MODULE 3 CONSTRUCTIVE ACCOUNTING THE | INSTITUTE OF CERTIFIED BOOK-KEEPERS LEARNING OBJECTIVES ‘A careful study of this modulle should enable you to know, explain and understand the 1 N& weon The Internal controls to safeguard assets most specially cash Imprest Cash System Single entry method bookkeeping Reconstruction of incomplete records Conversion of Cash-Basis of Accounting into Accrual Basis. Correction of errors. Analysis and interpretation statements. of financial144 Constructive Accounting Module 3 1.0 INTERNAL CONTROL OF CASH: 14 12. 13. 14, 15. wnaw.certscollege.org Cash ~ includes coins, checks, money orders, bank drafts and other forms of ‘money substitutes that can be accepted at face value upon deposit and can be used for general disbursement purposes. Money on deposit is also included in cash provided there is no restriction as to its withdrawal Internal controls comprise the plan of an organization together with all its methods and measures to safeguard its assets, check the accuracy and reliability of its accounting and financial information systems, promote operational efficiency, and encourage adherence to managerial policies. Cardinal Principles of Internal Controls. The most fundamental of all the internal controls set by the management are the following: 134 1.3.2. 1.3.3. Organizational controls (General controls) + Responsibilities must be fixed. ‘+ Transactional (e, functional) responsibilities must be segregated. + Noone person should be in complete charge of a business transaction ‘+ Use of all available proof of accuracy. Personnel controls (Application controls) + Employees should be carefully selected and trained. ‘+ Employees should be bonded, especially those in the position of trust + Employees should be rotated ‘Supervision controls (Application controls) Operating instructions should be reduced to writing, Use of controling accounts and subsidiary accounts. Do not overemphasize double-entry accounting, Use of mechanical and electronic equipment (ie, technology), if feasible Preventive Controls — are procedures designed to detect, prevent and protect cash from theft and misuse from the time cash is received until itis, deposited to a bank Internal Controls — refer to those steps and procedures the business takes to protect cash and other assets, Examples of cash internal controls are: ‘Synergy in Global Education!Module 3 Constructive Accounting 145 Limiting the number of persons handling cash. ‘The cashier must not have access to the accounting records, Bonding (insuring) employees who handle cash. Using a safe deposit or a cash register. Depositing cash receipts in the bank daily. Using checks to make payments, Establishing petty cash fund for making small payments. 2.0 IMPREST CASH SYSTEM Cash is the most liquid asset of a business hence strict control measures must be adopted to avoid loss due to theft, embezzlement and misappropriations. Cash must be accurately and correctly accounted for from the time itis received up to the time it is used. One of the most commonly used controls is the IMPREST CASH SYSTEM. Under this system, a checking account will be opened. All payments therefore will be made by checks except small payments, which will be paid out of the PETTY CASH FUND. The use of the checking account not only helps protect, cash but also provides a separate record of cash transactions. All collections for the day must be deposited intact the following day. 24. Checking Account ~ is a bank account that allows a bank customer to deposit cash and to write checks against the account balance. 2.2. Depositor ~ is a person or business that has cash on deposit in a bank. To open a checking account, a person or business owner must fil a signature card, deposit minimum’ cash required by the bank, and acquire a checkbook. 2.3. Signature Card ~ contains the signature(s) of the person(s) authorized to write checks on the bank account. The signature cash is kept on file by the bank so that it can be matched against signed checks presented for payment, This helps protect both the account holder and the bank against checks with forged signatures. ‘Synergy in Global Education! www.certscollege.org146 Constructive Accounting ‘Sample of a Signature Card Module 3 (NCB) [SPECIMEN [ACCOUNT NO, INEW CITY BANK [SIGNATURE CARD [1516.30445.3 \CCOUNT NAME: National Merchandising Company .ddress: (3411, National Road, Makati City [Tel No. 647-2354 \CCT. TYPE [Single Proprietorship - Wholesale and Retail [Print Name [Print Name: INESTOR VALENCIA It Nestor Valencia 2 It Nestor Valencia a Ht Nestor Valencia 2 l’We hereby agree to be governed by the terms and conditions set forth by the bank as wells as] the IBangko Sentral ng Pilipinas and the Bankers Association of the Philippines relative to the} pening 1nd operation of the deposit account. introduced by [Signature verified b proved bj ate jose Cortez [Manuel Yap [Andrew Martin june 30, 206¥ 3.0 MAKING DEPOSITS AND WRITING CHECKS 3.1. MAKING DEPOSITS A business should make regular daily deposits of their collections to protect cash (coins, bills and checks) it receives. Sometimes banks would do the service of getting the deposit from clients from their offices, which will be evidenced by a deposit slp. Recording Deposits in the Checkbook - the checks stubs in the checkbook are a duplicate record of the Cash in Bank account. The completed check stubs contain the records of all checking account transactions: deposits, withdrawals and bank collections and service charges. wnaw.certscollege.org ‘Synergy in Global Education!‘Synergy in Global Education! Module 3 Constructive Accounting 3.2. WRITING CHECKS Writing checks is a simple procedure governed by a few important rules. These rules must be followed to ensure correct record keeping and proper handling of the money represented by the check. Complete the check stub before writing the check to remove the chance of forgetting to complete the stub. 1. Write the checks in ink. Written in pencil is not acceptable. 2. Checks should by the depositor, ordering the bank to pay a sum of money to an individual or entity 3. Check writers are used by some companies for security and control. Check — is a written document signed by the depositor, ordering the bank to pay a sum of money to an individual or entity, ‘Sample of a check [P3,750.00 No. 312451 [National Merchandising Company ‘Check No. 312451 [DATE: July 1, 200 [3411, National Road, Makati Cy [TO: Makati Really Co wuiy 4, 2067 IFOR: July Rental Pay tothe. [AMOUNT [Order of _ Makati Really Company 3,750.00 (Bal, Bro. Fwa [22,500.00 [Adel Deposits Three Thousand Seven Hundred Fifty and 00/100-~ PESOS Luiy 1 151000,00, FFotal [27,500,00_INEW CITY BANK [Less:Check [3,750.00 [Makati City Nestor Valencia [Bal Car Fwd [23,750.00 Drawer - is the one who signs the check ordering the bank to make payment. Drawee ~ is the bank on which the check is drawn. Payee ~ is the party to whom payment is to be made. Deposit Slip - is a bank form on which the currency (bills and coins) and checks to be deposited are listed. The deposit slip gives both the depositor and the bank a detailed record of a deposit. The bank teller validates the deposit slip before a copy is given to the depositor or representative, 147 wuw.certscollege.org148 Constructive Accounting Module 3 ‘Sample of a deposit slip NCE NEW CITY BANK I [DEPOSIT SLIP [DATE June 90, DOCY TRCCOUNT NO. 1518-50845 [ACCOUNT NAME [atonal Merchandising Company /ALIDATION: June 30, 20CY {TOTAL CASH DEPOSTT Ho,000,00 (CHECK DEPOSITS: Please use separate sip for each ype of check [Loca TREGIONAL, [OTHERS [CHECK DETALS [DRAWEE BANK, [CHECK NO MOUNT i [Bank of P. Isa67123 5,000.00 B PCI Bank 1250789 7.500.090 5 rn 5 r. ITOTAL CHECK DEPOSIT 2.60000 [TOTAL DEPOSIT 2250000, 4.0 CHECKING THE CASH BALANCE ‘The balance in the Cash in Bank account in the general ledger is regularly compared (at the end of each month) with the balance in the checkbook. This is to check whether all the deposits and payments by checks are recorded in the books, If they do not tally, the error must be located and corrections be made. If the balance in the general ledger is in agreement with the balance as per the checkbook, the balance will now be compared with the bank statement. 4.1, Bank Statement ~ is an itemized statement prepared by the bank given to the depositor summarizing all his transactions (deposits and withdrawals) on a month to month basis. This includes 1, Cash balance at the beginning of the month 2. List of all deposits made by the depositor during the month. 3. List of all checks paid by the bank (called cancelled checks) during the ‘month wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 149 4, List of other deductions from the depositor’s account (e.g., bank charges). 5. List of other credits (additions) to the depositor’s account (e.g. bank collection for the depositor) 6. Cash balance at the end of the month, ‘Sample of a Bank Statement [NBO Page 1 INEW City BANK, [STATEMENT OF ACCOUNT (National Merchandising Company [Account No. [Statement Date [3451, National Road, Makati Cty jnsi8-20045-3_[rvs120CY. Previous| Total _[No_of] Total _[ No-of | _ Current Balance | Debits [Debits] Credits __[Credits| Balance: 22,500,00 | 3471965 [13 | 4411285 | 8 | 31,803.20 [Date feck No [Bebis [Code [Credits [Code [Balance lor-Jut 5,000.00 Jesh__| 27,500.00. fo2-Jur 3iaast 3750.00 lene 23,750.00 loa 312452 7,250.00 Jen | 6,250.60 [eka 28,750.60 for-Ju 312453, 2,850.90 enc. 25,899.70 foo-Jur 312454 3840.30 lene | 456075. lesh 26,820.15 htJul 312455, 4,875.80 enc 21,944.35 fastul 312456, 2,312.60 lence | 7,620.50 _[esh 27,252.36 he-Jul 312457 6,850.00 enc 20,402.35 hetul 312458, 7,052.25 enc | 350000 [eka 22,850.10 re 312459. 7,235,70 lene. 21,614.40 nm 312460, 3,265.90 enc | 6,645.50 _lesh 26,994.00 fos 312461 2,150.40 lene. 24,843.60 7h 312462 ‘985.90 [enc | 6505560 loka 29,363.20 [30 '500.00_|sve. 28,863.20 [st-Ju 3,080.00 fem 31,803.20 losh - Gash deposit. ckd - check deposit eno - Eneashment, sve - Service Charge, om - Credi [Please examine this statement and enclosed paid checks, particulary the signatures and lendorsements, and immediately report to the bank any discrepancy between your record, laccount balance and the statement balance. ‘The New City Bank Statement of Account showed a balance of P31,893.20 as of July 31, 20CY, a bank service charge (bsc) of P500 and a credit memo (cm) for 3,030.00. The bank retumed a check deposit amounting to P 2,000 for insufficiency of funds. The Checkbook showed the following checks issued but not ‘Synergy in Global Educatior wuw.certscollege.org150 Constructive Accounting Module 3 yet presented to the bank for payment. Check #312463, P1,860.60 and the last check issued on July 31, 20CY (see check below).The checkbook also showed a deposit of P7,845.80 made on July 31. The cash balance is P32,887.90 as of July 31, 20CY. The checkbook and the cash per book balance are in agreement. 42, — Cancelled Checks — checks paid by the bank that were deducted from the depositor’s account and retumed together with the monthly bank statement sent by the bank to the depositor. 43. — Bank Reconciliation ~ is the process of reconciling (determining the differences between) the cash balance shown in the bank statement with the cash balance as per the general ledger or checkbook. Four common differences (reconciling items) between the bank statement and the checkbook balance are as follows: a) — Deposit in Transit b) Outstanding Checks ©) Bank Service Charges d) Bank Collection. e) NSF Check (No sufficient fund), ie, DAIF or drawn against insufficient fund ‘Sample of a check stub (Pa, 460.50, [ No. 312464 National Merchandising Company ‘Check No_312464| [DATE: July 37, 20Cy [3414, National Road, Makati City fro: Sunshine Co, uly 31, 206Y IFOR: Invoice No. [Pay to the, 10256 AMOUNT [Order of — Sunshine Company Pa, 460.50 [Bal Bro Fwd | P 22,500.00 |Add. Deposits Four Thousand Four Hundred Sity and 50/100 PESOS Guiyt 7345.80) frotal 37,348 40NEW CITY BANK Less: Check 4,460. 50)Makati Ci Nestor Valencia [Bal Car Fwd 32,887.00) Note: The checkbook balance and the bank statement balance are not in agreement. The causes of the difference are the deposit in transit, outstanding checks, bank service charge, and credit memo for note collected by the bank and NSF (No Sufficient Fund) check. 4.4, Deposit in Transit ~ Is a deposit that has been made and recorded in the depositor’s book but that does not appear in the bank statement. Usually this is the end of the month deposit. wnaw.certscollege.org ‘Synergy in Global Education!Module 3 45. 48, aq. 43. 49. Constructive Accounting Outstanding Checks ~ are checks that have been written and recorded in the depositor's book but not yet deducted by the bank because they are Not yet presented for payment. Bank Service Charge ~ is a fee charged by the bank for the service itis, rendering. This is supported by a debit memo issued by the bank. Bank Collection — a collection made by the bank in favor of the depositor. NSF Check ~ is a check retumed by the bank because there is no sufficient funds (or DAIF, drawn against insufficient fund) in the drawer's checking account to cover the amount of the check. Under the current practice, when a depositor receives a check payment from a customer and deposits it in the bank, the bank will not credit the depositor’s, account until it is cleared by the drawee bank. If not cleared, the bank retums this check to the depositor as an NSF check with corresponding bank charges. Bank Debit Memo ~ is a charge (deduction) made by the bank to the depositor’s account, usually for bank service charge. ‘Sample of a bank debit memo 151 NCB) INEw city BANK DEBIT ADVICE \NationalMerchandising Compan [Account No. [3451, National Road, Makati City 1518-30445.3 | DATE uly 31, 200¥ [PARTICULARS [AMOUNT |For Bank services charges for the month of July, 20GY 500.00 |WWe have today debited your account for this amount 300.00 IMade by. [authonzedby, [Posted [Rose Manalo ‘Andrew Mantin ose Verdad I 440, Bank Credit Memo — is a credit made by the bank to the depositor's ‘Synergy in Global Education! account, sometimes for interest credit on deposits or collection made by the bank for the depositor’s account, wuw.certscollege.org152 Constructive Accounting Module 3 ‘Sample of a bank credit memo NCB) INE City BANK ‘CREDIT ADVICE \National Merchandising Company ‘Account No, [3451, National Road, Makati City 16-30445-3 [DATE] July 31, 2007 [PARTICULARS. ‘AMOUNT, IFor. Note collected with interest of P3000 P 3,0 30.00 [Wve have today credited your account for this amount P 3,030.00 IMade 6 [authorized by: [Posted by [Rose Manalo [Andrew Mantin \Jose Verdad I 441, BANK RECONCILIATION STATEMENT - It is a statement prepared at the end of each month which reconciles the bank balance with the book balance. itis assumed that there are no recording errors made by the bank or the depositor but the reconciliation statement should provide space in case such errors occur. Normally there are many outstanding checks to be listed, that is why the reconciliation statement provides for the purpose. If the adjusted balances of the bank and the book match, the bank statement has been reconciled. If the adjusted balances do not match, the error must be found and corrected and when necessary adjusting entries will be prepared National Merchandising Company Bank Reconciliation Staternent ‘July 31, 20CY Unadjusted balance per bank P 31,893.20 ‘Add: Deposit in transit 7,845.80 Total P 39,739.00 Less: Outstanding checks: #312463 P 1,860.60 #312864 4,860.50 6.32110 Adjusted balance per bank 33,417.90 Unadjusted balance per books P 32,887.90 ‘Add: Bank collection 3,030.00 Total P 35,917.90 Less: Bank charge P 500.00 NSF Check 2,000.00 2,500.00 Adjusted balance per books P.33.417.90 wnaw.certscollege.org ‘Synergy in Global Education!Module 3 442, ‘Synergy in Global Education! Constructive Accounting Adjusting entries to be made at the end of the month based on the above statement in the books of the depositor: Jul 31 Cash in Bank 3,030.00 Notes Receivable 3,000.00 Interest Income 30.00 31 Accounts Receivable 2,000.00 Miscellaneous Expense 500.00 Cash in Bank 2,500.00 + In practice, the name of the bank is substituted for the cash in bank account, Note: Only the reconciling items reflected in the balance per books are adjusted ‘STEPS IN THE BANK RECONCILIATION + Start with the unadjusted cash balance as per the bank statement. Compare the bank credits with the deposits as per the checkbook. Deposits not recorded by the bank are called deposits in transit, which must be added to the unadjusted balance per bank. Usually this is the deposit made at the end of the month. * Arranged the cancelled checks (checks retumed by the bank) in numerical order and compare with the checks issued as per the checkbook. Checks not yet retumed by the bank are outstanding checks, which are subtracted from the unadjusted bank balance + Copy the unadjusted cash balance as per the checkbook, * Look for a bank credit in the bank statement, which is not recorded in the books, This could be a bank collection, which should be added to the unadjusted book balance. * Compare the bank debits in the bank statement with the cash disbursements in the books, deductions, which are not cancelled checks, can either be bank charges or NSF checks which should be deducted from the unadjusted book balance 153 wuw.certscollege.org154 Constructive Accounting Module 3 5.0 PETTY CASH ‘Writing or issuing checks for very small payments is costly, time consuming, and impractical for many businesses. When creating a petty cash fund, each business determines the maximum amount that will be paid out of the petty cash. All payments in excess of the maximum amount are to be paid by check. Petty Cash Fund ~ it is a cash fund established by the business to handle small, incidental cash payments. Petty Cash Fund Custodian — It is the person responsible for maintaining petty cash fund and for making disbursement from the fund. Establishment of the Petty Cash Fund — Before a petty cash fund is established, a business must determine first the amount of cash needed in the fund, The business estimates the amount of cash that it will need for a certain period of time, usually a month. The entry to establish a petty cash fund is as follows Aug. 1 Petty Cash Fund 3,000.00 Cash in Bank 3,000.00 Making Petty Cash Payments - The petty Cash Custodian is responsible for making payments from the petty cash fund. Whenever a cash payment is made, a Petty cash voucher or receipt is prepared. Petty cash payments are initially Fecorded in the petty cash book or register if itis being maintained, but no entries are made yet. The entry for the expenses paid will be made when the fund is to be replenished Petty Cash Voucher/Receipt - Its a proof of payment from the petty cash fund. ‘Sample of petty cash voucher [PETTY CASH VOUCHER No, 001 laugust2, 200 Ever Office Suppiies| Pay to P 160.50, For. [Two reams of typing paper [Account [office Supplies [Approved by Payment Received Linda Perez ‘Antonio Lopez wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 155 Replenishing Petty Cash ~ As payment are made out of the petty cash fund, the amount of cash in the petty cash box decreases, Replenishing the petty cash fund restores the fund to its original balance. If the petty cash vouchers, coins and currency total differ from the established fund, there is cash short or over. ‘Assuming at the end of the month the summary of petty cash payments are: Office ‘Supplies ~ P544.60; Delivery Expense ~ P345.90; Advertising Expense — P300.00; Travel Expenses — P200.00; Miscellaneous Expense - P480.80. ‘The entry to replenish the fund is: ‘Aug. 31. Office Supplies 544.60 Delivery Expense 345,90 Advertising Expense 300.00 Travel Expense 200.00 Miscellaneous Expense 480.80 Cash in Bank 1,871.30 Note: Petty Cash fund is debited only when the fund is set up or the amount of the fund is increased. EXAMPLE PROBLEM ‘The accounting records of Jumbo Company showed the following summary of data for cash receipts and payments for July of the current year. July 1 Cash balance — 78,870.00; Total cash receipts ~ 579,432.00; Total checks issued — P564,116.40. The bank statement received for July 31 indicated a balance of P 182,862.20. In making the bank reconciliation, the following reconciling items were discovered a. A deposit of P37,044,20 representing receipts of July 31 has been made too late to appear in the bank statement b. Check outstanding were: #321228 — P32,652.70; #321231 - P26,557.20; and #321235 — P46,095.50. c. The bank collected for Jumbo Company P20,600 on a note left for collection. The face value of the note was P20,000. d. Check #321225 for P3,690 was incorrectly charged by the bank as P3,960 e. Check #321232 cleared by the bank for P2,400 had been recorded in the depositor’s book as P4,200. This was in payment of a creditor's account. f. Acustomers check for P3,850.60 was retumed by the bank with stamped NSF. g. The bank service charges for the month of July totaled P864,00, Required: a) Prepare a bank reconciliation statement for July b) —_Joumal entries to be made by Jumbo Company. ‘Synergy in Global Education! www.certscollege.org156 Constructive Accounting Module 3 Solution Example Problem 4 - a) JUMBO COMPANY BANK RECONCILIATION STATEMENT July 81, 200¥ Unadjusted balance per bank P 182,862.20 ‘Add: Deposit in Transit P 37,044.20 Bank error - Check No, 321228 (3,960 ~ 3,690) 27000 __37.31420 Total P 220,176.40 Less: Checks Outstanding No. 221228 P 32,652.70 No. 321231 26,557.20 No. 321235 49,095 50 __108,305.40 ‘Adjusted Bank Balance B11187100 Unadjusted balance per books (78,870.00 + 579,432.00 ~ 564,116.40 P 94,185.60 ‘Add: Note and interest collected by bank P 20,800.00 Book error (4,200 ~ 2,400) 4,800.00 __22.400.00 Total P116,585.60 Less: Bank service charges P 64.00 Book error 3,850.60 __471460 Adjusted Book Balance Ptt1a7100 ‘Solution Example Problem 1-b) July 31 Cash in Bank 22,400.00 Notes Receivable 20,000.00 Interest Income ‘600.00, Accounts Payable 1,800.00 31 Accounts Receivable 3,850.60, Miscellaneous Expenses 864 Cash in Bank 4,714.60 6.0 SINGLE ENTRY METHOD OF BOOKKEEPING 6.1. Normally used by small businesses This is a method used where transactions are recorded without analyzing and considering the dual effect of each transaction on the accounting elements as opposed to the double entry method where the recording is in terms of debit and credit wnaw.certscollege.org ‘Synergy in Global Education!Module 3 62. ‘Synergy in Global Education! Constructive Accounting Under the single entry method, informal records are normally maintained for cash, accounts receivable, accounts payable, property and equipment, and expenses paid. The most important record is the Cash Record or the Cash Book. ‘The cash record or cash book shows the cash receipts and payments with description of what is received and paid but without specific debits or credits. With respect to accounts receivable and accounts payable, only a list of customers and creditors is available with their corresponding balances. This method is used by small enterprises, professionals, and non-profit organizations who cannot afford to hire the services of a regular bookkeeper. ‘A company using a single entry method is said to have incomplete records hence preparation of the financial statements becomes a litle complicated as there is a need to reconstruct the records. PROBLEMS ENCOUNTERED IN SINGLE ENTRY SYSTEM: 1. Determining the firm's profit or loss, 2. Preparation of Statement of Profit or Loss. 3. Preparation of Statement of Financial Position. Net Assets or Capital Approach of Determining Profit: Because the records are incomplete, the profit or loss may be computed using the capital approach as follows: For a Sole Proprietorship or Partnership: For a Sole Proprietorship or Partnership: Capital, end of the accounting period P xx Add: Withdrawals during the period x Total Px Less; Capital, beginning of the accounting period Pox x ‘Additional investment x = Pox Profit (Loss) For a Corporatior Retained Earnings, end of the accounting period P xx Add: Dividends declared or paid during the period x Total Pox Less; Retained Earnings, beginning of the accounting period x Profit (Loss) Pox 157 wuw.certscollege.org158 Constructive Accounting EXAMPLE PROBLEM 2: December 31, 2000 Total Assets 1, 000,000 Total Liabilities 600,000 Net Assets (Capital) 400,000 For Single Proprietorship or Partnership: ‘Additional Investments. Withdrawals For Corporation: Retained Eamings 100,000 Capital Stock 300,000 Dividends dectared and paid Required: Module 3 December31 200 P2, 000,000 1,400,000 600,000 500,000 600,000 200,000 ‘400,000 300,000 a) Determine the profit for 200 for a Single Proprietorship or Partnership. b) Determine the profit for 200 for a Corporation. Sol 1m Example Problem 2-2) Capital, December 31, 200E Add: Withdrawals during 200€ Total Less: Capital, December 31, 2000 Additional Investment Profit Alternative Solution: Increase in Net Assets Add: Excess of withdrawals over investment Profit Solution Example Problem 2 -b) Retained Earnings, December 31, 200E ‘Add: Dividends declared and paid during 2008. Total Less: Retained Earnings, December 31, 2000 Profit Alternative Solution: Increase in Net Assets ‘Add: Dividends declared and paid Less: Increase in Capital Stock Profit wnaw.certscollege.org P 400,000 P 300,000 100,000 P 600,000 600,000 P 1,200,000 900,000 P 200,000 100,000 P_ 300,000 P 200,000 300,000 P 500,000 100,000 P 400,000 P 200,000 200,000 P.400,000 ‘Synergy in Global Education!Module 3 Constructive Accounting 159 7.0 RECONSTRUCTING INCOMPLETE RECORDS: If the company is using the single entry method of bookkeeping, there is a need to reconstruct the incomplete records before the financial statements can be prepared, ‘The different items in the Statement of Profit or Loss (revenue and expenses) can be computed from the incomplete records as follows: Computation of Gross Sales 2 Notes Receivable (trade) ~end Accounts Receivable - end Collections of Notes Receivable (trade) Collections of Accounts Receivable Sales Returns and Allowances Sales Discounts Accounts written off Total Less: Notes Receivable ~ beg. Accounts Receivable - beg Sales on account ‘Add: Cash sales TOTAL GROSS SALES v ® Es Fhe ske shennan Note: if only the increase or decrease in the notes receivable or accounts receivable is given, add the increase and deduct the decrease Computation of Gross Purchases Notes Payable (trade) — end Pox Accounts Payable - end xx Payments of Notes Payable (trade) x Payments of Accounts Payable Xx Purchase Retums & Allowances x Purchase discounts xx Total Xx Less: Notes Payable ~ beg. Pox ‘Synergy in Global Education! www.certscollege.org160 Constructive Accounting Module 3 Accounts Payable ~ beg. x Ea Purchases on account x ‘Add: Cash purchases Xx TOTAL GROSS PURCHASES Px Note: If only the increase or decrease in the notes payable or accounts payable is given, add the increase and deduct the decrease. Computation of Other Income (ther Income received Px Add: Uneamed income ~ beg, Px Accrued income - end xxx Total x Less: Uneamed income ~ end x Accrued income ~beg, Kx TOTAL INCOME Px Note: If only the increase or decrease in the uneamed income is given deduct the increase and add the decrease. In the case of accrued income, add the increase and deduct the decrease. Computation of Expenses Expense paid Prox ‘Add: Prepaid expense - beg. Px Accrued Expense ~ end eee Total OK Less: Prepaid expense - end x Accrued expense ~- beg. XK Expenses Px Note: If only the increase or decrease in prepaid expense is given, deduct the increase and add the decrease. In the case of accrued expense, add the increase and deduct the decrease ‘The Statement of Financial Position items not determinable from the incomplete records may be computed as follows: a. CASH ~ this can be determined through cash count and by looking at the bank statement, wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 161 b. NOTES and ACCOUNTS RECEIVABLE - this can be determined by summarizing the uncollected sales invoices and the confirmed promissory notes of the customers. c. INVENTORY and SUPPLIES ON HAND at the end ~ this can be determined by physical count. To check the accuracy of the count, the beginning inventory plus the purchases minus the sales (in the case of inventory) or used (in the case of supplies) should be equal to the ending inventory. d. PROPERTY and EQUIPMENT ~ This can be determined by looking at the deed of sale and other documents evidencing ownership. e. NOTES and ACCOUNTS PAYABLE - this can be determined from by summarizing the unpaid invoices and the confirmed promissory notes given to the suppliers. f EQUITY OR CAPITAL ~ this can be determined by subtracting the assets and liabilities as of any given date, EXAMPLE PROBLEM ‘The following data are available from a single entry set of books of ABC Trading owned by Juan Abaios: Assets taan 31-Dee Cash 900,000 1,200,000 Notes Receivable 270,000 ‘550,000 Accounts Receivable 4,200,000, 41,100,000 Inventory ‘900,000 "750,000 Prepaid Expense 30,000 50,000 Fumiture and Equipment "750,000 200.000 Total Assets 24050000 4,550,000 Liabilities ‘Notes payable P 400,000 © P_§00,000 ‘Accounts payable £850,000 710,000 ‘Accrued Expense 50,000 40,000 Interest Payable 5,000 Uneamed rent income 20,000 Total Liabilties P4,325-000 _P7,285,000 ‘Synergy in Global Education! www.certscollege.org162 Constructive Accounting Module 3 ‘The cash record of the current year showed the following information: Receipts: Disbursements: Balance, January 1 900,000 Accounts payable P 1,200,000 Accounts Receivable 2,150,000 Notes payable 950,000 Notes receivable 750,000 Cash purchases ‘450,000 Cash Sales 600,000 Interest paid 50,000 Rent collected 160,000 Expenses paid 600,000 Sale of equipment 100,000 Equipment purchased 300,000, Additional investment 400.000 Withdrawals 300,000 TOTAL 5,050,000 TOTAL P 3,850,000 ‘Additional Information: 1. Sales returns and allowance granted to customers P 175,000 2. Sales discounts granted to customers, 75,000 3. Uncollectible accounts written off 40,000 4. Purchase discounts on accounts payable paid 50,000 5. Equipment costing P 150,000 (50% depreciated) was sold, Required: ‘a. Determine the proft or loss for the year ending December 31, 20CY. b. Compute the gross sales and net sales, ©. Compute the total gross purchases, net purchases. d. Compute the cost of goods sold. e. Compute the depreciation on furniture and equipment f. Compute the accrual administrative expenses aside from depreciation expenses. g. Compute the total administrative expenses. h. Compute the interest expense, i. Compute the rent income. i. Compute the gain on sale of equipment. k. Prepare the Statement of Profit or Loss for the year ended December 31, 20CY (Use the functional format) ee Prepare the Statement of Financial Position as of December 31, 20CY (Use the traditional presentation) ‘Solution Example Problem 3-a) Profit computation Capital, December 31 (4,550,00 — 1,295,000) P 3,255,000 ‘Add: Withdrawals dunng 20C¥ 300,000, Total 3,555,000 Less: Capital, January 1, (4,050,000 ~ 1,325,000) P 2,725,000 Additional investments 400,000___3,125,000 Profit B__ 430,000 wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 163 Note: The increase in assets and decrease in liabilities increase profit while the decrease in assets and increase in labilties decrease proft. ‘Solution Example Problem 3- b) Computation of Gross Sales and Net Sales Notes receivable, December 31 P 550,000 Accounts receivable, December 31 4,100,000, Collections of Notes receivable 1:100,000 Collections of Accounts receivable 2/150,000 Sales retums and allowances 175,000 Sales discounts 75,000 ‘Accounts written off — Impairment loss. 40,000. Total 840,000 Less: Notes receivable, January 1 P 270,000 ‘Account receivable, January 1 41,200,000 ___1,470,000 Sales on Account 3,370,000 Cash Sales ‘600,000 GROSS SALES 3,970,000 Sales retums and allowances (175,000) Sales discounts 75,000 NET SALES. P 3,720,000 Note: If the information given is only the increase or decrease in Notes or Accounts Receivable, the treatment is, add the increase or deduct the decrease in your computation. The same treatment is followed in the computation of purchases below. Solution Example Problem 3-c) Computation of Gross Purchases and Net Purchases. Notes Payable, December 31 P $00,000 ‘Accounts payable, December 31 710,000 Payments of Notes payable 950,000 Payments of Accounts payable 1,200,000 Purchase discounts 0,000 Total 310,000 Less: Notes payable, January 1 P. 400,000 ‘Accounts payable, January 1 850,000 __1,250,000, Purchases on Account 2, 160,000 Cash Purchases "480,000 Total Gross Purchases 610,000 Freightin 0 Purchases discounts (50,000) NET PURCHASES 2,560,000 ‘Synergy in Global Education! www.certscollege.org164 Constructive Accounting Module 3 ‘Solution Example Problem 3 ~d) Computation of Cost of Goods Sold Merchandise Inventory, January 1 P_ 900,000 ‘Add; Net Purchases 2,560,000 Total goods available for sale 3,460,000 Less: Merchandise Inventory, December 31 "750,000 Cost of Goods Sold 2,710,000 ‘Solution Example Problem 3 - e) Computation of Depreciation Expense Furniture and Equipment — January 1 P 750,000 ‘Add: Equipment purchased 300,000 Total 7,050,000 Less: Furniture and Equipment - December 31 900,000 BV of Equipment sold — 180,000 x 50% 75,000__ 975,000 Depreciation Expense B_ 75,000 ‘Solution Example Problem 3 - f) Computation of Administrative Expenses Aside from Depreciation Expense Cash Expenses ‘Add: Prepaid expenses ~ January 1 P 30,000 600,000 ‘Accrued expenses ~ December 31 40,000 70,000 Total 70.000 Less: Prepaid expenses - December 31 0,000 ‘Accrued expenses ~ January 1 50,000 100,000 Accrual expenses aside from depreciation 570.000 ‘Solution Example Problem 3 - g) Computation of Total Administrative Expenses ‘Accrual expenses other than depreciation 570,000 Depreciation expense 75,000 Bad debts 40,000 Total administrative expenses 85,000 ‘Solution Example Problem 3-h) Computation of Rent Income Rent income received P 180,000 ‘Add: Unearned rent income — January 1 20,000 Total P 770,000 Less: Uneamed rent income - December 31 30,000, Rent Income 2740.00 ‘Solution Example Problem 3 - i) Computation of Gain on Sale Selling Price P 100,000 Less: Book Value of equipment sold (P'180,000 x50%) 75,000 Gain on sale of equipment © 25,000, wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Account ting 165 ‘Solution Example Problem 3 -j) Computation of Interest Expense Interest expense paid ‘Add; Interest payable - December 31 Total Less: Interest payable ~ January 1 Interest Expense Solution Example Problem 3 - k) 3-k1) Statement of Profit or Loss (Expenses Classifie ABC COMPANY Statement of Profit or Loss For the Year Ended, December 37, 20CY (Expenses Classified by Funetion) P 50,000 45,000 5,000, 5,000 550.000 .d by Function) Net Sales P 3,720,000 Cost of Sales 2,710,000, Gross Profit P 1,010,000 Rent Income 140,000 Gain on sale of equipment 25,000, Administrative expenses (85,000) Interest expense (60,000) PROFIT FOR THE PERIOD = 430,000- 3-k2) Statement of Profit or Loss (Expenses Classified by Nature) ABC COMPANY Statement of Profit or Loss For the Year Ended, December 31, 200Y (Expenses Classified by Nature) Net Seles P 3,720,000 Rent Income 140,000 Gain on sale of equipment 25,000 Total Income 3,885,000 Merchandise purchases 2/560,000 Decrease in inventory (10,000) ‘Operating expenses (570,000) Depreciation expense (7,000) Bad debts (40,000) Interest expense (60,000) Profit 430,000, ‘Synergy in Global Education! wuw.certscollege.org166 Constructive Accounting Module 3 ‘Solution Example Problem 3 - |) Statement of Changes in Equity ABC COMPANY Statement of Changes in Equity For The Year Ended, As at December 31, 20CY ‘Accumulated Contributions Profit Balances January 1 P 2,725,000, P 2,725,000 ‘Additional investments "400,000 "400,000 Proft 430,000 430,000 Drawings 300,000) 300,000) December 31 E 725;000___P. 130,000 P'3.255,000 ‘Solution Example Problem 3 - m) Statement of Financial Position (Traditional) ABC COMPANY Statement of Financial Position ‘As at December 31, 20CY ASSETS Current Assets Cash P 1,200,000 Notes receivable ‘600,000 Accounts receivable 41,100,000 Inventory 750,000 P 3,650,000 Non Current Assets Furniture and Equipment (Net) 900,000 Total Assets 4,550,000. LIABILITIES AND EQUITY Current Liabiltes: Notes payable P- 500,000 ‘Accounts Payable 750,000 Interest Payable 16,000 Uneamed rent income 30,000 Total labilties 7,295,000 Equity J. Abalos, Capital, December 31 3,255,000 Total Liabilities and Equity 4.550.000 8.0 CASH BASIS VERSUS ACCRUAL BASIS OF ACCOUNTING: 8.1, Cash Basis of Accounting — this method of accounting recognizes and records revenues, services provided or products sold, only when cash has been received, On the other hand, expenses are recognized and recorded wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 167 only when cash has been paid. The cash method is generally used in small businesses or by practicing professionals. 8.2, Accrual Basis of Accounting — this method of accounting recognizes and records revenues, services provided or products sold, when eamed regardless of whether cash has been received or not. It also recognizes and. records expenses when incurred regardless of whether cash has been paid or not. The accrual method is used by most companies because profit is ‘more accurately measured under this method. TRANSACTIONS METHOD OF ACCOUNTING CASH BASIS. Revenue — Expense ‘ACCRUAL BASIS Revenue Expensé 2. Rendered services on account, P5,000 : 5,000, b. Received cash for services rendered, P 6,000 6,000 6,000 ©. Paid salaries and wages, P 2.500 2,800 2,500 4. Received the bill rom Meralco, P 4,000 4000 Total Revenue 6,000 11,000 Total Expenses 2,00 6,500 Cash Profit (P6,000 — 2,500) 3,500 Accrual Profit(P11,000 ~ P4,500) 4,500 Revenue are recognized and recorded when Received Eamed Expenses are recognized and recorded when Paid Incurred Comparative Recording of the Transactions CASH BASIS ‘ACCRUAL BASIS a NOENTRY Accounts Receivable 5,000 Service Income 5,000 b. Cash. 6,000 cash 6,000 Service Income 6,000 Service Income 6,000 © Salaries ana Wages 2,500 Salaries and Wages 2,500 Cash 2.500 cash 2,500 6 NOENTRY Light & Water Expense 4,000 ‘Accrued Light and Water Exp. 4,000, Note: The accrual basis of accounting will require adjusting entries at the end of the accounting period to record the accruals and deferrals so that there will be proper ‘matching of costs against revenue. Only in this way will the profit be accurately measured. ‘Synergy in Global Education! wuw.certscollege.org168 Constructive Accounting Module 3 EXAMPLE PROBLEM 4: The following are the summarized transactions of XYZ Trading for the year 20CY, its ‘second year of operations: Cash sales P 750,000 Sales on account 4,800,000 Collections from customers 4,300,000, Sales retums & discounts 80,000 Cash purchases 450,000 Purchases on account 3,000,000 Payment to creditors 2,700,000, Rental collections 140,000 Purchase returns and discounts 60,000 Salaries and wages paid 4,050,000 Store and office supplies used ‘300,000 Other operating expenses paid 400,000 Interest racaived 60,000, Equipment purchased 600,000 Interest paid ‘50,000, ‘Accounts receivable writen off 40,000 Equipment was acquired at the beginning of its first year with a 10-year useful life Additional Information at December 31, 20CY: 12/31 PY) 19/31 CY) Notes & Accounts Recelvable 210,000 P 320,000, Unused Store & Office Supplies 75,000 ‘Accrued Interest Receivable 15,000 Inventory 00,000 600,000 Uneared Rent Income 20,000 Accrued Salaries Payable 110,000 Notes and Accounts Payable 300,000 540,000 Required: 1. Compute the following under the CASH BASIS and ACCRUAL BASIS of accounting: a. Gross sales €. Interest expense b. Gross and net purchases f. Salaries and wages c. Interest Income . Store and offices supplies expense 4d. Rent income h. Depreciation expense 2. Statement of Profit or Loss for the year ended December 31, 20CY under the CASH BASIS of accounting, wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 3. Recast the Statement of Profit or Loss using the ACCRUAL BASIS of accounting, 4. Adjusting entries necessary to convert the CASH BASIS into ACCRUAL BASIS of accounting. Solution - Example Problem 4-1) Computations Cash Basis Accrual Basis a, Cash Sales P 750,000.00 P_ 750,000.00 Sales on accounts ~ 4,500,000.00 Collections from customers 4,300,000.00 Gross Sales s,050,000.00 2 5.250,000.00 Computations of the gross sales under the Accrual Basis if sales on account is not given: Notes & Accounts receivable, 12/31/CY P 320,000.00 Collections from customers 4,300,000.00 Sales returns and discounts 20,000.00 Accounts receivable written off 40,000.00 Total ‘710,000.00 Notes and Accounts receivable, 12/31/PY 210,000.00 Sales on accounts, 500,000.00, Cash Sales 750,000.00 Gross Sales P.5.250,000.00 b. Cash Purchases P 450,000.00 P 450,000.00 Purchases on account - 3,000,000.00 Payments to creditors 2,700,000.00 Gross Purchases 3,150,000.00 3,450,000.00 Purchases retums and allowances 80,000.00 Net Purchases 23.150,000.00 E3.370,000.00 Computations of the gross purchases under the Accrual Basis if Purchases on account is not given: Notes & Accounts payable 12/31/CY P 540,000.00 Payment to creditors 2,700,000.00, Purchases retums and discounts 60,000.00 Total 3,300,000.00 Notes & Accounts payable 12/31/PY ‘300,000.00 Purchases on account 3,000,000.00 Cash Purchases 450,000.00 Gross Purchases E3.450,000.00 c. Interest received P 60,000.00 P 60,000.00 Accrued interest receivable 45,000.00 Interest Income E60,00000 75,000.00 ‘Synergy in Global Education! 169 wuw.certscollege.org170 Constructive Accounting Module 3 d. Rental collections P 140,000.00 P_—_140,000.00 Unearned rent income (20,000.00) Rent income B 14900009 © B 120,000.00 e. Interest paid P 50,000.00 P —_ 50,000.00 ‘Accrued Interest Payable 410,000.00 Interest expense P50,000.00 © ~P__60,000.00 f. Salaries and wages paid P 1,050,000.00 P-_1,050,000.00 Accrued Salaries payable 110,000.00 Salaries and Wages Bi050.00000 PB 1,160,000.00 9. Store and office supplies paid P 300,000.00 P 300,000.00 Unused Store & office supplies 75,000.00 Store and office supplies expense B_300,000.00 © B 225,000.00 h. Depreciation expense (P600,000/10 years) B 0 B__ 60,000.00 Sol n - Example Problem 4-2) Statement of Profit or Loss (Cash Basis) XYZ Trading Statement of Profit or Loss For the Year Ended December 31, 20CY Sales P 5,050,000.00 Rent income 140,000.00 Interest income 0,000.00 Total income 250,000.00 Merchandise purchases ( 3,150,000,00) Increase in inventory 100,000.00 Salaries and wages ( 4,050,000.00) ‘Store and office supplies (300,000.00) Other operating expenses (100,000.00) Interest expense 50,000.00 Profit B700,000.00 wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting m1 ‘Solution - Example Problem 4-3) Statement of Profit or Loss (Accrual Basis) XYZ TRADING Statement of Profit or Loss For the Year Ended December 31, 20CY Sales P 5,170,000.00 Rent income ‘120,000.00 Interest Income 75,000.00 Total Income 5 365,000.00 Merchandise purchases ( 3,390,000.00) Increase in inventory "100,000.00 Salaries and wages ( 1,160,000.00) Store and office supplies (228,000.00) Other operating expenses (100,000.00) ( ( Bad debts expense 10,000.00) Depreciation expense 60,000.00) Interest expense 60,000.00) Profit B_ 700,000.00 ‘Solution Example Problem 4-4) Adjusting entries to convert into Accrual Basis 1. Sales 210,000.00 Capital/ Retained earnings 210,000.00 Notes/Accounts receivable - 12/31/PY collected in the CY, 2. Notes/Accounts receivable 320,000.00 Sales 320,000.00 Unrecorded Notes/Accounts receivable — 12/31/CY 3. CapitaliRetained earings 300,000.00 Purchases 300,000.00 Unrecorded Notes/Accounts payable -12/31/PY paid in the CY. 4, Purchases 540,000.00 Notes/Accounts payable 540,000.00 Unrecarded Notes/Accounts payable ~ 12/31/CY. 5. Accrued interest receivable 15,000.00 Interest Income 15,000.00 Unrecorded Accrued interest receivable ~12/31/CY 6. Rent Income 20,000.00 Uneamed rent Income 20,000.00 Unrecorded Unearned rent income - 12/31/CY ‘Synergy in Global Education! www.certscollege.org172 Constructive Accounting Module 3 7. Interest expense 10,000.00 ‘Accrued interest payable 10,000.00 Unrecorded Accrued interest payable- 12/31/CY 8. Salaries and wages 110,000.00 Accrued salaries payable 110,000.00 Unrecorded Accrued salaries payable ~ 12/31/CY 9. Unused store and office supplies 75,000.00 Store and office supplies 75,000.00 Unrecorded Unused store and office supplies - 12/31/CY 10. CapitalRetained earings 60,000.00 Depreciation expense 60,000.00 ‘Accumulated depreciation 120,000.00 Depreciation expense for CY and unrecorded depreciation for PY. NOTE: All adjustments for the previous year should be debited or credited to the capital account (if the business is a sole proprietorship or ‘partnership) or to the retained earnings account if the business is a corporation. * In the case of a partnership all the adjustments to their capital accounts must be in accordance with their profit and loss sharing ratio. 9.0 CORRECTION OF ERRORS Errors may be committed at any stage in the accounting cycle. Once discovered, they must be corrected before the preparation of the financial statements. 9.1. KINDS OF ERRORS 1, Clerical Errors - errors that are normally detected in the performance of the accounting procedures and are immediately corrected. Examples are arithmetical errors (error in addition, subtraction, multiplication or division), posting to the wrong side or account, misstating an amount (over or understated) or error of omission. 2. Statement of Financial Position Errors - errors that will affect only the real accounts (Statement of Financial Position accounts). Examples are misstatement of Statement of Financial Position items, errors in the Classification such as current asset is erroneously classified as non- current asset, etc, wnaw.certscollege.org ‘Synergy in Global Education!Module 3 ‘Synergy in Global Education! Constructive Accounting 3. Statement of Profit or Loss Errors ~ errors that will affect only the nominal accounts (Statement of Profit or Loss accounts). Example are misstatement items in the Statement of Profit or Loss, errors in the Classification of expenses such as insurance expense erroneously charged to miscellaneous expense, etc. 4. Errors affecting both Statement of Financial Position and Statement of Profit or Loss ~ errors that will affect both the Statement of Profit or Loss and the balancer sheet accounts. The effect will be an under or overstatement of the profit with a corresponding under or overstatement in the assets, liabilties or owner's equity. Examples are failure to record depreciation of equipment, failure to recognize accruals and deferrals, etc. This type of error will be further classified into counterbalancing and, non- counterbalancing error, Counterbalancing Error ~ is an error that will be automatically corrected in the next period without the benefit of any correcting entry. Example — misstatement of inventory. Non-counterbalancing Error — is an error that is not corrected in the next period and will require correcting entry in the period discovered For counterbalancing or non-counterbalancing error, the required correcting entry will depend on whether or not the books are already closed in the period the error is discovered Ifthe books are close a. For counterbalancing error, no correcting entry is necessary. b. For non-counterbalancing error, a correcting entry is necessary to adjust the current balance of capital or retained earings. Ifthe books are not yet close a. For both the counterbalancing or non-counterbalancing error, a correcting entry is necessary to correct the current period and to adjust the beginning balance of capital or retained earings. 173 wuw.certscollege.org174 EXAMPLE of ERRORS PRIOR YEAR ERROR Counterbalancing Errors a. Ending inventory — understated, P10,000 b. Ending inventory — overstated, P 15,000 ©. Sales of PY recorded in the CY, P20,000 d. Purchases of PY recorded ‘in the CY, 12,000 e. Accrued expense — unrecorded, P2,000 {Prepaid expense — unrecorded, P3,000 g. Accrued income — unrecorded, P4,000 h. Unearned income — unrecorded, P5,000 Non-counterbalancing Errors Depreciation — unrecorded, P 6,000 Impairment loss ~ unrecorded Constructive Accounting Module 3 Effects of Errors - Overstated (understated) (Previous Year) (Current Year) Capital or Retained Capital or Retained Eamings Eamings (P10,000) 10,000 15,000 (P 15,000) (P20,000) 20,000 12,000, 12,000) 2,000 2,000) (P3,000) 3,000 (4.000) 4,000 P5,000 (P5,000) 6,000 6,000 P1000 1,000 NOTE: The effects on the capital or retained earnings above are based on the assumption that the books for both years are already closed. End of Current Year Correcting Entries Books Not Yet Closed Books Already Closed 2 Inventory - Beginning 70,000 No entry ~ Error is countered CapitalRetained Eamings 10,000 _balanced in the current year B. CapiialRetained Eamings 75 000 No entry = Error is countered Inventory - Beginning 18,000 balanced in the current year 3 Sales 20,000 No entry ~ Error is countered CapitauRetained Eamings 20,000 _ balanced in the current year @__GapiialRetained Eamings 72,000 No entry ~ Error is countered Purchases 412,000 _ balanced in the current year © Capitaletained Eamings 2,000 ‘No entry ~ Error is countered Expense Account 2,000 _balanced in the current year 1 Expenses Account 3,000 No entry ~ Error is countered Capitaletained Earnings. 3,000 _balanced in the current year @ Income Account F000 'No entry ~ Error is countered CapitalRetained Eamings 4,000 balanced in the current year h. CapitaliRetained Eamings 5,000 No entry ~ Error is countered Income Account 5,000 _balanced in the current year T CapiiavRetained Eamings 000 6,000 ‘Accumulated depreciation 6,000 6,000 T Capfalietained Eamings 7000 7000 ‘Allowance for Bad Debts, 4,000 4,000 wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting EXAMPLE PROBLEM 5: 175 Jumbo Trading owned by Mario Portal reported profit as follows: Current year ~ 350,000; Previous Year ~ P500,000. It is assumed that year-end adjustments for the current year were properly made except for the errors and misstatements for the previous year. ‘The audit and review of the records of Jumbo Trading disclosed the following errors made in the previous year: Required: Inventory at the year-end was understated, Sales on account were recorded in the current year Purchases on account were recorded in the current year Year -end accrued advertising was not recorded Year ~ end prepaid insurance was not adjusted Year -end uneamed rent income was omitted Year end accrued interest income was omitted Year-end unused office supplies was not adjusted ‘Year -end depreciation of equipment was omitted 10. Year ~end provision for bad debts expense was nottaken up 3,500 60,000 20,000 15,000 5,000 8,000 6,000 3,000 2/500 4,000 a. Prepare an analysis showing the corrected profit for the previous and current year. b. Prepare the correcting entries at year-end of the current year assuming that the 1) Books have not been closed. 2) Books have been closed ‘Solution - Example Problem 5-a Unadjusted Profit Errors made in the Previous Year: 4. Inventory — understated Sales on account - unrecorded Purchases on account - unrecorded ‘Accrued advertising - unrecorded Prepaid insurance ~ not adjusted Uneamed rent income - omitted Accrued interest income — omitted Unused office supplies ~ not adjusted Depreciation of equipment — omitted (0. Bad debts expense — not taken up Corrected Profit ‘Synergy in Global Education! Previous Year P 500,000.00 60,000.00 20,000.00 (18,000.00) 6,000.00) 8,000.00 (6,000.00) 3,000.00 2,500.00 (4,000.00) (3,500.00) 560,000.00 Current Year P 350,000.00 (60,000.00) (20,000.00) 15,000.00 5,000.00 (8,000.00) 6,000.00 (3,000.00) (2,500.00) 282,500.00 wuw.certscollege.org176 Constructive Accounting Module 3 ‘Solution Example Problem 5-b. End of Current Year Correcting Entries Books Not Yet Closed Books Already Closed 4, Inventory - Beginning 0,000 No entry — Error is countered Mario Portal, Capital 60,000 _balanced in the current year 2 Sales 720,000 No entry — Error is countered Mario Portal, Capital 20,000 balanced in the current year 3, Mario Portal, Capital 75,000 No entry — Error is countered Purchases 15,000 _balanced in the current year “4. Mario Portal, Capital 5,000 No entry — Error is countered Advertising Expense 5,000 balanced in the current year 3. Insurance Expense 8,000 No entry — Error is countered Mario Portal, Capital 8,000 _balanced in the current year. 6 Mario Portal, Capital 6,000 No entry — Error is countered Rent Income 6,000 balanced in the current year 7. Interest Income 3,000 No entry — Error is countered Mario Portal, Capital 3,000 _balanced in the current year 8 Office Supplies Expense 2,500 No entry — Error is countered Mario Portal, Capital 2,500 _balanced in the current year 9. Matio Portal, Capital 4,000 4,000 Accumulated depreciation 4,000 4,000 10. Mario Portal, Capital 3,500 3,500 Allowance for Bad Debts 3,500 3,500 Note: if Jumbo Trading is a corporation, instead of debiting or crediting Mario Portal Capital account, the Retained Earnings account will be substituted. Errors of the previous year are treated as adjustments for the current year's beginning balance of the capital account or the retained eamings account. If comparative statements are to be presented the previous year's statements should be restated to correct the error, 10.0 FINANCIAL STATEMENTS ANALYSIS, 10.1, GENERAL OBJECTIVE To evaluate the past performance of the business as a whole for a given period of time as a basis for making present and future plans or decisions, wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 177 10.2, ANALYZE VERSUS INTERPRET To analyze means to develop significant financial ratios while to interpret ‘means to explain the significance of the financial ratios developed. 10.3, CARDINAL RULES TO BE FOLLOWED (before interpreting the financial ratios): 1. Develop a group of related financial ratios, ~ a single ratio is meaningless because it is an isolated ratio. it only becomes meaningful after relating to other allied ratios. 2. Make comparison, — In the analysis and interpretation of financial ‘staternents, comparison is a must. Without comparison, no interpretation can be made. 3. Be aware of the assumptions and limitations of the financial statements. The results of the analysis will depend on how reliable is the information contained in the financial statements. 10.4, LIMITATIONS OF THE FINANCIAL STATEMENTS ‘The financial statements have so many assumptions and limitations, which the analyst must be fully aware of lest he makes a wrong interpretation or conclusion. Because of these assumptions, which are not valid, the results of the analysis might be negated and no accurate interpretation can be made. ‘Among the limitations and assumptions of the financial statements being analyzed are the following 4. The financial statements are not exact. 2. The financial statements are not yet final. They are merely interim statements. 3. The statements are quantitative rather than qualitative. 4. Inflation is ignored 5. Non-comparabilty of companies although they are engaged in the sane line or they belong to the same industry. 6. The financial statements are historical in nature 10.8. FINANCIAL RATIO - is the ratio of one iter in the financial statements to another item, KINDS OF FINANCIAL RATIOS Statement of Profit or Loss Ratio - the ratio of one item in the Statement of Profit or Loss to another item in the same Statement of Profit or Loss. Example ~ Gross Profit rate - the ratio of the gross profit to sales. (both items are found in the Statement of Profit or Loss). ‘Synergy in Global Education! www.certscollege.org178 Constructive Accounting Module 3 Statement of Financial Position Ratio — the ratio of one item in the Statement of Financial Position to another item in the same Statement of Financial Position., Example - Current ratio — the ratio of current assets to the current liabilities, (both are found in the Statement of Financial Position). Inter-Statement Ratio — the ratio of one item in the Statement of Profit or Loss to another item in the Statement of Financial Position. Example - Accounts Receivable Turnover ~ the ratio of sales to the average accounts receivable. (The sales revenue is shown in the Statement of Profit or Loss while the accounts receivable item is shown in the Statement of Financial Position, ‘Trend Ratio - the ratio of one item to the same item. Example — the ratio of sales this year compared to the sales last year. USES OF RATIO ANALYSIS: 41. It provides an indication of the firm’s financial strengths and weaknesses and should generally be used in conjunction with other evaluation techniques. 2. Ralios are useful tools in the analysis of financial statements because they summarize data in a form easy to understand, interpret, and compare. SPECIFIC OBJECTIVES - The results of the analysis should be able to determine the following: LIQUIDITY - the ability of the company to convert non-cash current assets into cash, SOLVENCY - the ability of the company to pay liabities on time. A company Which cannot pay on time is said to be "technically insolvent", Solvency is of two types, short-term solvency which is the ability to pay current liabilities and long-term solvency which is the ability to pay principal on the long-term liabilities including the interest. STABILITY — the ability to withstand financial reverses. PROFITABILITY ~ the ability to generate adequate profits to sustain the operations of the business and eam satisfactory retum to the owners, EFFICIENCY — the ability to manage the business effectively and meet the goals and objectives. wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 179 10.6. TECHNIQUES IN ANALYZING FINANCIAL STATEMENTS: 1. Comparative Statements - The presentation of comparative financial ‘statements for the current and prior periods, allows the user or reader to compare the changes in the individual items. 2. Horizontal Analysis — Under this technique, each item in the financial statements of the current period is compared with the previous period. The increase or decrease in peso amount will be expressed in percentage or as a ratio to be more meaningful Example 2008 2006 Peso Change % Change Sales j00,000 120,000 ~~ -P 20,000 20% 3. Vertical Analysis - Under this technique, the ratio of each item in the financial statements to a certain base item is obtained and is expressed in percentage. In the Statement of Profit or Loss the base item is the net sales. In the Statement of Financial Position, the base item is the total assets. Example Sales P 100,000 100% Cost of sales 60,000 60 Gross Profit 40,000 40% Expenses 25,0025 Profit 15.000 15% Statements, which show only the component percentages of each item without the corresponding amount is called “COMMON SIZE STATEMENTS” 4. Dynamic Ratio Analysis — the following are dynamic financial ratios: ‘Synergy in Global Education! www.certscollege.org180 Constructive Accounting Module 3 EVALUATION OF SHORT-TERM SOLVENCY (ie, ability to pay maturing current RATIO |. Net Working Capital Net Monetary Assets Current Ratio (Working Capital Ratio) Quick Ratio (Acid-Test Ratio} Cash Flow from Operati FORMULA, SIGNIFICANCE Current Assets ~ Current Liabilities A measure of short-term solvency. Quick Assets - Current Liabilties A measure of immediate short-term solvency. = * Current assets Measures the degree of Current Liabilities short-term solvency. Quick Assets Measures the degree of Current Liabilities immediate short-term solvency jons = Cash Flow from Operations This ratio will overcome or Current Liabilities offset to current liablities a low current or quick ratio. EVALUATION OF LIQUIDITY RATIO (ability to convert non-cash current assets 1. into cash) Inventory Turnover Cost of Sales Measures efficiency in Average Inventory selling inventory Age of Inventory = _No. of business days Number of days to sell the Inventory tumover Inventory Receivable Turnover = _Net Credit Sales Measures efficiency in ‘Ave. Receivables, collection ‘Age of Receivables = No. of Business Davs Operating Cycle = Age of inventory + Age of Receivables Percentage Distribution of Current Assets wnaw.certscollege.org Number of days to collect Receivable tumover receivables Number of days to convert into cash = Individual Current Asset Shows the composition of Total Current Assets the current assets expressed in percentage ‘Synergy in Global Education!Module 3 Constructive Accounting 181 7. Ratio of Current Assets = _Current Assets Measures the over-all to Total Assets Total Assets liquidity of the assets ‘+The current assets arranged in the order of their liquidity are the following: Cash Marketable Securities Accounts Receivable Inventory Prepaid Expenses Cash, marketable securities and accounts receivable are considered quick assets while the inventory and prepaid expense are considered non-quick assets. EVALUATION OF STABILITY (ability to withstand financial reverses) 4, Debt Utilization Ratio = Total Liabilities Measures the proportion of Total Assets debts to the company’s Capital structure 2. Equity Ratio = Owner's Equity Measures the proportion of Total Assets equity to the company's capital structure. 3. Debt-Equity Ratio = — _TotalLLiabiliies Measures the extent of the Total Owner's Equity Trading on Equity 4. Equity-Debt Ratio = -—_Total Owner's Equity Total Liabilities 5. Book Value per Share = Total Owner's Equity Market price determinant Outstanding shares 6. Cash Flow from Operations to Total Liabilities = Cash Flow from Operations This ratio will overcome or ‘Average Total Liabilities offset a high debt ratio 7. Times Interest Earned Ratio *EBIT Ability to pay interest interest Expense ‘+ EBIT- Eamings before interest and taxes 8. Debt-Service Coverage Ratio EBIT Ability to pay principal on Interest + Principal long-term obligation plus ‘Synergy in Global Education! www.certscollege.org182 Constructive Accounting Module 3 9. Times Preferred Dividends Earned Profit Measures the adequacy of Annual Preferred Dividend profit earned for the payment of preferred dividend EVALUATION OF PROFITABILITY (ability to earn adequate profits) 4. Gross Margin Ratio= __Gross Margin Measures the markup on Net Sales, sales Gross Margin Measures the markup on Cost of Sales cosr of sales. 2. Operating Ratio = Cost of Sales & Expenses Measures the cost of Net Sales operations (in percentage) 3. Return on Sales Profit Measures the profitability Net Sales rale based on sales 4, Return on Assets = Profit Measures the efficiency in ‘Ave. Total Assels ‘managing the assets 5. Return on Current Assets = Profit Measures the profitability of ‘Ave, Current Assets the current assets 6. Return on Fixed Assets = Profit Measures the profitability of, ‘Ave. Fixed Assets the fixed assets 7. Return on Equity = Profit Measures the rate of return ‘Ave. Equity on the capital provided by the owners 8. Earnings per Share = Profit ‘The amount of earnings No. of Common Shares Outstanding attributable to each share of stock 9. Dividends per Share Dividends of Common ‘The amount of dividend No, of Common Shares Outstanding attributable to each share of stock 10. Dividend Payout Ratio = Dividends per share Measures how many Eamings per share percent of the profit is deciared as dividends wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 14. Earnings-Price Ratio = __Eaminas per Share Market Price per Share 42. Yield on Common Dividends per Share Market Price per Share EVALUATION OF THE OVER-ALL EFFICIENCY 4. Asset Turnover - Net Sales, ‘Ave. Total Assets 2. Current Assets Turnover = Cost of Sales & Expenses Ave. Current Assets 3. Fixed Assets Turnover = __Net Sales ‘re. Fixed Assets 4, Working Capital Turnover = Net Sales. ‘Ave, Net Working Capital 5. Equity Turnover Net Sales ‘Ave, Owner's Equity ‘Synergy in Global Education! 183 Measures the relationship of the earings per share to ‘The market price per share Measures the return on investment in common stock Measures the effectiveness. of the utilization of total assets Measures the effectiveness of the utilization of current assets Measures the effectiveness of the utilization of fixed assets Measures the effectiveness of the management of net working capital Measures the effectiveness of the use of capital provided by the owners wuw.certscollege.org184 Constructive Accounting Module 3 EXAMPLE PROBLEM 6: The following data are obtained from the financial statements of CERTS TRADING COMPANY for the year ended December 31, 20CY: ‘Statement of Financial Position 20.GY Statement of Profit or Loss. Accounts (Dec 31 20 PY 20cY Accounts, cash P150,000 P 283,000 Sales P 6,250,000 Marketable Securities 850,000 1,000,000 Sales Return & Allow. 250,000 Accounts Receivables, net 500,000 1,000,000 Inventory, Dec31, 20CY 500,000, Inventories 750,000 500,000 Inventory, Dec31,20PY 750,000 Lang 00,000 500,000 Purchases 2,750,000 Building, net 550,000 500,000 Selling Expenses, ‘400,000 Machinery and Equipment, net 41,700,000 1,500,000 Administrative Expenses, Goodwill 400,000 400,000 (Including Depreciation Other Assets 100,000 90,000 of 250,000) 600,000 Notes Payable, Trade 100,000 10,000 Interest on LT Notes 250,000 Accounts Payable, net 610,000 790,000 Expenses Payable 40,000 60,000 Long-term notes- due 2014 2,800,000 2,280,000 18% Preference Shares, P100 Par 00,000 800,000 Ordinary Shares, P10 Par 1,600,000 1,500,000 Retained Earnings 250,000 523,000 Additional Information: Dividends on preferred 75,000 Dividends on common 162,000 Market price per share on Ordinary Share 18 Income taxes, 32% There are only 300 business days during the year. The annual amortization of term Notes is P 250,000. Required: 1. Prepare comparative Statement of Financial Positions for 20PY and 20CY, showing peso and percentage changes for each item. (Horizontal Analysis). 2. Prepare Statement of Profit or Loss for the year ended December 31 20CY showing the ratio of each item to Sales expressed as a percentage. (Vertical Analysis). 3, Prepare comparative Common-Size Statement of Financial Positions. wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting Evaluate the firm's short-term solvency for 20CY. Determine the relative liquidity of the firm's assets. Evaluate the firm’s stability. Evaluate the over-all efficiency in managing the business for 20CY. Evaluate the firm's profitability for 20CY. ‘SOLUTION TO EXAMPLE PROBLEM 6-1 CERTS COMPANY COMPARATIVE STATEMENT OF FINANCIAL POSITIONS ‘As of December 31, 20PY and 20CY Peso ASSETS 20PY 20cY Change Current Assets Cash 180,000 283,000 133,000 Marketable Securities 850,000 1,000,000 180,000, ‘Accounts Receivable 500,000 1,000,000 800,000, Inventories 750,000 __'500,000__*250,000 Total Current Assets 2,250,000 2,783,000 533,000. Non-current Assets: Land 500,000 $00,000 Building, net 550,000 500,000 —_*50,000, Machinery and Equipment, net 1,700,000 1,500,000 *200,000 Goodwill ‘400,000 400,000 : Deferred Charges 100,000 90,000 ___*10,000 Total Non-current Assets 250,000 2,890,000 *20, 000- TOTALASSETS. 5,500.00 5,773,000 __273,000 LIABILITIES AND SHAREHOLDERS EQUITY Current Liabilties: Notes Payable, Trade 100,000 180,000 50,000 Accounts Payable, Trade 610,000 790,000 180,000 Expenses Payable 40,000 0,000 20,000 Total Current Liabilities 750,000 1,000,000 350,000. Non-current Liabilties: Long-term Notes due 2015 2,500,000 _2,250,000__*250,000 ‘SHAREHOLDERS’ Equity 15% Preference Share 100 par 500,000 500,000 Ordinary Share, 10 par 1,500,000 1,500,000 : Retained Earnings '250,000___"523,000__273,000 Total Shareholders’ Equity 2,250,000 323,000 273,000 185 Percent 89% 18% 100% +339 24% +09% 12% “10% *08% 5.0% 50% 30% 50% 33% 10% 109% 12% ‘Synergy in Global Education! www.certscollege.org186 Constructive Accounting Module 3 TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY 5.0% * MEANS DECREASE ‘SOLUTION T EXAMPLE PROBLEM 6-2 CERTS COMPANY ‘STATEMENT OF PROFIT OR LOSS For the Year December 31 20CY (With Common-size Percentages) Amount Percent Sales '5,250,000.00 105.00 Less: Sales Retums and Allowances '250,000,00, 5.00 Net Sales 000,000.00 700.00 Cost of Goods Sold Inventory, December 31 20PY 750,000.00 15.00 ‘Add: Goods Available for Sale 2,750,000.00 55.00 Total Goods Available for Sale 500,000.00 70.00 Less: inventory, December 31, 20CY ‘500,000.00 40.00 Cost of Goods Sold 000,000.00 “40.00 Gross Margin on Sales Selling and Administrative Expenses Selling Expenses 400,000.00 00 ‘Administrative Expenses 600,000.00 12.00 Total Selling and Administrative Expenses 7,000,000.00. 720.00 Operating Income 7,000,000.00 20.00 Less: Interest Expense 250,000.00, 5.00 Profit Before Income Taxes "750,000.00 75.00 Less: Provision for Income Tax, 32% 240,000.00, 4.80 PROFIT ‘SOLUTION TO EXAMPLE 6-3 CERTS COMPANY COMPARATIVE COMMON-SIZE STATEMENT OF FINANCIAL POSITION As of December 31 20PY and 20CY ASSETS 20PY 20cy Current Assets: Cash 273 490 Marketable Securities 16.45 17.32 wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 187 ‘Accounts Receivable, net 9.09 17.32 Inventories 1364 8.65, Total Current Assets 40.94 78.21 Non-current Assets: Land 9.09 8.68 Buliding 10.00 8.65, Machinery and Equipment, net 3091 25.98 Goodwill 727 6.93 Deferred Charges 1.82 1.58, Total Non-current Assets 30.09 S179 TOTALASSETS. 700.0% 700.0036 LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilities: Notes Payable 1.82 260 Accounts Payable 11.09 1369 Expenses Payable 073 ‘Log Total Current Liabilities 7364 17.33 Non-current Liabilties: Long-term Notes Due 2015 45.45. 38.97 ‘SHAREHOLDERS’ Equity 15% Preference Share, 100 par 3.09 8.65 Ordinary Share, P10 par 227 25.98 Retained Eamings 455 9.05, Total SHAREHOLDERS’ Equity 40.91 3.70 TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY 70.00% 70.00% ‘SOLUTION TO EXAMPLE PROBLEM 6-4 4a, Current Assets: Cash 283,000 Marketable Securities 4,000,000 ‘Accounts Receivable, net 1,000,000, Inventories '500.000 2,783,000 Current Liabilities: Notes Payable, Trade 160,000 Accounts Payable, Trade 790,000 Expenses Payable 60,000 41,000,000 ‘Working Capital for 200Y 783,000 4b. Current Ratio = 2,783,000/1,000,000 278 4c. Quick Assets: Cash 283,000 Marketable Securities 1,000,000, ‘Accounts Receivable, net 41,000,000 2,283,000 ‘Synergy in Global Education! www.certscollege.org188 Constructive Accounting Current Liabilities, net Net Monetary Assets 4d. Quick Ratio :283,000/ 1,000,000 de. Profit ‘Add: Depreciation Inc. in Accounts Receivable Dee. in Inventories Ine. in Notes Payable Ine. in Accounts Payable, Trade Ine. in Expenses Payable Net Cash Flow from Operations ‘Average Current Liabilties = (70,000 + 1,000,000) /2 Ratio of Cash Flow from Operations to Ave cL= Module 3 SOLUTION TO EXAMPLE PROBLEM 6-5 5a. Inventory Turnover ‘5b. Age of Inventory Sc. Accounts Rec’ble Tumover = Cost of Sales Ave. Inventory = No.of Days = Inv. Tumover 4,000,000 282.000 2284, 510,000 250,000 (600,000) '250,000 50,000 180,000 20.000 250.000 — 180.000 —8r5.000 (760,000 875,000) _B6 86% 3,000,000 48X % (750,000 + 500,000) —300_= 62,5days 48 Net Credit Sales =_6.67x Ave. Accts. Rec’ble 8d. Age of Accounts Rec'ble No. of Days AS days Aces. Recble Turnover Se. Operating Cycle = Age of Inv, + Age of Accts. Recible = 62.5 + 45 = 107.5 days 6f. Percentage Distribution of Current Assets (Current Year) ‘Amount Cash P 283,000 Marketable Securities 1,000,000 ‘Accounts Receivable 1,000,000 Inventories ‘500,000 2.783.000 _ wnaw.certscollege.org Percent 10% 36 36 8 100% ‘Synergy in Global Education!Module 3 Constructive Accounting 189 5g. Ratio of __Current Assets (CY) _ = 2,783,000 = 48.21% Total Assets (CY) 5,779,000 ‘SOLUTION TO EXAMPLE EPROBLEM 6 - 6 6a. Debt Ratio = TotalLiabilities_ = 3,250,000 = 56.3% Total Assets 5,773,000 6b. Equity Ratio = Total SHAREHOLDERS’ Equity = 43.7% Total Assets 6c. Debt-Equity Ratio = Total Liabilities 1.29% Total SHAREHOLDERS’ Equity or Equity-Debt Ratio = _Total SHAREHOLDERS’ Equity = 77.63% Total Liabilities 6d. Book Value per Share = _Common Equity _ = 2,523,000 ~*575.000 = Pp 12.99 of Ordinary Share Outstanding Common (1,500,000/10) Shares * Pref. Stock + preferred dividend (600,000 + 75,000) 575,000 6e. Ratio of _Cash Flow from Operations = _760,000. = 23.38% ‘Ave. Total Liabilities. 3,250,000 6f. Times Interest Eamed Ratio = “BIT 000,000 = 4x Interest, 250,000 * EBIT = Eamings before interest and taxes 6g. Debt-Service Coverage Ratio = __E BIT 1,000,000 = 1.62 Int # Principal 250,000 + 250,000 (1 tax rate) (1 32) 6h. Times Preferred Dividend is Eamed Profit 510,000 =6.8x Preferred Dividend 75,000 ‘SOLUTION TO EXAMPLE PROBLEM 6 -7 7a. Asset Turnover 5,000,000 Net Sales, Ave. Total Assets /2°,500,000 + 5,773,000) ‘Synergy in Global Education! www.certscollege.org190 Constructive Accounting Module 3 7b. Current Asset Tumover = Cost of Sales & Exp. = _3,000,000+*750,000_= 1.49 ‘Ave, Current Assets % (2,250,000+2,783,000) * Selling expenses P 400,000 Adm, Expenses 350,000 750,000 7c. Fixed Assets Tumover = _Net Sales 5,000,000 = 16x Ave. *Fixed Assets _14(3,250,000+2,990,000) ‘© Fixed Assets — all the non-current assets 7d, Working Capital Turnover = _Net Sales 5,000,000 3.05x ‘Ave. Net Working _%(1,500,000+1,783,000) Capital Py oY Current Assets 2,250,000 2,783,000 Current Liabilities 750,000 _1,000,000 Net Working Capital 7,500,000 "783.000 Te. Equity Tumover = Net Sales 5,000,00 ‘Ave. Shareholders Equity _% (2,250,000+2,523,000 ‘SOLUTION TO EXAMPLE PROBLEM 6-8 8a. Gross ProfitRate = Gross Profit 2,000,000 Net Sales, 5,000,000 or = Gross Profit 2,000,000 = 86.87% Cost of Sales 3,000,000 8b. Operating Ratio = _ Cost of Sales & Exp. 3,750,000 Net Sales 5,000,000 8c. RetumonSales = Net Profit 510,000. = Net Sales 5,000,000 8d. Retum on Assets = __Net Profit 510,000 = 9.05%, Ave. Total Assets %(6,500,000+5,773,000) Be. Return on Current Assets = __Net Profit 510,000 ‘Ave. Current Assets % (2,250,000+2,783,000) 20.27% wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 191 8f. Return on Fixed Assets = ___Net Profit 510,000 Ave: Fixed assets % (3250,000+2,980 000) 8g. Retum on Common Equity = Net Profit Available to Common ‘Ave. Ordinary Equity *435,000 : % (4,750,000 + 2,023,000) * Profit P 510,000 Less: Preferred dividend 75.000 Net Profit Available to Common ‘1435,000 Previous Year Current Year Ordinary Share 1,500,000 4,500,000 Retained Eamings 250,000 523,000 Total —1750,000 -2.028,000 8h. Earnings per share = Profit Available to Ordinary, 435,000 = P.2.90/share Ordinary Shares Outstanding 150,000 8i. Dividends per share = Total Dividends of Ordinary = 162,000 =P 1.08/share of common Oridnary Shares Outstanding 150,000 8]. Dividend Payout Ratio = Dividends per share = © 1.08 = 37.24% Eamings per share 2.90 8k. Eamings price ratio= _Earnings per share = 290 = 16.11% Market price per share 18,00 81. Yield onCommon= Dividends per share = 408 = 6% Market price per share 78.00 ‘Synergy in Global Education! www.certscollege.org192 Constructive Accounting Module 3 PROBLEMS: 3.1. Everest Company received the August Bank Statement that showed a balance of 38,810.00 as of August 31. Other information are as follows: Balance per checkbook, P38, 120.00 Checks Outstanding No. 750150 P 438.70 No. 750159 P 6,508.00 No. 750152 681.30 No. 750160 732.50 No. 750157 41,404.50 No. 750162 495.00 Customer's check retumed NSF P 680.00 August 31 deposit not recorded in the bank statement 8,430.00 Check No. 750153 for P 2,120.00 retuned with the statement Had been recorded in the books as P 2,210.00 Bank service charges 550.00 Required: Prepare bank reconciliation on August 31 3.2 The following information pertains to GH Company's checking account for the month of ‘October current year: Balance per bank statement, October 31 P 67,777.70 Balance per checkbook, October 31 73,331.00 Check Outstanding: No. 159179 310.00 Deposit on October 31 not recorded by the bank 4,000.00 Returned check marked *NSF” 552.30 Bank Service Charge 141.00 ‘The bookkeeper of GH Company had recorded several checks incorrectly: ‘Check No. Recorded Amount Correct Amount 159159 P 4,120.00 Pp 2,110.00 158173 ‘580.00 ‘850.00 159180 760.00 670.00 Required: Prepare bank reconciliation on October 31. 3.3 On June 30, the Francis Trading Co. had a cash account balance of P20,880. The bank statement for June showed a balance of P6,970. The deposit of 18,500 made on June 30 were stil in transit. The following information was also available: wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 193 Customer's check returned for no sufficient funds. P 530.00 Bank service charges for June 80.00 Check No. 211346 had been written for 3,620 but had been recorded in the books at 6,320 for payment of accounts. ‘The bank incorrectly credited Francis account for 2,500 deposit made by Francis Enterprises. Required: a, Prepare bank reconciliation. b. Prepare journal entries necessary to correct cash account. 3.4 Joy Enterprises owned by Joyce Marcela uses a single entry system and her accountant provided the following data for the year 20CY: January 1 December 31 cash P 600,000.00 P 800,000.00 Notes Receivable 200,000.00 300,000.00 Accounts receivable 800,000.00 1,000,000,00 Inventory 800,000.00 480,000.00 Equipment 600,000.00 640,000.00 Notes Payable 360,000.00 240,000.00 Accounts Payable 600,000.00 20,000.00 Interest Payable 440,000.00 20,000.00 Uneamed Rent Income 60,000.00 20,000.00 ‘The cash record of the current year showed the following information: Receipts: Disbursements: Balance, January 4 P 600,000.00 Accounts Payable P 760,000.00 Accounts receivable 41,500,000.00 Notes Payable 1640,000,00 Notes receivable "480,000.00 Cash Purchases 30,000.00 Cash sales 400,000.00 Interest paid 40,000.00 Rent Collection 140,000.00 Expenses paid 670,000.00 Sale of Equipment costing Equipment purchased 200,000.00 100,000 - 30% depreciated 60,0000 Withdrawals, 200,000.00, Additional investment 200,000.00 Total [380,000.00 Total 2,880,000.00 Balance, December 31, P __ 800,000.00 ‘Synergy in Global Education! www.certscollege.org194 Constructive Accounting Module 3 ‘Additional information: 1, Sales retums and allowances granted to customers P 160,000 2 Sales discounts granted to customers 50,000 3. Uncollectible accounts written off 60,000 4, Purchase discounts on accounts payable paid 50,000 5, Purchase retums on merchandise purchases 40.000 Required a. Determine the Profit or Loss for the year ending December 31, 20CY. b. Compute the total gross sales. c. Compute the total gross purchases. d. Compute the interest expense. e. Compute the rent income. Compute the depreciation on equipment. 9g. Compute the loss on sale of equipment, hh. Prepare the Statement of Profit or Loss for the year ended December 31 20CY. i, Prepare the Balance a Statement of Financial Position as of December 31 20CY. 3.5 An analysis of the incomplete records of Darlene Trading owned by Darlene Roxon showed the following data for the year 20CY: Increase (Decrease) cash P 145,000.00 Notes receivable (120,000.00) Interest receivable 20,000.00 Accounts receivable 280,000.00 Inventory 320,000.00 Prepaid insurance (20,000.00) Equipment 80,000.00 Notes payable 100,000.00 Accounts payable 200,000.00 Uneamed interest income (10,000.00) wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 195 ‘The cash book for the current year showed the following entries: Receipts: Disbursements: Cash sales Pp 500,000.00 Accounts payable 750,000.00 Accounts receivable 1,480,000.00 Notes payable-trade 320,000.00 Notes recewable "480,000.00 Cash purchases 270,000.00 Interest received 55,000.00 Insurance paid +30,000.00 Purchse returns & Allow. (total returns - P70, 000) 20,000.00 Other expense paid 690,000.00 Additional Inverstment 100,000.00 Equipment purchased 200,000.00 Total 27635,000.00_ Sales returns (total return ~ P 80,000) 30,000.00 Withdrawals 200,000.00 Total 249,000.00) ‘Additional information: 1. Sales discounts granted to customers, P 20,000. 2. Uncollectible accounts written off, P 5,000. 3. Purchase discounts on accounts payable paid, P 22,000. Required: a. Determine the Profit or Loss for the year ending December 31 20CY b. Compute the total Sales. ©. Compute the total purchases. d. Compute the insurance expense. e. Compute the interest income. Compute the depreciation on equipment . Prepare the Statement of Profit or Loss for the year ended December 31, 20cy. 3.6 The following information is made available on December 31of the current year: Balance perbank -P'110,820 Balance per book == P'113,240 Outstanding checks 13,650 Deposit in transit 10,920 Bank collection 1,200 Bank service charge 1,850 A deposit of P 2,000 was erroneously recorded as P 200 by the bank. ‘A-check issued for P 3,000 was erroneously recorded as P 300 in the books. Required: Bank Reconciliation Statement. ‘Synergy in Global Education! www.certscollege.org196 a7 38 Constructive Accounting Module 3 ‘The following data represent the summarized transactions of ABC Trading (owned by Adeline Cruz for the year 20CY, its second year of operations: Cash sales P 375,000.00 Collections from customers 2,250,000.00 Sales returns & discounts “40,000.00, Cash purchases 225,000.00 Payment to creditors, 1,380,000.00 Purchase returns & discounts 30,000.00 ‘Accounts receivable writen off 7,800.00 Rental collections Salaries and wages paid ‘Advertising expense paid (Other operating expenses paid Interest received Equipment purchased on Jan. Interest paid 150,000.00 150,000.00 75,000.00 180,000.00 30,000.00 300,000.00 0,000.00 At the beginning of its first year, (20PY) equipment costing P100,000 was acquired with a 10-year useful life Notes & Ale receivable, 12/31/CY 200,000.00 Notes & Alc receivable, 12/81/PY 207,500.00 Accrued salaries payable 440,000.00 Prepaid advertising 1,350,000.00 Accrued interest receivable ‘30,000.00 Uneamed rent income 7,500.00 Additional information at December 31 20CY ‘At December 31, 20PY, Equipment account had a beginning balance of P 100,000. Notes & Alc payable, 12/31,CY Notes & A/c payable, 12/31,PY ‘Accrued interest payable Inventory, 12/31/CY Inventory, 12/3PY ‘Acquisition for 20CY was made at the start of the year. Required: 1 ‘Compute the following under Cash and Accrual basis of accounting: Gross and net sales Gross and net purchases Interest Income Rent Income Interest expense Salaries & Wages Advertising expense Depreciation expense 270,000.00 450,000.00 30,000.00 300,000.00 ‘50,000.00 2. Statement of Profit or Loss for the year ended December 31, 20CY under Cash basis of accounting 3. Convert the Cash basis Statement of Profit or Loss into Accrual basis of accounting 4, Adjusting entries necessary to convert the cash into accrual basis. Zulu Enterprises began operations on January 1, 20PY, During the two-year period ended December 31, 20CY the cash basis of accounting has been employed. The trial balance prepared from these records on December 31, 20CY appeared as follows: wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting Cash P 750,000.00 P Sales 2,500,000.00 Purchases 1,200,000.00 Operating expenses "750,000.00 Land 400,000.00 Building 800,000.00 Equipment 200,000.00 Bank —_Loan-Long term 500,000.00 Jose Zulu, Capital (00,000.00 The following data were gathered from the records: a. Accounts receivable December 31, 20PY 150,000 December 31, 20CY 250,000 . Included in sales of 20PY was a 30,000 deposit by @ customer for merchandise to be delivered in 20CY. ©. Accounts payable: December 31, 20PY 140,000 December 31, 20CY 175,000 d. Included in purchases of 20PY was 50,000 cash advance to supplier for merchandise to be delivered in 20CY. fe. Accrued expenses: December 31, 20PY 140,000, December 31, 20CY 175,000 {Merchandise Inventory: December 31, 20PY 350,000 December 31, 20CY 420,000 9. Building and equipment were acquired on January 1, 20PY. Building has an estimated useful life of 10 years and equipment 5 years. h. It was determined that accounts receivable as of December 31, 20CY has 95% collectibility and the remainder is uncollectible. i. Bank loan was made on July 1, 20CY with the interest rate of 12% per annum payable semi-annually on July 1 and January 1. the loan is for § years. Required: 1 2 ‘Synergy in Global Education! ‘Compute the Statement of Profit or Loss accounts that will be converted from cash to accrual basis. Prepare the adjusting entries on December 31, 20CY. 197 wuw.certscollege.org198 3 4 Constructive Accounting Module 3 Statement of Profit or Loss for the year ended December 31, 20CY\ under. accrual basis ‘Statement of Financial Position as of December 31, 20CY 3.9 The following errors were made in 20PY by the accountant of Mabuhay Trading: a wnaw.certscollege.org ‘The ending inventory is understated as a result of an error in the physical count of goods on hand by 5,500. ‘The ending inventory is overstated as a result of an error including in the physical count goods received on consignment by 8, 000. ‘A purchase of merchandise for 10, 000 at the end of 20PY is not recorded until payment is made for the goods in 20CY. The goods purchased were included in the ending inventory of 20PY. A:sale of merchandise in 20PY for P15, 000 is not recorded until cash is received for the goods in 20 CY. The goods sold with a cost of 12, 000 ‘were excluded from ending inventory of 20PY. Goods shipped to consignees in 20PY were reported as sales of P12, 000. Goods in the hands of the consignees at the end of 20PY were not, recognized for inventory purposes. Sale of such goods in 2OCY and collection as such sales were recorded as credits to the receivables established with consignees in 20PY. Accrued interest receivable was not recognized and recorded at the end of 20PY amounting to P3, 000, Prepaid insurance of P2, 500 was not recognized and recorded at the end of 20PY, Unpaid sales salaries of P 6, 000 were omitted at the end of 20PY, Uneamed rent of P5, 000 was not recorded at the end of 20PY. ‘The total of one week's sales of P25, 000 during 20PY was not recorded. No depreciation statement in 20PY and 20CY for equipment costing 200, 000 acquired on June 30PY. The equipment has a useful life of 10 years, ‘A customer notes receivables of 30, 000 was debited to accounts receivable ‘Synergy in Global Education!Module 3 Constructive Accounting 199 REQUIRED: Analyze the effects of the above errors using the format below: Statement of Profit or Loss ‘Statement of Financial Position 20PY Income 20CY Income 20PY Cap/RE 20CY CapJRE 3.10 Rambo Trading owned by John Rambo reported profit as follows: 20PY ~ 250,000; 20CY — 300,000. It is assumed that year-end adjustments for 20CY were properly made except for errors and misstatements for 20P. The audit and review of the records of Rambo Trading disclosed the following errors made in the year 20Y: 1. Inventory at the year-end was overstated Pp 30, 000 2. Sales on account was recorded in 20CY 12, 500 3, Purchases on account was recorded in 20CY 10, 000 4. Year-end accrued advertising was not recorded 3,000 5. Year-end prepaid insurance was not recorded 4,000 6. Year-end uneamed rent income was omitted 3, 500 7. Year-end accrued interest income was omitted 2, 500 8. Year-end unused office supplies was unrecorded 2,000 9. Year-end depreciation of equipment was omitted 5,000 10. Year-end provision for bad debts was not taken up 1,750 Required: a. Prepare an analysis showing the corrected profit for 20PY and 20C: b. Prepare the correcting entries at year-end f 20CY assuming 1. Books have not been closed 2. Books have been closed 3.11 The following errors were discovered in the accounting records of Paul and Phil Partnership on January 5, 20SY. Accrued Accrued Interest Ending Ret Income Income Inventories Depreciation Not Not Year of Error Overstated __Understated__Recorded __ Recorded 20PY 10,000 33,000 20cy 36,000 4,000 ‘The partners share profit and losses as follows: Paul -40%; Phil - 60%, ‘Synergy in Global Education! www.certscollege.org200 Constructive Accounting Required: 1 Module 3 Prepare correcting journal entries on January 5, 20SY, assuming that the books were closed for 20CY. 2. Prepare the correcting journal entries on January 5, 20SY, assuming that the books were still open for 20CY. + SY~ Subsequent year. 3.12 CAMEO Company's Comparative Statement of Financial Position at December 31 wnaw.certscollege.org are shown below: 2ocy Assets Cash Pp 90,000 P. ‘Accounts receivable, net 425,000 Inventory 310,000 Total current assets 825,000 Plant and equipment 3,770,000, ‘Accumulated Depreciation (960,000 Total assets 3,635,000 Equities Accounts payable 110,000 Accrued expenses 225,000 Total current liablities "335,000 Long-term debt 00,000 Total liabilities 835,000 Ordinary Share, no per value 2,000,000 Retained earnings ‘200,000 Total equities 535,000 Cam Company, Statement of Profit or Loss for 20CY 20CY Sales P 4,325,000 P Cost of goods sold 2.412.000, Gross Margin Operating expenses: Depreciation 210,000 Other 1,087,000 Total Income before interest and taxes Interest expense Income before taxes Income taxes at 20% Profit Dividends on Ordinary Share P zoey 100,000 415,000 280,000 795,000 3,325,000 (750,000, 3,370,000 95,000 220,000, 315,000, 475,000 790,000 2,000,000 $580,000, 3,370,000 1,912,500 4,277,500 ‘635,000 35,000 00,000 180,000, "420,000 200,000 ‘Synergy in Global Education!Module 3 Constructive Accounting 201 Cam had 10, 000 shares of Ordinary Share outstanding throughout the year. The market price of the Ordinary Share at year-end was P65 per share. All sales are on credit REQURIED: Compute the following financial ratios as of the end of 20CY 1 Current ratio. 10 Return on equity 2 Quick ratio 11 Eamings per share 3 Accounts receivable turnover 12 Price-eamings ratio 4 Days’ sales in accounts receivable 13 Dividend per share 5 Inventory turnover 14 Dividend yield 6 Days’ sales in inventory 15 Payout ratio 7 Gross profit ratio 16 Debt ratio 8 Return on sales 17 Times interest eamed 9 Return on assets 3.13. The Statement of Financial Position, Statement of Profit or Loss, and other related information of the Brief Company are shown below: BRIEF COMPANY. STATEMENT OF FINANCIAL POSITION December 31, 20CY ASSETS. Cash P 106,000 Accounts Receivable 566,000 Inventories 320,000 Plant and Equipment, net 740,000 Patents 26,000 Other Tangible Assets 34.000 Total Assets P EQUITIES ‘Accounts Payable P 170,000 Income Tax Payable 32,000 Miscellaneous Accrued Payables 38,000 Bonds Payable (4% due-2018) 300,000 Preference Share 7% (P100 par-Cumulative Non-participating and callable at 110) 200,000 Ordinary Share (no par, 20,000 shares Authorized, issued and outstanding) 400,000 Retained Earnings 720,000 Treasury Stock, 800 shares of Preference Share (68,000) Total Equities Pp ‘Synergy in Global Education! www.certscollege.org202 Constructive Accounting Module 3 BRIEF COMPANY STATEMENT OF PROFIT OR LOSS For The Year Ended, December 31, 200Y Net Sales P 1,500,000 Cost of Goods Sold ‘900,000 Gross Margin on Sales 600,000 (Operating Expenses (including bond interest expense) 498,000 Income Before Tax 102,000, Income Taxes 37,000 Proft P. 5,000 ‘Additional Information: There were no preferred dividends in arrears and the balances in the accounts receivable and inventory accounts remained unchanged from January 1, 20CY and there were no changes in the bonds payable, Preference Share and Ordinary Share accounts during 20CY. REQUIRED: Compute the financial ratios for the year 20CY: ‘Current ratio Number of times bond interest was earned Average number of days’ sales in inventories (360 days) Book value per share of Ordinary Share Rate of return on common SHAREHOLDERS’ equity Debt equity ratio 3.14 Shown below are the financial statements of LEE Van Trading: New Trends Corporation New Trends Corporation INCOME “AND RETAINED EARNINGS ‘STATEMENT OF FINANCIAL POSITION ‘STATEMENT December 31, 20PY and 20CY For The Year Ended, December 31,20CY ASSETS 20PY 20cY Net Sales P _4,000,000 Current Assets: Cost of Goods Sold Cash P 75,000 P 85,000 Inventory, Dec. 31, 20PY 250,000 Marketable securities 25,000, 25,000, Purchases 720,000 Trade receivables, net 185,000 245,000 Total Goods Available 970,000 Inventory, at cost 260,000 220,000 Inventory, Dee. 31, 20CY _220,000. Prepaid expenses 45,000 40,000 Total Cost of Sales "750,000 Total Current Assets 550,000) '585,000_ Gross Margin on Sales 250,000 Property and Other Assets: Selling and Adm. (including Equipment 340,000 320,000 Depreciation of P20,000) —_125,000 Other assets, 18,000, 46,000 ___Profitbefore Tex 725,000 Total 355,000, "535,000 Provision for income Tax 35,000 Total Assets P 7905.00 P 820,000 Profitfor the Year ‘80,000 Retained Earnings, Beginning _130,000 wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 203 LIABITIES AND SHAREHOLDERS’ EQUITY Total 220,000 Dividends Paid 30,000 Current Liabilities Retained Earnings, Trade Payables P 185,000 P 165,000 Dec, 31, 20cY P _190,000 Accrued Expenses 20,000 25,000 Other Current Liabilities 410,000 40,000 Total Current Liabilities 215,000 200,000 Long-term Liabilly Mortgage Payabie 120,000 420,000 Total Lisbilties 335,000 320,000 SHAREHOLDERS’ Equity Capital Stock, P100, par 300,000 300,000 ‘Additional paid-in Capital 30,000 30,000 R. Earnings-Appropriates 30,000 20,000, RE - Unappropriated 460,000, 190,000, Total SHAREHOLDERS’ Equity "570,000 600,000 Total Liabilties & S Equity — P “905,000 P 920.000 REQUIRED: Compute the following ratios and measurements for 20CY: ‘Amount of Working Capital ‘Amount of Net Monetary Assets Current Ratio Acid-test (Quick) ratio Cash flow from Operations to Current Liabilties Inventory Tumover Rate of Gross Profit on sales Book value per share of stock Ratio of profit to Net Sales Net eamings per share of stock Rate of return on invested capital Cash flow from Operational to Total Liabilities, Ratio of SHAREHOLDERS’ Equity o Total Liabilities grerrsenppege 3.15 The following data are made available to you by the management of CORVEAU Trading Credit sales P 420,000 Inventory turnover 7x. Current liabilities P 80,000 Current ratio 2t01 Quick ratio 1.25101 ‘Average collection period 36 days, Number of working days 360 REQUIRED: Compute the following} ‘Synergy in Global Education! www.certscollege.org204 Constructive Accounting Module 3 cash Accounts Receivable Inventory Total current assets P 3.16 The accountant of Comelius Trading, using HORIZONTAL ANALYSIS. for analyzing the Statement of Profit or Loss, came up with the following: 2014. 2015. Peso Change Percentage Change Sales P 100000 P 1) P 2) 20% Cost of sales 2) 63,000 3,000 4) GrossProft. P 5) P 6 P 7) 8) Expenses 30,000 9X 10) “1 Net Profit bom -& 2 2 14 50% REQUIRED: Compute the missing amounts. (1-14) 3.17. Shown below is the condensed Statement of Profit or Loss of Arevalo Trading: Sales P 4) 2)% Sales Return 3 40) Net Sales Pay 5) Cost of sales 8 70% Gross Proft, P 7) 8) Expenses 9 40) Net profit F-35000 75% REQUIRED: Compute the missing amounts. (1-10) 3.18 C Vibes Company has a quick ratio of 1.25:1. The net monetary assets are P 15,625. Inventories are P 171,875. There are no prepaid expenses. REQUIRED: How much are the current liabilities? How much are the quick assets? How much are the current assets? How much is the net working capital? What is the current ratio? wnaw.certscollege.org ‘Synergy in Global Education!Module 3 Constructive Accounting 3.19 The following data are made available by ANN Company: Beginning Accounts Receivable P 900,000 Inventory 4,100,000 Receivable tumover 5x Inventory turnover 4x Expenses P 80,000 Accounts payable turnover 6x. REQUIRED: ‘a. What is the profit? b. What is the cash cycle? 205 Ending 1,000,000 1,200,000 3.20 The following information is made available by DIOSA Company: Yield on Ordinary Share Income taxes 8% Bonds payable 12% Cumulative Preference Share Ordinary Share, par P10 Earnings after taxes Market price per share of Ordinary Share REQUIRED: a. What is the dividend payout ratio? b. What is the eamings-price ratio? c. What is the times interest earned ratio? ‘Synergy in Global Education! 19.44% 40% P 100,000 100,000 50,000 55,200 20 wuw.certscollege.org206 Constructive Accounting Module 3 (This page is intentionally left blank.) wnaw.certscollege.org ‘Synergy in Global Education!