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)
------
NET INCOME xxx
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 Xx
EQUITY ======
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
Fiscal and Calendar Years

Question
The time period assumption states that:
a. revenue should be recognized in the accounting
period in which it is earned.

b. expenses should be matched with revenues.

c. the economic life of a business can be divided into
artificial time periods.
d. the fiscal year should correspond with the calendar
year.

LO 1
Accrual- versus Cash-Basis Accounting

Accrual-Basis Accounting
 Transactions recorded in the periods in which the
events occur.
 Companies recognize revenues when they perform
services (rather than when they receive cash).
 Expenses are recognized when incurred (rather than
when paid).
 In accordance with generally accepted accounting
principles (GAAP).

LO 1
Accrual- versus Cash-Basis Accounting

Cash-Basis Accounting
 Revenues recognized when cash is received.
 Expenses recognized when cash is paid.
 Cash-basis accounting is not in accordance with
generally accepted accounting principles (GAAP).

LO 1
Page 100 Qn E3- 3
 EXERCISE 3-3
 
(a) Cash received from revenue $108,000
 Cash paid for expenses (72,000)
 Cash-basis net income $ 36,000
  
(b) Revenues [($108,000 – $25,000) + $36,000] $119,000
Expenses [($72,000 – $30,000) + $42,000] (84,000)
Accrual-basis net income $ 35,000
Recognizing Revenues and Expenses

REVENUE RECOGNITION PRINCIPLE

Recognize revenue in the
accounting period in which the
performance obligation is
satisfied.

LO 1
Recognizing Revenues and Expenses

EXPENSE RECOGNITION PRINCIPLE

Match expenses with revenues
in the period when the company
makes efforts that generate those
revenues.

“Let the expenses

follow the revenues.”

LO 1
Illustration 3-1
GAAP relationships in
revenue and expense
recognition

LO 1
Recognizing Revenues and Expenses

Question
One of the following statements about the accrual basis of
accounting is false? That statement is:
a. Events that change a company’s financial statements are
recorded in the periods in which the events occur.
b. Revenue is recognized in the period in which the performance
obligation is satisfied.
c. The accrual basis of accounting is in accord with generally
accepted accounting principles.
d. Revenue is recorded only when cash is received, and
expenses are recorded only when cash is paid.
LO 1
The Need for Adjusting Entries

Adjusting Entries
 Ensure that the revenue recognition and expense
recognition principles are followed.
 Necessary because the trial balance may not contain
up-to-date and complete data.
 Required every time a company prepares financial
statements.
 Will include one income statement account and one
balance sheet account.

LO 1
The Need for Adjusting Entries

Question
Adjusting entries are made to ensure that:
a. expenses are recognized in the period in which
they are incurred.
b. revenues are recorded in the period in which
services are performed.
c. balance sheet and income statement accounts
have correct balances at the end of an accounting
period.
d. all of the above.

LO 1
Types of Adjusting Entries
Illustration 3-2
Categories of adjusting entries

Deferrals Accruals

1. Prepaid Expenses. 1. Accrued Revenues.

Expenses paid in cash before Revenues for services
they are used or consumed. performed but not yet received
Eg : Rent paid in adavace in cash or recorded.

2. Unearned Revenues. 2. Accrued Expenses.

Cash received before services Expenses incurred but not
are performed. yet paid in cash or recorded.
Eg: Outstanding salary

LO 1
Prepaid Expenses

Payment of cash, that is recorded as an asset to show the

service or benefit the company will receive in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

 insurance  rent
 supplies
 advertising

LO 2
Prepaid rent is rent paid in advance of the rental period

Rental Expenses XXX

Prepaid Rent XXX

Prepaid insurance
Insurance expense XXX
Prepaid insurance (asset) XXX
 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
Page 101 : Q E3-6
 (a) (b)
Item Type of Adjustment Accounts before Adjustment
1. Accrued Revenues Assets Understated
Revenues Understated

2. Prepaid Expenses Assets Overstated

Expenses Understated

3. Accrued Expenses Expenses Understated

Liabilities Understated

4. Unearned Revenues Liabilities Overstated

Revenues Understated

5. Accrued Expenses Expenses Understated

Liabilities Understated

6. Prepaid Expenses Assets Overstated

Expenses Understated
Page 101 : Q E 3-7
EXERCISE 3-7

1. Mar. 31 Depreciation Expense ($400 X 3) ................ 1,200

Accumulated Depreciation—
Equipment ......................................... 1,200

2. 31 Unearned Rent Revenue .............................. 3,400

Rent Revenue ($10,200 X 1/3) .............. 3,400

3. 31 Interest Expense .......................................... 500

Interest Payable .................................... 500

4. 31 Supplies Expense ........................................ 2,050

Supplies ($2,800 – $750) ...................... 2,050

5. 31 Insurance Expense ($300 X 3) ..................... 900

Prepaid Insurance ..................................................... 900
Depreciation

 Buildings, equipment, and motor vehicles

(assets that provide service for many years) are
recorded as assets, rather than an expense, on
the date acquired.

 Depreciation is the process of allocating the cost

of an asset to expense over its useful life.

 Depreciation does not attempt to report the actual

change in the value of the asset.

► Allocation concept, not a valuation concept.

LO 2
Depreciation

Illustration: For Pioneer Advertising, assume

that depreciation on the equipment is $480 a
year, or $40 per month.

Oct. 31
Depreciation expense 40
Accumulated depreciation 40

LO 2
Depreciation

STATEMENT PRESENTATION
 Accumulated Depreciation is a contra asset account
(credit).
 Offsets related asset account on the balance sheet.
 Book value is the difference between the cost of any
depreciable asset and its accumulated depreciation.
Illustration 3-8

LO 2
Unearned Revenues

Receipt of cash that is recorded as a liability because the

service has not been performed.

Cash Receipt BEFORE Revenue Recorded

Unearned revenues often occur in regard to:

 Rent  Magazine subscriptions
 Airline tickets  Customer deposits

LO 2
Unearned Revenues

Oct. 31 Unearned Service Revenue 400

Service Revenue 400

LO 2
DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond Company, on March 31, 2017, includes these

selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of $100 per month.
2. Supplies on hand total $800.
3. The equipment depreciates $200 a month.
4. During March, services were performed for one-half of the unearned
service revenue.
Prepare the adjusting entries for the month of March.
LO 2
DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond Company, on March 31, 2017, includes these

selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.

1. Insurance expires at the rate of $100 per month.

Insurance Expense 100

Prepaid Insurance 100

LO 2
DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond Company, on March 31, 2017, includes these

selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.

2. Supplies on hand total $800.

Supplies Expense 2,000

Supplies 2,000

LO 2
DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond Company, on March 31, 2017, includes these

selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.

3. The equipment depreciates $200 a month.

Depreciation Expense 200

Accumulated Depreciation—Equipment 200

LO 2
DO IT! 2 Adjusting Entries for Deferrals

The ledger of Hammond Company, on March 31, 2017, includes these

selected accounts before adjusting entries are prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $5,000
Unearned Service Revenue 9,200
Prepare the adjusting entries for the month of March.

4. During March, services were performed for one-half of the unearned

service revenue.

Unearned Service Revenue 4,600

Service Revenue 4,600

LO 2