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ACTBAS2 (Term 3, AY 2010-2011) Special Journals (Optional Journals) They are used to record transactions of similar nature, which

hich frequently occur. They cannot replace the general journal. Special journals are optional in nature. The form (e.g. number of columns) of a special journal could vary depending on the firms need and nature of transaction. Advantages of Special Journals 1. 2. 3. Division of Labor A firm may have a bookkeeper to handle the recording in each special journal in order increase efficiency in the recording process. Economy in the use of space in the journal A transaction is posted in one line and does not require an explanation. Minimized posting to the general ledger Accounts with special columns are posted in totals only once at the end of the period normally a month in order to avoid extensive delay if the posting is to be postponed for a period longer than a month. 4. Data are readily available on specific accounts. For example, total sales for the period can easily be obtained from the specific special journals. Verification from the general journal will take some time. 4 Common Special Journals 1. 2. 3. 4. Sales Journal Purchases Journal Cash Receipts Journal Cash Payments Journal Used on sale of merchandise purely on account. If a note is received as temporary settlement, whether partial or full, the transaction is recorded first in the sales journal for the whole amount. Another entry is then made in the general journal crediting the Accounts
Additional Information:

Sales Journal

Receivable and debiting Notes Receivable for the amount of the note.
Purchases Journal Used to record purchase of merchandise purely on account. If the firm as temporary settlement issues a note, whether partial or full, the transaction is recorded first in the purchases journal for the whole amount. Another entry is made in the general journal debiting Accounts Payable and crediting Notes Payable for the amount of the note. Cash Receipts Journal Used to record all cash receipts for the period regardless of the source Any entry that debits the Cash account is recorded in this special journal.

Cash Payments Journal Used to record all cash payments regardless of purpose Any entry that credits the Cash account Along with the Cash Payments Journal, a Petty Cash Book is also used to record all small or petty cash disbursements through the issuance of petty cash vouchers. Unlike the journals, a petty cash book is not a book of original entry but rather a memorandum book only. Adjusting Entries General Characteristics Adjusting entries always involve one nominal account and one real account. It would be invalid and illogical if two real accounts or two nominal accounts are involved. Adjusting journal entries are prepared at the end of the accounting period to update the ledger not to correct the ledger. Adjusting entries are necessary every time financial statements are prepared. Three accounting principles govern and support the preparation of adjusting entries: Accrual assumption, Revenue recognition, and Matching (Expense Recognition). All adjusting entries are classified as an internal transaction. Adjusting entries are always prepared at the end of the accounting period. Accrual Type It records revenue when already earned even if not collected, and expense when already incurred when not even paid. Deferral Type Actual amount of income and expense is determined at the end of the period based on a previously recorded pre-payment or pre-collection. Accrual Type Adjusting Entry Special Characteristics Accrual types always increases an income statement account and a balance sheet account. The amount of an accrual type adjusting entry covers a maximum period of one year. It does not relate to a previously recorded entry. Accrued Income Income already earned but not yet collected nor recorded. The pro-forma journal entry to record accrued income is as follows: RECEIVABLE account INCOME account Two kinds of Accrual Type Adjusting Entries
Additional Information:

Types of Adjusting Entries

Accrued Expense Expense already incurred but not yet paid for. The pro-forma journal entry to record accrued expense is as follows: EXPENSE account PAYABLE account

Notes to Accrual-type Adjusting Entries 1. 2. 3. 4. 5. An asset-income relationship exists in accrual of income. An expense-liability relationship exists in accrual of expense. Accrual of income increases assets, revenues, net income, and owners equity. It does not affect liabilities and expense. Accrual of expense increases expenses and liabilities but decreases net income and owners equity. It does not affect assets and revenues. Failure to prepare Adjusting Journal Entries for accrued income would understate assets, revenues, net income, and owners equity. It does not affect expenses and liabilities. 6. Failure to prepare Adjusting Journal Entries for accrued expense would understate liabilities and expense, and overstate net income and owners equity. It does not affect assets or revenues. Rules affecting accrual of interest 1. 2. 3. Know your cut-off date Accrue interest only on un-matured notes Accrue interest for a maximum of one year
Additional Information: 1. Always remember to distinguish trade receivables and payables from non-trade receivables and payables. {e.g. Accounts Payable vs. Utilities Payable} 2. Always maintain awareness on the year of the recording of an adjusting entry especially when it is a leap year or a calendar year. 3. There is a significant difference in the phrases accrual of income and accrual-type adjusting entries in a sense that the former always increases net income and the latter may but not always will increase net income.

Deferral-type Adjusting Entries Special Characteristics Deferral-type adjusting entries always increase a nominal account with a corresponding equal decrease in a real account while a decrease in a nominal account is paired with a corresponding equal increase in a real account. There is an inverse relationship between the nominal and real account. The amount of adjusting entry for the unexpired or unearned portion may cover a year exceeding one year. This characteristic is only applicable to the real account portion. The nominal account portion must be an amount covered by one year or most. 1. A prior or original entry is necessary to record a deferral-type adjusting entry. Prepaid Expense (pre-payment) expense already paid but not yet incurred. 2. 1. Debited either to an asset account or expense account It is a mixed account because at the end of the period before adjusting, it is partly asset and partly expense. Other names include Deferred Charge, and Deferred Debit. Credited to either liability or income account It is a mixed account because at the end of the period before adjusting, it is partly income and partly liability. Other names include Deferred Credit, Pre-collected Income. Two Methods of Recording Prepayments Asset Method Other names are Statement of Financial Position method, Real Account Unearned Income (pre-collection) income already collected but not yet earned. Two Kinds of Deferral
Additional Information: Commission any amount over/above the salary of an employee. The purpose of a deferral-type adjusting entry is to split mixed accounts into their components with the proper amounts. Accrual-types do not involve mixed accounts. Permanent account balances are carried over to the succeeding period. The point at which an expense is computed is on the effective month/date not on the point of transaction.

method, and Permanent Account method.


Initial Entry: Asset account Cash account adjusting entry. Adjusting Entry: Expense account Asset account

* The expired or expense portion is the computed and recorded amount of the

2.

Expense Method Other names are Income Statement method, Nominal Account method, and Temporary Account

method.
Initial Entry: Expense account Cash account adjusting entry. Two Methods of Recording Pre-collections 1. Liability Method Other names are Statement of Financial Position method, Real Account Adjusting Entry: Asset account Expense account
Additional Information: The expense method is also known as the alternative method, since the asset method is most common. If the deferral covers a period that does not exceed the period of the cutoff date, it is more convenience to be recorded under the nominal account method because an adjusting entry is not necessary. If an asset expires even if expiration is long before the cut-off date but is covered within the period, an adjusting journal entry must be prepared since adjust entries can only be prepared at the end of the period. Depreciation, being the expensed portion of the fixed assets for the current account period, is calculated at an amount that, at most, covers one accounting period. Net book value is the carrying amount. Fractional depreciation is a form of depreciation with an amount always less than the annual depreciation expense. Fractional depreciation is normally encountered at the year of acquisition if the day of acquisition is after the start of the accounting period or the year the asset is fully depreciated only if it fully depreciates before the end of the accounting period. Accumulated Depreciation is a series of depreciation expenses since the year of acquisition.

* The unexpired portion is computed and recorded as the amount of the

method, and Permanent Account method.


Initial Entry: Cash account Liability account adjusting entry. 2. Income Method Other names are Income Statement method, Nominal Account method, and Temporary Account method. Initial Entry: Cash account Income account the adjusting entry. Depreciation Definition of Terms 1. 2. Depreciation the systematic and rational allocation of the depreciable cost of fixed assets over its estimated useful life. Accumulated Depreciation the total depreciable cost of the fixed assets that has been charged to expense from its date of acquisition to the current accounting period. 3. 4. Depreciable Cost the portion of original cost that is subject to depreciation. The amount is obtained by deducting the residual value from the original cost. Residual Value the remaining cost of the fixed asset at the end of its estimated useful life. It is also the estimated amount at which a fixed asset can be sold at the end of its estimated useful life. Other names are salvage value and scrap Adjusting Entry: Income account Liability account Adjusting Entry: Liability account Income account

* The earned or income portion is computed and recorded as the amount of the

* The unearned or liability portion is computed and recorded as the amount of

value.
5. Carrying Amount the difference between the acquisition cost of the fixed asset and its accumulated depreciation

6.

Fractional Depreciation (a.k.a. fraction-of-a-year) amount of depreciation that is less than one year. This is normally recorded in the year when the fixed asset is acquired after the start of an accounting period or in the year the fixed asset becomes fully depreciated.

7.

Straight-line Method the simplest and the most widely used method of computing the depreciation expense of fixed assets. The formula for the Straight-line Method is
!"#$%&%'%() !"#$!!"#$"%& !"#$% !"#$%&#'( !"#$%& !"#$

Three Stages in Life of Fixed Asset 1. 2. 3. Brand New Inadequacy a condition when a fixed asset is unable to cope with the expanded volume of operations Obsolescence a condition wherein a fixed asset is rendered worthless due to the introduction of a new and superior brand or model of similar asset, or due to advances in technology. Pro-forma Entry Depreciation Accumulated Depreciation Doubtful Accounts Background All businesses face risks. One prevalent risk would be the inability to collect accounts. Risks should be mitigated. A portion of receivables should be anticipated to be uncollectible at the end of accounting period in support of the Conservatism concept. However, the Prudence concept does not give provisions for the deliberate understatement of net income. Definition of Terms 1. Doubtful Accounts an expense account representing receivable accounts that, for some reasons, have become doubtful of collection or worthless as of a given balance sheet date. The practice of maintaining this account is supported by the Conservatism/Prudence principle. 2. Allowance for Doubtful Accounts the contra-account of Accounts Receivable representing the accumulated amount that has been provided for anticipating losses on uncollectible accounts from the time the firm started its operations up to its current accounting period. Methods of Recording Doubtful Accounts 1. Allowance Method an estimated percentage of Accounts Receivable based on company experience is recognized as a loss or uncollectible at the end of the accounting period through an adjusting entry. Doubtful Accounts Allowance for Doubtful Accounts
Additional Information: It is better to sell fixed assets in order to avoid repair cost. Maintaining a salvage value for fixed assets is not required by accounting standards. It depends on the policy of the company. Estimates on salvage value, estimated useful life, and acquisition cost must be objective. Always remember the year of computing depreciation. The scrap value is always the carrying value of the fixed asset at the end of its estimated useful life. Formula for converting estimated useful life to annual depreciation rate and vice versa: !"# = !"# = 1 !"# 1 !"#

Old names of Doubtful Accounts: Bad Debts and Uncollectible Accounts The Allowance Method is supported by Generally Accepted Accounting Principles. Preparation of adjusting journal entries is ALWAYS at the end of the year. Anticipation of losses is made at the end of the year if provisions are made for the purpose of the Allowance Method.

2.

Direct Write-off Method Specific accounts are written-off only when determined to be uncollectible. NO PROVISION for doubtful accounts is made at the end of the accounting period. This method of dealing with doubtful accounts is considered inappropriate by accounting standards. Doubtful Accounts Accounts Receivable

Method of Estimating Doubtful Accounts Percentage-of-Receivables Approach It gives a reasonably accurate estimate of the realizable value of receivables, but does not fit the matching of costs and revenues. It normally takes into account the previous balance of the valuation account, Allowance for Doubtful Accounts. It falls under the Allowance Method of recording doubtful accounts. Formula for Computing Doubtful Accounts Accounts Receivable, end Multiplied By: Estimated Loss Rate Required Allowance Less/Add: Previous Allowance (if any) Doubtful Accounts Write-off of Accounts (Allowance Method) It does not affect net income because no loss or expense is recorded. It does not affect total asset since the amount to be written-off on both accounts will just offset each other. Allowance for Doubtful Accounts Accounts Receivable Recovery of Written-off Accounts The entry recording the recovery on written-off accounts antedates the usual annual adjusting entry for doubtful accounts. Cash Doubtful Accounts Formula to Update Accounts Receivable Balance Accounts Receivable, beg. Add: Sales on Account Correction of Errors Sub-total
Additional Information: Basis of computing the Doubtful Accounts is the Accounts Receivable balance at the end of the period. This basis gives rise to it being called the Statement of Financial Position Method or Real Account Method. The Required Allowance is the amount presented in the notes to the Statement of Financial Position. It is never possible for the beginning balance of the Allowance for Doubtful Accounts to be a debit balance. It is possible for the Allowance for Doubtful Accounts to have a temporary debit balance within the accounting period before adjusting entries. Always remember to check the date involve in doubtful accounts especially the beginning balance and ending balance of the respective period. One duty of adjusting entry is to return accounts back to their normal balances. Accounts affecting the Accounts Receivable balance are the following: (1) Sales Discount (always decreasing the accounts receivable balance) (2) Sales Returns and Allowances (only on charge sales) (3) Freight (FOB Destination, collect and FOB Shipping, prepaid; decrease and increase respectively) (4) Sales (made on account whether merchandising or non-merchandising transaction)

Sub-total Less: Collection of accounts Written-off accounts Sales Returns and Allowances Sales Discount Correction of Errors Accounts Receivable, end Formula to Update Allowance for Doubtful Accounts balance Allowance for Doubtful Accounts, beg. Less: Written-off Accounts Allowance for Doubtful Accounts, end. Notes
Additional Information: Allowance for Doubtful Accounts and Accounts Receivable balances are only updated if the ending balance for the end of the current accounting period is unavailable. Aging of Accounts is the most widely use and effective method of estimating doubtful accounts. The aging-of-receivables method is under the percentage-of-receivables method and is also known as the real account, balance sheet, and permanent account method. Estimated loss rate may be applied on accounts not yet due with respect to the possibility of not collecting due to unforeseen circumstances. Credit period is always the indicator of the age of the account. 2 1 ! 10 15 !" Amount of doubtful accounts should be rounded off to the nearest peso since the amounts are just estimates.

Valuation account always refers to the Allowance for Doubtful Accounts


Basis of computing Doubtful Accounts is always the corrected or updated ending balance of Accounts Receivable. Previous balance of valuation account is normally considered. The information on Written-off accounts is taken into account only if the Accounts Receivable and Allowance for Doubtful Accounts balances are given as of the start of the accounting period or as of the end of the previous accounting periods.

Increased by means that the previous balance of the valuation account should be
disregarded in the computation of Doubtful Accounts.

Increased to indicate the significance of the previous balance of the valuation


account in the computation of Doubtful Accounts.

Aging of Accounts Receivable A process of estimating loss on accounts whereby outstanding customer accounts are grouped according to maturity date and each group is assigned a specific loss rate. This is the most widely used method of estimating doubtful accounts.