ABM5 NOTES (1st QUARTER)

FUNDAMENTALS OF ACCOUNTANCY BUSINESS AND MANAGEMENT 2

Steps in Accounting Cycle:

 Identifying and Analyzing
 Journalizing
 Posting
 Unadjusted Trial Balance
 Adjusting Entries
 Adjusted Trial Balance
 Financial Statements
 Closing Entries
 Post-closing Trial Balance
 Reversing Entries

Financial Statements
Financial Statements are interconnected reports.
 The first report prepared is the Statement of Comprehensive Income (SCI). This
report computes for the net income.
 The net income is transferred to the Statement of Changes in Equity (SoCE). SoCE is
the report that presents the computation of the year end balance of equity accounts
that are reported in the Equity section of the SFP.
 The last statement is the Statement of Cash Flows (SCF). This statement explains the
cash balance that is reported on the SFP.
 The interconnected reports eventually end on the Statement of Financial Position
(SFP).

Statement of Comprehensive Income

Prepared by: Ms. Ma. Kristina Ilano – Madrid, LPT

Learning Objectives:
Understand: Understand the purpose of the Statement of Comprehensive Income
Identify: Identify the elements of the Statement of Comprehensive Income (SCI);
Describe: Describe the nature of the accounts reported on the Statement of Comprehensive
Income (SCI);
Prepare: Prepare a single-step Statement of Comprehensive Income for a service company;
Prepare: Prepare a multi-step Statement of Comprehensive Income for a service company;
Prepare: Prepare a multi-step Statement of Comprehensive Income for a merchandising
company; and
Determine: Determine the normal balances of the element of the Statement of
Comprehensive Income (SCI).

RESULTS OF THE COMPANY’S OPERATIONS

• The Statement of the Comprehensive Income is a statement that reports the results of the
operations of the business for one accounting period.
• This statement contains the following information:
• Revenue generated by operating the business;
• Costs spent to generate the revenue; and
• Income, which is the excess of revenue over costs.
• The Statement of the Comprehensive Income is the same as the Income Statement.
COMPONENTS OF THE STATEMENT OF THE COMPREHENSIVE INCOME
 Income and Expense are the general terms used to describe the elements of the SCI.
 Income refers to a transaction that increases assets and/or decreases liabilities
leading to increase in equity resulting from operations of the business and not from
the owner’s contribution.
 Expenses are transactions that decrease assets and or/increase liabilities leading to
decrease in equity resulting from operations of the business and not because of
distributions to owners.

ACTIVITY:
1. Maria Reyes, the regular customer of Juana Dela Cruz. Maria purchased 3 small cans of
sardines that Juana sells for P25 each. Maria asked Juana to include it in her account. Juana
purchased the sardines from her wholesale supplier at P15 per can.
2. Pedro Benitez who rented a small space on the store’s countertop for his coffee vending
machine. On October 1, 20X1, he paid 6 months advance rental of P500 per month.
3. Juana Dela Cruz owner of the store, deposited P1,000 to the store’s savings account from
her personal account.
Which of the above transactions will be reported as income?

ANSWER:
1. Analysis of the transaction with Maria Reyes
Decrease in Inventory 3 x 15 P (45.00)
Increase in Accounts Receivable 3 x 25 75.00
Net effect in Total Assets P 30.00

Conclusion: These transactions met the definition of net income. Asset increased by P30.
this increase resulted from the operations of the store and not contribution from the
owner. Hence, this transaction should be counted as income.
2. As of December 31, 20X1, the unearned rent will have a balance of P1,500 (500 X 3). Its
original balance is P3,000 (P500 X 6) representing the 6 months advance rent paid by
Pedro Benitez. Liability decreased by P1,500 which is the rent from October to December.
This met the definition of income. A decreased in Liability from the operations of the
business.
3. The asset, specifically cash, will increase by P1,000. however, this is a contribution from
the owner and therefore not reportable as income.

Two kinds of income

1. Revenue
• Revenues are are income generated from the primary operations of the business.
• Example: Sale of merchandise
2. Gains
• Are income derived from other activities of the business.
• Example: Interest income from the time deposit.
• Classification of income as to revenue and gains is dependent on the nature of the
business.

Two kinds of expenses

1. Expenses
• Expenses are related to the primary operations of the business.
• Example: Cost of Merchandise Sold is part of the store’s selling activities
2. Losses
• Losses are from other activities of the business.
• Example: Interest expense is not part of the selling activities of the store.

• The primary operation of the business is the main criterion for the classification.
• This classification method is to help the readers of the financial statements to understand
the operations of the reporting company.
• Those items that are from the primary operations of the business are expected to
continue regularly.
• Those from other activities of the business may be of one time or limited occurrence.
Accrual concept of accounting
• Accrual is one of the fundamental concepts of financial accounting.
• This is the concept that dictates when an item must be reported on the SCI.
• Accrual states that revenue must be reported on the accounting period that it was earned.
Similarly, expenses must be recorded during the same reporting period they were incurred.
• Rational allocation is an estimation to “match” the expense used to generate the revenue.
• The principle of rational allocation requires the cost of long-term expenditure to be
rationally allocated over the period of usage based on the expected pattern of usage. An
example of expenses estimated using rational allocation is the depreciation of equipment.
• Revenue is recognized on the period of delivery. Expense, on the other hand, is recorded
in the same period of the revenue it was able to generate.
Statement of Comprehensive Income

Two kinds of income

1. Revenue
• Revenues are income generated from the primary operations of the business.
• Example: Sale of merchandise
2. Gains
• Are income derived from other activities of the business.
• Example: Interest income from the time deposit.
• Classification of income as to revenue and gains is dependent on the nature of the
business.

Two kinds of expenses

1. Expenses
• Expenses are related to the primary operations of the business.
• Example: Cost of Merchandise Sold is part of the store’s selling activities
2. Losses
• Losses are from other activities of the business.
• Example: Interest expense is not part of the selling activities of the store.

• The primary operation of the business is the main criterion for the classification.
• This classification method is to help the readers of the financial statements to understand
the operations of the reporting company.
• Those items that are from the primary operations of the business are expected to
continue regularly.
• Those from other activities of the business may be of one time or limited occurrence.
Accrual concept of accounting
• Accrual is one of the fundamental concepts of financial accounting.
• This is the concept that dictates when an item must be reported on the SCI.
• Accrual states that revenue must be reported on the accounting period that it was earned.
Similarly, expenses must be recorded during the same reporting period they were incurred.
• Rational allocation is an estimation to “match” the expense used to generate the revenue.
• The principle of rational allocation requires the cost of long-term expenditure to be
rationally allocated over the period of usage based on the expected pattern of usage. An
example of expenses estimated using rational allocation is the depreciation of equipment.
• Revenue is recognized on the period of delivery. Expense, on the other hand, is recorded
in the same period of the revenue it was able to generate.

Elements of the statement of comprehensive income

REVENUE

Service Income
• The Service Income account is generally used to described revenue derived from
rendering of services. A more specific account name may be used to identify the services
rendered such as Rental Income, Professional Fee and Tuition Fee Revenue.
• Recall that revenue from services is recognized when they have already been rendered.
However, contract of services may take a long time to complete. For example, when you
enrolled in high school sometime May or June, you initially signed a service contract for one
school-year (June to March). The revenue generated from this enrolment contract may be
reported as Tuition Fee Revenue. If the school follows the calendar year of reporting, then
we will have a problem because of the misaligned time period. Your enrolment contract is
for June of the current year to March of the next year. However, revenue to be reported in
the SCI is for services rendered to students from January to December of the current year,.
How do we solve the problem of misaligned time period?
Example:
• Tuition fee for one school year is P50,000 for one student. One school year is equivalent
to 10 months (June to March). hen tuition fee revenue from June to December is P35,000
(P50,000/10 months x 7 months).
• Accountants use the percentage of completion to allocate revenue to the appropriate
period. It is generally assumed that services are rendered evenly throughout the contract
period.

ACTIVITY:
• Twinkle-Twinkle Pre-school collected tuition fee of P1,250,000 and P1,455,000 for the
school years 20X1-20X2 and 20X2- 20X3, respectively. The school closed in April and May.
Determine the tuition fee revenue to be reported on SCI for the calendar year 20X2.

SALES
• The Sales Revenue account is generally used to describe revenue derived from selling of
goods. A more specific account name may be used to identify the goods sold such as Office
Supplies Sales, Book Sales, Food Sales etc.
• Revenue from sales of goods is recognized when goods have been delivered. However,
customers are allowed to return goods that do not meet their quality standards. Recall that
we already counted the goods delivered as Sales on the date of delivery. When goods are
returned, it is not deducted from Sales. Rather, normal accounting practice is to report it
under the account name Sales Return and Allowances – a Contra Sales Account.
• You delivered goods to the buyer and appropriately recorded as Sales Revenue based on
full selling price. You gave the buyer the credit terms of 2/10, n/30. the customer took
advantage of the discount and paid within the ten day discount period. Accounting practice
does not deduct the discount from Sales Revenue. Rather, we use another Contra-Sales
account called Sales Discount.

SALES

• Only Net Sales is reported on the face of SCI.

• Net Sales refer to Gross Sales less Sales Return and Allowances
and Sales Discount. (Net Sales = Gross Sales – Sales Return and
Allowance – Sales Discount)

ACTIVITY:
Juana Dela Cruz, owner of Friendly Convenience Store, sold 3 boxes of ballpoint pens to
Mrs. Susan Gonzales on account at a price of P150 per box or P15 per pen. Juana gave Mrs.
Gonzales two week to pay the account. Moreover, Juana told Mrs. Gonzales that she will
deduct 2% discount if she pays within a week. Mrs. Gonzales returned one week later. She
returned five pens and took advantage of the discount. Determine the amount of Sales,
Sales Return, Sales Discount and Net Sales from the transaction with Mrs. Gonzales.
EXPENSES

COST OF GOODS SOLD (COST OF SALES)

• This is an account used by companies that sells goods instead of services.
• For trading operations, Cost of Sales collects the cost of the merchandise sold. This
includes the purchase price of inventory, brokerage and shipment cost to bring the goods
to the premises of the company. This shipment is called Freight-in.

COST OF GOODS SOLD (COST OF SALES)

• Cost of Sales is part of inventory accounting. Accountants have two ways of keeping
records of inventory:
• Perpetual means that the Inventory and Cost of Goods Sold accounts are
“perpetually” updated. The inventory account is increased when goods for sale are
acquired and decreased when goods are sold. The Cost of Goods Sold account is
updated every time a sale is made.
• Periodic inventory system means that the Inventory account is only “periodically”
updated. ”Periodically” means that the inventory account is updated only at end of
the year or end of the month. Cost of merchandise acquired is collected using the
Purchases account.

COST OF GOODS SOLD (COST OF SALES)

• Two contra-Purchase accounts:
• Purchase Returns and Allowances
• Return of defective goods
• Purchase Discount
• Discounts taken.

• “Net purchases” is equivalent to Purchases plus Freight In – Purchases Returns –

Purchase Discount
• (Net Purchases = Purchases + Freight-In – Purchase Returns – Purchase Discount)
PERIODIC INVENTORY SYSTEM ACCOUNTS
Beginning Inventory
Add: Net Purchases (Purchases + Freight In – Purchase Returns – Purchase
Discount)
Cost of Goods available for sale
Less: Ending Inventory
Cost of Goods Sold

Beginning and ending inventory are determined based on the physical count of the
merchandise owned by the company. The ending inventory of the prior-period is also the
beginning inventory of the current period. The “periodic” adjustment updates the
inventory account to bring it to the balance based on year-end physical count.

Activity:
• Juana Dela Cruz, owner of Friendly Convenience Store, asked for your help to determine
the cost of sales of her store. This is the first year of operations for Juana’s store she
provided the following data to you.

• Based on the inventory count taken at the last day of the year, the ending inventory is
valued P2,320. How much is cost of sales?
Answer:
OPERATING EXPENSES
• Operating Expenses refer to all other expenses related to the operation of the business,
other than the cost of sales. These include salaries of employees, supplies, utilities, gasoline
expense, representation, bad debts expense, depreciation and amortization.
• Bad debts expense is an operating expense related to accounts receivable. It is an
estimated expense.
• The accounting rule is:
• To periodically analyze the collectability of Accounts Receivable
• To immediately charge to expense the amount deemed uncollectible. This
account refer as bad debts expense.
ACTIVITY
• Current year sales of the store amounted to P128,865. Of this, only P70,000 is cash sales.
Based on company’s experience, bad debts is 3% of total sales or 6.5% of credit sales.
Determine bad debts expense given the following:
• Juana Dela Cruz, the manager-owner decided to use percentage of total sales method.
• Juana Dela Cruz, the manager-owned decided to use percentage of credit sales method.

Answer:

Other expenses and other income

• Losses and other expenses as well as gains and other income are reported after the
operating section of the SCI.
• Line items included under this section are interest income from investments of excess
cash, interest expense from borrowings and gain or loss from sale of equipment (proceeds
from sale less net book value of PPE on date of sale).
PRESENTATION OF STATEMENT OF COMPREHENSIVE INCOME
•Two formats for the SCI
• Single-step – closely related to the nature of expense format
• Multi-step – multi-step approach is also associated with the function of expense

Single-step statement of comprehensive income

•Groups all revenue items and all expense items together.
•It is called single-step SCI because net income is computed using only one step, deducting
total expenses from total revenues.
•This format is generally used by small businesses and service businesses because of its
simplicity.

Format:

1. Shows the name of the company

• It allows easy identification of the reporting entry.
2. Identifies the Financial Statement which is Statement of Comprehensive Income
3. Describe as a “for the period” report.
• This means that the amounts presented on the report include those that occurred
within the given period.
• This is the peso value of the revenue generated by the company from January 1 to
December 31, 20X1. This amount does not include the revenue generated before
and after this twelve month period.
• It states the “for the year ended” December 31, 20X1.
Example:
1. ABC Company
2. Statement of Comprehensive Income
3. For the Year Ended December 31, 20X1
Single-Step Statement of Comprehensive Income

MULTI-STEP INCOME STATEMENT

Comparison of nature and function of expense format

NORMAL BALANCES

Expense Account
+ -
Ending Balance = Debits – Credit

Revenue Account
- +
Ending Balance = Credit – Debit