance sheet account and increases an income statement account. Deferrals would be needed in two cases: 1. Allocating assets to expense to reflect expenses incurred during the accounting period (e.g. prepaid insurance, supplies and depreciation). 2. Allocating revenues received in advance to revenue to reflect revenues earned during the accounting period (e.g. subscriptions). ‘Accrual is the recognition of “an expense already incurred but unpaid”, or “revenue camed but uncollected”. This adjustment deals with an amount unrecorded in any count; the entry, in effect, increases both a balance sheet and an income statement ‘count. Accruals would be required in two cases: 1 Accruing expenses to reflect expenses incurred during the accounting period that are unpaid and unrecorded. . 2 Accruing revenues'to reflec revenues earned during the accounting period that are Uncollected and unrecorded.stment process. The k ‘The Weddings “R” Us case is continued to illustrat ena cae aha A, L, OE, OE:! and OE:E are still used to ensure 2 better un of the accounts affected. te the adi ADJUSTMENTS FOR DEFERRALS (Step 5) ‘Allocating Assets to Expenses Entities often make expenditures that benefit more than Lire These expenditures are generally debited to an asset account. At the end of each accountng period, the estimated amount that has expired during the period or that has Benefteg the period is transferred from the asset account to an expense account. TWO ofthe more: important kinds of adjustments are prepaid expenses, and depreciation of property and equipment. Prepaid Expenses Some expenses are customarily paid in advance. These expenditures (e.g. supplies, rent ‘and insurance) are called prepaid expenses. Prepaid expenses are assets, not expenses ‘At the end of an accounting period, a portion or all of these prepayments may have expired. The portion of an asset that has expired becomes an expense. Prepaid expenses expire either with the passage of time or through use and consumption, The flow of costs from the balance sheet to the income statement s illustrated below: Cost of re As insurance Balances Income Statement icarance policies expire and | income Statement policies an supplies used supplies. —>|(_ Assets ee Revenues that will benefit Prepaid pads eal | eee future Insurance Insurance Expense periods Supplies Supplies Expense If adjustments for prepaid expenses are not made at the end of the period, both the balance sheet and the income statement will be misstated. First, the assets of the entitY will be overstated; second, the expenses of the company will be understated. For tis reason, owner's equity in the balance sheet and profit in the income statement will bth be overstated. Besides prepaid rent, Weddings “R” Us has enter a supplies and insurance, both accounts need adjusting entries, PP *Pe “esAdjusting the Accounts | 4-7 id Rent (Adjust roa dea = Tieoea On May 1, Weddings “R" Us paid P8,000 for two months’ eens me rele Fesulted to an asset consisting of the right to occupy i be a anche eee Of the asset expires and becomes an expense each : , fe asset had expired er an Transaction Expiration of one month's rent. Analysis, Assets decreased. Owner's equity decreased Rules Decreases in assets are recorded by credits. Decreases in ‘owner's equity are recorded by debit Entries carted Deeri i 'ecrease in owner's equity is recorded by a debit to rent expense. Decrease in assets is recorded by a credit to prepaid rent. or. cr. Rent Expense (OE:£) 4,000 Prepaid Rent (A) 4,000 Alter adjustments, the prepaid rent account has a balance of P4,000 (May 1 prepayment of P8,000 less the P4,000 expired portion); the rent expense account reflects the P4,000 expense for the month, a as at se eae ie ae Prepaid Insurance (Adj. b). Weddings “R” Us acquired a one-year comprehensive insurance coverage on the service vehicle and paid P14,400 premiums. In a manner similar to prepaid rent, prepaid insurance offers protection that expires daily. The adjustment is analyzed and recorded as shown below: Transaction Expiration of one month's insurance. Analysis Assets decreased. Owner's equity decreased, Rules Decreases in assets are recorded by credits. Decreases in ‘owner's equity are recorded by debits. Entries Decrease in owner's equity is recorded by a debit to insurance expense; decrease in assets as a credit to prepaid insurance. Or. cr. Insurance Expense (OE:E) 1,200 Prepaid Insurance (A) 1,200 ‘The prepaid insurance account has a balance of P13,200 (May 4 prepayment of P14,400 less P1,200) and insurance expense reflects the expired cost of P1,200 for the month. Asa matter of company policy, the period May 4 to 31 is considered a month.jn Ballo 48 | Basic Financial Acountng ond Reporting by PLUS purchased Supplies, P18,9, apt US Supplies (Adjustment c}. On May 8, Weddings ease ceed supplies inte PES During the month, the entity used suppl da " vupplies every clients. There is no need to account for = pape month. At the end of statements will not be prepared until the en! inventory of the su accounting period, Perez-Manalo makes a careful physical It oli, (000 are still on hand, The inventory count showed that supplies costing p1s,00 Ths transaction is analyzed and recorded as follows: s of performing Services, y since the finan, Transaction Consumption of supplies: cag Analisis Assets decreased. Owner'sequity dee) ain Rules Decreases in assets are recorded by haan 7 jebit ‘owner's equity are recorded by Entries Decrease in owner's equity is recorded by a debit to supplies expense. Decrease in assets is recorded bY @ credit to ‘supplies. Dr. Cr. Supplies Expense (OE:£) 5 oe supplies (A) : he adjusted amount of P15,000 (P28,000 ls The aset account supplies now reflect tt e accounting period i 3,000). In addition, the amount of supplies expensed during th reflected as P3,000. Pec a Depreciation of Property and Equipment ‘When an entity acquires long-lived assets such as buildings, service vehicles, computes of office furnitures, its basically buying or prepaying for the usefulness of that as ‘These assets help generate income for the entity. Therefore, a portion of the cost ofthe assets should be reported as expense in each accounting period. Proper accountrg requires the allocation of the cost of the asset over its estimated useful life. The festimated amount allocated to any one accounting period is called depreciation o depreciation expense. Three factors are involved in computing depreciation expense: 1. Asset costs the amount an entity paid to acquire the depreciable asset 2. Estimated salvage value is the amount that the asset can probably be sold for at the end ofits estimated useful life. 3, Estimated useful life is the estimated number of periods that an entity can make use of the asset. Useful lifeis an estimate, not an exact measurement.‘Adjusting the Accounts | 4-9 —eEeEeE———EEEE As the asset's Balance Sheet useful life Income Statement Cost of a expires depreciable —> |(~ Assets females asset Service Vehicle =e Expenses Office Equipment Depreciation Accountants estimate periodic depreciation. They have developed a number of methods for estimating depreciation. The simplest procedure is called the straight-line method. The formula for determining the amount of depreciation expense for each period using this method is: Asset cost mx Less: Estimated salvage value a Depreciable cost 1 Divided by: Estimated useful life x Depreciation Expense for each time period = xx _ e The asset account is not directly reduced when recording depreciation expense. Instead, the reduction is recorded in a contra account called accumulated depreciation. A contra account is used to record reductions in a related account and its normal balance is opposite that of the related account. Use of the contra account— accumulated depreciation—allows the disclosure of the original cost of the related asset in the balance sheet. The balance of the contra account is deducted from the cost to obtain the book value of the property and equipment. Service Vehicle and Office Equipment (Adjs. d and e). Suppose that Weddings “R” Us estimated that the service vehicle, which was bought on May 4, will last for seven years (eighty-four months) and with a salvage value of P84,000. The office equipment that was acquired on May 5 will have a useful life of five years (sixty months) and will be worthless at that time. Substitution of the pertinent amounts into the basic formula will Yield depreciation for service vehicle and office equipment for the month as P4,000 [(420,000 - P84,000}/84 months} and P1,000 (P60,000/60 months), respectively. These amounts represent the cost allocated to the month, thus reducing the asset accounts and increasing the expense accounts. As @ matter of company policy, the period May 4 to 31 is considered a month. The analysis follows: Transaction Recording depreciation expense. Analysis. Assets decreased. Owner's equity decreased. Rules Decreases in assets are recorded by credits. Decreases in ‘owner's equity are recorded by debits.Entries Owner's equity is decreased by debits to depreciation expense service vehicle and depreciation expense-office equipment Assets are decreased by credits to contra-asset accounts accumulated depreciation-service vehicle and accumulated depreciation-office equipment. Dey § ach Depreciation Expense-Service Vehicle (OE:E) 4,000 Accumulated Depreciation-Serv. Vehicle (A) 4,000 Depreciation Expense-Office Equipt. (OF:E) 1,000 1,000 Accumulated Depreciation-Off. Equipt. (A) After adjustments, the property and equipment section of the balance sheet for Weddings “R” Us will be: Weddings “R” Us Partial Balance Sheet May 31, 2019 Property and Equipment (Net): Service Vehicle 420,000 Less: Accumulated Depreciation 4,000_ P416,000 Office Equipment : P 60,000 Less: Accumulated Depreciation 1,000 _59,000 475,000 — Allocating Revenues Received in Advance to Revenues ‘There are times when an entity receives cash for services or goods even before service s rendered or goods are delivered. When such is received in advance, the entity has an obligation to perform services or deliver goods. The liability referred to is unearned revenues. For example, publishing companies usually receive payments for magazine subscriptions in advance. These payments must be recorded in a liability account. If the company fails to deliver the magazines for the subscription period, subscribers are entitled to @ refund. As the company delivers each issue of the magazine, it earns a part of the advance payments. This earned portion must be transferred from the unearned subscription revenues account to the subscription revenues account.idjusting the Accounts | 4-11 rere nS Value of ‘As the goods goods or Balance Sheet er sarices Income Statement services are provided tebe >| Liabitties = oo Unearned Revenues from Revenues provided in future periods Unearned Referral Revenues (Adj. f). On May 15, Weddings “R” Us received P10,000 as. ‘an advance payment for referrals made. Assume that by the end of the month, one of. the three couples referred has already taken their marriage vows and as a result the amount of P4,000 pertaining to the referred event has been realized. This transaction is analyzed as follows: Transaction Recognition of income where cash is received in advance. Analysis Liabilities decreased. Owner's equity increased. Rules Decreases in liabilities are recorded by debits. Increases in owner's equity are recorded by credits, Entries Decrease in liabilities is recorded by a debit to unearned referral recorded by a credit revenues. Increase in owner's eq to referral revenues. Dr. Gr. Unearned Referral Revenues (l) 4,000 Referral Revenues (OE:!) 4,000 ‘he liability account unearned referral revenues reflects the referral revenues still to be earned, P6,000. The referral revenues account reflects the amount of referrals already ‘completed and considered as revenues during the month, P4,000. ADJUSTMENTS FOR ACCRUALS (Step 5) Accrued Expenses ‘An entity often incurs expenses before paying for them. Cash payments are usually made at regular intervals of time such as weekly, monthly, quarterly or annually. If the accounting period ends on a date that does not coincide with the scheduled cash payment date, an adjusting entry is needed to reflect the expense incurred since the last payment. This adjustment helps the entity avoid the impractical preparation of hourly or daily journal entries just to accrue expenses. Salaries, interest, utilities (eg, electricity, telecommunications and water) and taxes are examples of expenses that are incurred before payment is made.4-12 | Basie Financial Accounting and Reporting by Prof. WIN Batlada Accrued Salaries (Adj. g). Entities pay their employees at regular intervals. It can weekly, semi-monthly or monthly. Weekly payrolls are usually made on Fridays (gy, five-day workweek) or Saturdays (for a six-day workweek). Weddings “R” Us p, salaries every two Saturdays. Assume that the calendar for May appears as follows: May $0 MP SOW Thar se sa es aia geee| 4 5 6 Pobe fo ao mks wz 8 rs ae yr a 29 20 2 a wae 6. 238 agit 96" esa The office assistant and the account executive were paid salaries on May 13 and 27, a month-end, the employees have worked for three days (May 29, 30 and 31) beyond thy last pay period. The employees have earned the salary for these days, but it is not due to be paid until the regular payday in April. The salary for these three days is rightuly an expense for May, and the liabilities should reflect that the entity owes the employee, salaries for those days. Each of the employee's salary rate is P7,800 per month or P300 per day (P7,800/26 working days). The expense to be accrued is P1,800 (P300 x 3 days x 2 employees). This | accrued expense can be analyzed as shown: ‘ Transaction Accrual of unrecorded expense. Analysis Liabilities increased. Owner's equity decreased. Rules Increases in liabilities are recorded by credits. Decreases in owner's equity are recorded by debits. Entries Decrease in owner's equity is recorded by a debit to salaries expense. Increase in liabilities is recorded by a credit to salaries payable. Drees Salaries Expense (OE:E) 1,800 Salaries Payable (L) 1,800 The liability of P1,800 is now correctly reflected in the salaries payable account. Tre actual expense incurred for salaries during the month is P15,600, seAdjusting the Accounts | 4-13 accrued Interest (Adj. h). On May 2, Perez-Manalo borrowed P210,000 from Metrobank. She issued a prot Issory note that carried a 20% interest per annum. Both the interest and principal will be payable in one year. The note issued to the bank accrues interest at 20% annually. At the end of May, Perez-Manalo owed the bank 3,500 (see computation below) for interest in addition to the P210,000 loan. Interest is a charge for the use of money over time. Interest expense is matched to a particular period during which the benefit—the use of borrowed money—is received. The interest isa fixed obligation and accrues regardless of the results of the entity's operations. Interest rates are expressed at annual rates, so if interest is being calculated for less than a year, the calculation must express time as a portion of a year. Thus, the interest expense (simple) incurred on this note during the month is determined by the following formula: Interest. = Principal x Interest Rate x Length of Time 210,000 x 20% per year x 1/12 of a year 210,000 x .20 x 1/12 = P3,500 The adjusting entry to record the interest expense incurred in May is as follows: Transaction Accrual of unrecorded expense, Analysis _Liabilities increased. Owner's equity decreased. Rules Increases in liabilities are recorded by credits. Decreases in ‘owner's equity are recorded by debits. Entries Decrease in owner's equity is recorded by a debit to interest ‘expense; increase in liabilities as credit to interest payable, Dr. Cr, Interest Expense (OE:E) 3,500 Interest Payable (L) 3,500 —— ne Accrued Revenues ‘An entity may provide services during the period that are neither paid for by clients nor billed at the end of the period. The value of these services represents revenue earned by the entity. Any revenue that has been eared but not recorded during the accounting period calls for an adjusting entry that debits an asset account and credits an income account. Accrued Consulting Revenues (Adj. i). Suppose that Weddings “R” Us agreed to arrange a rush but simple civil wedding for a madly-in-love couple in the afternoon of May 31 The entity intended to charge fees of P5,300 for the services, which is earned but Unbilled. This should be recorded as shown below:4-14 | Basic Financial Accounting and Reporting b) Accrual of unrecorded revenue. Transaction Analysis Assets increased. Owner's equity increased, Rules increases in assets are recorded by debits. Increases in owner's equity are recorded by credits. Entries Increase in assets is recorded by a debit to accounts receivable, Increase in owner's equity as a credit to consulting revenues, Dr. cr | ‘Accounts Receivable (A) 5,300 5,300 Consulting Revenues (OE:!) A total of P67,700 in consulting revenues was earned by the entity during the month, ‘The Weddings “R” Us illustration did not tackle entries related to uncollectible accounts, Hence, the ensuing discussion on the accrual of uncollectible accounts is not in any way related to the Weddings "R” Us illustration. This is to complete the illustrations oy adjustments for accruals. ACCRUAL FOR UNCOLLECTIBLE ACCOUNTS Entities often allow clients to purchase goods or avail of services on credit. Some of these accounts will never be collected; hence, there is a need to reflect these as charges against income. In practice, an expense is recognized for the estimated uncollectitle accounts in the current period, rather than when specifi¢ accounts actually become Uncollectible. This practice produces a better matching of income and expenses Estimates of uncollectible accounts may be based on credit sales for the period or on the accounts receivable balance. ‘Assume that an entity made credit sales of P1,100,000 in 2019 and prior experience indicates an expected 1% average uncollectible accounts rate based on credit sales, The contra account—Allowance for Uncollectible Accounts has a normal credit balance and is shown in the balance sheet as a deduction from Accounts Receivable. The allowance account need to be increased by 11,000 (P1,100,000 x 1%) because accounts receivable in that amount is doubtful of collection. The adjustment will be: Dr. Cr. Uncollectible Accounts Expense (OE:E) 11,000 Allowance for Uncollectible Accounts (A) 11,000 Throughout the accounting period, when there is positive evidence that a specie account is definitely uncollectible, the appropriate amount is written off agains te contra account. For example, ifa P1,500 receivable were considered uncollectibl, that amount would be written off as follows:Or. cr. Allowance for Uncollectible Accounts (A) 1,500 Accounts Receivable (A) 1,500 we antes ae Uncollectible Accounts Expense, since the adjusting entry has already Provided for an estimated expense based on previous experience for all receivables. A more detailed discussion of this topic is found in Part Four of this book EFFECTS OF OMITTING ADJUSTMENTS. When ‘an accountant failed to include the proper adjusting entries, the resulting financial statements will not accurately reflect the financial position and the performance of the entity. Inaccuracies in one accounting period can cause further inaccuracies in the statements of subsequent periods. Illustration. On July 1, 2019, Cabuyao Manpower Services owned by Warlito Blanche borrowed P100,000 by signing an 18-month note at 16% interest per annum. The principal and interest are to be repaid when the note matures on Dec. 31, 2020, ‘As at Dec. 31, 2019, the entity has incurred interest expense of P8,000 (P100,000 x 16% x 6/12). The accountant did not record the adjustment for the accrued interest. The entry should have been a debit to Interest Expense and a credit to Interest Payable for 8,000. ‘The effects of the omission in the 2019 financial statements are as follows: > In the 2019 income statement, Interest expense is understated by P8,000 and, therefore, profit is overstated by P8,000. > Inthe Dec. 31, 2019 balance sheet, owner's equity is overstated by P8,000 because of the overstatement in profit. Total liabilities is understated because of the omission of the P8,000 interest payable. ‘0n Dec. 31, 2020, the maturity date, the note is paid together with interest. Since there was no adjusting entry made to accrue interest in 2019, the entire interest of P24,000 {P100,000 x 16% x 18/12) was erroneously charged against 2020 profit. The correct interest expense for 2020 should have been P16,000 (P100,000 x 16% x 12/12). The effects of the omissions in the 2020 financial statements are as follows: > In the 2020 income statement, interest expense is overstated by P8,000 and, therefore, profit is understated by P8,000. Thebes ah nna be sees corety aed since he ate ng wth stress The Dc 2, 2020 anes ea tiomison scorned the en te second accounting period4-16 | Basic Financial Accounting and Reporting by Prof. WIN Ballada In summar the omission has produced two erroneous income statements and erroneous balance sheet. the entity should have reported acarrect prot of Psat in the 2019 and 2020 income statements, As a result of the omission “th pproprietorship’s profit in 2019 is P508,000 and in 2020, P492,000. ue ANALYSIS USING T-ACCOUNTS. To recapitulate, each adjusting entry affects @ balance sheet account (an asset org lability account) and an income statement account (an incame or an expense accouny Almost every revenue or expense account on the income statement has one or mor related accounts on the statement of financial position. For instance, rent expense's related to prepaid rent, supplies expense to supplies, service revenues to unearney service revenues and salaries expense to salaries payable. Having been apprised of these relationships, transactions affecting particular accouns can now be analyzed using T-accounts. This learning will be of use in reconstruct accounts to derive details like cash inflows, cash outflows, revenues recognized for the period or expenses charged for the period. To illustrate, Eco-Tours, established by Galicano Del Mundo at the start of the month, reported at month-end the following related accounts and account balances: Supplies, 36,600 and Supplies Expense, P15,400. Looking at the foregoing, Del Mundo wants to know how much cash was paid out » purchase supplies, Start by placing the relevant information in a T-account. Input the beginning balance on the normal balance of the account. In this case, Supplies is debit, There is no beginning balance since the company just started operations this month. As a technique, the ending balance of an account, here, Supplies for P36,600, is placed ‘opposite its normal balance. In adjusting for supplies expense, the entry made was debit Supplies Expense, P15,400 and credit Supplies, P15,400. Total both debit and credit sides. The cash paid out for supplies can now be derived; it’s P52,000 (P52,000- zero}, the plug figure. If there was a beginning balance of P2,000, then cash paid out ‘would have been P50,000 (P52,000 ~ P2,000). ‘Supplies Debit Great + iC) Benning Balance 0 15,400 expense forthe Month CashPaidforSupples Phi fgure J 36,600 Ending Balance Too 2000] 52,000_ Total —‘Adjusting the Accounts | 4-17 assume instead that the P36,600 ending balance for Supplies and the P52,000 cash paid for ae were given, using the T-account, supplies expense is P15,400 (P52,000 — P36, Supplies Desi Credit co) 0 Beginning Balance 0 Pug figure Expense forthe Month Cash Pai for Supplies 52,000 36,600_ Ending Solace Total 52,000 52,000 Total —— To illustrate further, a company reported at month-end the following related accounts and account balances: Prepaid Insurance, End, P67,000; Insurance Expense, P12,000 and Prepaid Insurance, beginning, 48,000. How much cash was used to pay for insurance this period? Answer: P31,000 Prepaid Insurance Debit Credit @) a Beginning Balance 48,000 12,000 Expensefor the Month ‘cash Paid for Insurance Plug figure | 67,000 _ Ending Balance otal Total 000 To have an ending balance of P67,000, there must have been a P31,000 debit to the Prepaid Insurance account. Since a debit to this account is normally offset by a credit to Cash, the analysis confirms that cash outflows for insurance was 31,000.IN Balada 2 sanuanoy (v) aigenaoey pateisiapun awosuy paieisiapun siassy senuaney pansy (i) aigedeg asuada | parersiepun sesueda | _porerssepun sanmigen sasuadyg paninoy (1) sanuanay pauseaun ‘anuanay |, parersiano sanuanay | parersiapun saniqen poypau auosuy senuaney | (1) sanuanay paweoun.| —_parersipun ewooul | parerssano sanmigen poyow Amgen :sanuanay pauseaun assy enuo> asuadg | payersrepun sosuadeg paversiong siassy uonesasdoq asuadra (v) asuadsa predaig | —parersiaag sasuadig | pareisiepun sassy | pouyaus asuodxa () asuadea predaug asuadea | porersiepun sasuadsg porersiono sassy pourow yassy sesuada predaig poupesp unosoy pouged aunosay sney sine, quaurereis auo2y) yeays oourjeg ‘Anua Sunsnipy auounsn{py a70Jag ssouejeg quno2ay quaunsnfpy yo adAy Sal¥LNA ONILSATay 40 AVN