Module 2
Balance Sheet and Income Statement
Preparation of Income statement and
Balance sheet with out adjustments
-------SERVICE ORGANISATIONS-------
Income statement
for the year ended…..
Revenues:
Service revenue
Expenses: Xxx
salaries Xx
Wages Xx
supplies expense Xx
Utilities Xx
Insurance Xx
Xx
------
Total expense
Net Income Xxx
(Revenue – Total ---------
expense) xxx
Balance Sheet
as on …..
ASSETS
Cash
Accounts receivable Xx
Plant Xx
Machinery XX
Land XX
Equipment XX
-------
TOTAL ASSETS Xx
======
LIABILITIES AND OWNER’S EQUITY Xx
Accounts payable Xx
Unearned service revenue Xx
Owner’s capital ----
Xx
TOTAL LIABILITIES AND OWNER’S EQUITY ======
Preparation of Income statement and
Balance sheet with out adjustments
-------MERCHANDISING ORGANISATIONS-------
Income measurement – Merchandising organisations
Sales revenue xxx
Less Sales return xx
Less sales discounts xx
-----
Net sales revenue Xxx
Less Cost of Goods Sold Xx
-------
GROSS PROFIT xxx
Less Operating expenses Xx
---
INCOME FROM OPERATIONS Xxx
Add Other revenues and gains Xx
Less other expenses and losses (xx)
------
Cost of Goods Sold
Cost of Goods Sold - Total cost of goods sold during the accounting period
Periodic Inventory system -
does not keep detailed inventory records through out the accounting period
cost of goods sold is determined only at the end of the accounting period.
Calculated as:
COGS = Opening stock + cost of goods purchased - closing stock
Cost of goods purchased = purchases-(purchase returns and allowances,
discounts) +freight in
Perpetual inventory system - continuously calculate inventory on hand
cost of goods sold is determined each time a sale is made
Operating Expenses
Expenses incurred in the process of earning sales revenue
Examples: salaries and wages, utilities, advertising, depreciation,
insurance etc.
Non-operating activities
Unrelated to organisation’s main line of business
Other revenues and gains
Revenues and gains from non-operating activities
Interest, dividend, rent, gain from sale of property etc.
Other expenses and losses
Expenses and losses on account of non operating activities
Interest, loss from sale of property etc.
Balance Sheet
ASSETS as on …..
Cash
Accounts receivable Xx
Plant Xx
Machinery XX
Land XX
Equipment XX
-------
TOTAL ASSETS Xx
LIABILITIES AND OWNER’S EQUITY ======
Accounts payable Xx
Unearned service revenue Xx
Owner’s capital Xx
----
TOTAL LIABILITIES AND OWNER’S EQUITY Xx
======
Adjusting Entries
Need for Adjustment entries
Ensure that the accounting principles are followed
Accounting period assumption
Accrual and cash basis of accounting
Recognition(revenue and expense) principle
Accounting periods
Monthly and quarterly time periods - interim period
Accounting time period that is one year in length – fiscal year
Fiscal year begins with first day of the month and ends 12 months later on
the last day of a month
Accounting period beginning with January 1st and ending on 31st
December – calendar year
Adjustment Entries
Required every time the organization
prepares financial statements
Every adjusting entry will include one
income statement account and one
balance sheet account
Correcting entries
Entries required to rectify the errors occur in the recording process.
Required only if errors are there
How to write correcting entry – first identify the error, then pass journal entry
to correct the error
Eg. Mercato Co. recorded Rs.50 collection on account from a customer as
debit to cash and credit to service revenue. Correct the entry
Incorrect entry Correcting entry
cash Dr 50 Cash Dr. 50
Service revenue 50 Accounts receivable 50
Types of Adjusting Entries
Deferrals
Prepaid expenses - asset
Unearned revenues - liability
Accruals
Accrued Revenues - asset
Accrued Expenses - liability
Types of Adjusting Entries
Prepaid expenses
Expenses paid in cash before they are
used/consumed
Unearned revenues
Cash received before services are performed
Accrued Revenues
Revenue for services performed but not yet
received in cash
Accrued Expenses
Expenses incurred but not yet paid in cash
Adjusting Entries
Prepaid expenses
Expense Dr.
Asset(prepaid expense)
Unearned revenues
Liability Account Dr.
Revenue Account
Accrued Revenues
Asset account Dr.
Revenue account
Accrued Expenses
Expense account Dr.
Liability Account
Examples
Prepaid expense - supplies
Pioneer advertising purchased supplies costing Rs. 2,500 on
October5. inventory count at the end of the business on
October 31 reveals that Rs.1000 of supplies are still on hand
Supplies expense Dr. 1,500
supplies (asset) 1,500
Prepaid insurance
Paid Rs.600 for a one year fire insurance policy on October 4.
Coverage began on Oct.1. adjustment on Oct. 31
Insurance expense Dr. 50
Prepaid insurance (asset) 50
Adjustment of Unearned revenue
Pioneer advertising received Rs.1200 on October 2
from R Knox for advertising services expected to be
completed by Dec 31. what is adjusting entry on Oct.
31
Unearned service revenue Dr. 400
Service revenue 400
Adjustment of accrued revenue
In Oct. Pioneer advertising performed services
worth Rs.200 that were not billed to clients on or
before Oct.31
Accounts receivable account Dr. 200
Service revenue 200
Adjustment of accrued Expense
Annual Interest payable on note payable for Rs. 5000
@12%. What is the adjusting entry on Oct 31
Interest Expense Account Dr. 50
Interest payable 50
Depreciation - Adjustment
Cost concept – assets to be recorded at cost
Assets have long lives – called useful life
Depreciation – process of allocating cost of an
asset to the period in which it is used
Purchase of asset – long term prepayment for the
use of the asset.
Adjusting entry is required to recognize cost that
has been used (expense) during the period and to
report the unused cost (asset) at the end of the
accounting period
Adjustment entry for depreciation
Depreciation Expense Dr.
Accumulated depreciation - asset
Accumulated depreciation account is called contra
asset account. It offset against asset account in the
balance sheet
If it is accumulated depreciation of equipment – it offset
against equipment asset
Example
Depreciation on equipment for the whole year Rs.480
Depreciation expense Dr. 40
Accumulated depreciation – equipment 40
Adjusted Trial balance
Trial balance prepared after posting adjusting entries
Shows balance of all accounts, including those adjusted,
at the end of the accounting period
Closing entries
Entries made at the end of an accounting period to transfer the
balances of temporary accounts to permanent accounts
Temporary accounts - accounts that relate only to a given
accounting period. Consists of all income statement accounts
and owner’s drawings account. All temporary accounts are
closed at the end of the accounting period (Eg. all revenue,
expense and owner’s drawings accounts)
Permanent Accounts - relate to one or more future accounting
periods. All balance sheet accounts, including owner’s capital.
Carry forward the balance of permanent accounts to next
accounting period(Eg. All assets, liabilities and owner’s capital
accounts)
Closing entries
For closing all revenue accounts
Revenue account(individual) Dr
Income Summary
For closing all expense accounts
Income Summary Dr
Expense account(individual)
For closing net income
Income summary
Owner’s capital
For closing owner’s drawings
Owner’s capital
Owner’s drawings
Write entries for closing the following
accounts
Service Revenue 10,600
Supplies Expense 1500
depreciation expense 40
Insurance expense 50
salaries &Wages expense 5200
Rent expense 900
Interest expense 50
Owner’s capital 2860
Owner’s drawings 500
Closing entries- example
Service Revenue account Dr 10,600
Income Summary 10,600
(To close revenue account)
Income Summary Dr 7740
supplies Expense 1500
depreciation expense 40
Insurance expense 50
salaries &Wages expense 5200
Rent expense 900
Interest expense 50
(To close expense account)
Income summary 2860
Owner’s capital 2860
(to close net income)
Owner’s capital 500
Owner’s drawings 500
(to close drawings)
FOB – freight terms
FOB destination – freight terms indicating that the seller places the goods
Free On Board to the buyer’s place of business and the seller pays the
freight
FOB shipping point - – freight terms indicating that the seller places the
goods Free On Board the carrier and the buyer pays the freight
FOB terms 2/10,n/30 - (2/10, net 30) means buyer will get 2% discount if the
payment is made with in 10 days, or the buyer can pay the full amount with
in 30 days
FOB – freight terms - Example
June 1 Mr. X Purchased books on account for Rs. 1,600, FOB Destination,
on credit terms 2/10, n/30. If he makes the payment on June 9th, what is
the amount payable ?
1600 - (1600x2%) = Rs. 1568
If he makes the payment on June11th - amount payable is Rs. 1,600
Classified balance sheet
A balance sheet that contains standard classifications or sections
ASSETS
Current assets
Cash Xx
Accounts receivable Xx
Inventory, supplies XX
Long term investments
Investment in real estate XX
Investment in stocks XX
Property, plant & Equipment
Plant Xx
Machinery Xx
Land Xx
Equipment
Intangible assets
Patents xx Xx
TOTAL ASSETS ---- ======
LIABILITIES AND OWNER’S EQUITY
Current Liabilities
Accounts payable
Unearned service revenue
Long term liabilities Xx
Mortgage payable ======
Notes payable
Total liabilities
Owners equity
Preparation of income statement and
Balance sheet with Adjustments