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Topic 3 the
Topic 3
the

Completing

Accounting

Cycle

LEARNING OUTCOMES By the end of this topic, you should be able to: 1. Describe
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Describe the types of adjusting entries;
2. Prepare the Adjusted Trial Balance;
3. Prepare the financial statements consist of income statement,
statement of changes in owner’s equity, balance sheet statement and
cash flow statement;
4. Prepare the closing entries; and
5. Prepare the reversing entries.

INTRODUCTION

This topic is the continuation of Topic 2, where you have come across the unadjusted trial balance. This topic will also discuss the preparation of adjusting entries for the purpose of preparing the adjusted trial balance. The adjusted trial balance is prepared after the adjusting entries have been recorded and transferred.

The four main components of financial statements, comprising the income statement, statement of changes in owner’s equity, balance sheet and cash flow statement; are prepared based on the information from the adjusted trial balance. The preparation of cash flow statement also requires all information related to cash that can be found in the records.

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At the end of Topic 3, you will be exposed to closing and reversal entries to complete the accounting cycle.

3.1

ADJUSTING ENTRIES

You might be wondering why adjusting entries need to be discussed before completing the accounting cycle. The answer becomes clearer once you know what adjusting entries are.

Adjusting entries are additional accounting information recorded at the end of the accounting period to
Adjusting entries are additional accounting information recorded at the end of the accounting period to
Adjusting entries are additional accounting information recorded at the end of the accounting period to
Adjusting entries are additional accounting information recorded at the end of the accounting period to

Adjusting entries are additional accounting information recorded at the end of the accounting period to accurately match revenues with expenses.

additional accounting information recorded at the end of the accounting period to accurately match revenues with

It is the main element in accrual-basis accounting. The accrual basis refers to revenues or expenses which are recognised in the current period irrespective of whether cash has been received. It is different from cash basis accounting, where revenues or expenses are only recognised when they involve cash receipts or payments.

Adjusting entries will affect at least one income statement account (revenue or expense) and one balance sheet account (asset or liability). After the adjustments, the accounts in the trial balance will show the updated balances, which will then be used to prepare the financial statements.

Prepaids and accruals are the basis for making adjusting entries. Prepaid refer to cash received or paid before revenues or expenses are recorded, while accruals are revenues or expenses which are recorded before cash is received or paid.

Adjusting entries are divided into 5:

(a)

prepaid expenses;

(b)

depreciation expenses;

(c)

unearned revenue;

(d)

accrued expenses; and

(e)

accrued revenue.

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3.1.1 Prepaid Expenses

Prepaid expenses refer to all expenses that have been paid in advance by cash but
Prepaid expenses refer to all expenses that have been paid in advance by cash but
Prepaid expenses refer to all expenses that have been paid in advance by cash but
Prepaid expenses refer to all expenses that have been paid in advance by cash but
Prepaid expenses refer to all expenses that have been paid in advance by cash but

Prepaid expenses refer to all expenses that have been paid in advance by cash but the benefit from the expenses has not been received or obtained.

all expenses that have been paid in advance by cash but the benefit from the expenses
all expenses that have been paid in advance by cash but the benefit from the expenses

It is an asset to the business and will be written off after it has been used or when it expires. Adjusting entries must be made at the end of the accounting period to recognise assets that have been written off as expenses.

Examples of prepaid expenses are prepaid rental and prepaid insurance.

Example 3.1

On 1 April 2006, Encik Zaini rented a house and paid a total of RM900 for the first 3 months. The landlord had set the rental at RM300 per month. The journal entries are as follows:

1 April 2006

Dr. Rental Prepaymewnt Cr. Cash

RM900

RM900

When the entry is transferred to ledger, the accounts involved will be:

Rental Prepayment Account

 

RM

April 1 2006

900

Cash Account

 

RM

April 1 2006

900

The trial balance on 30 April 2006 before adjustment shows the rental prepayment account with a normal debit balance of RM900. This amount is incorrect if used for the purpose of preparing the financial statement.

Therefore, an adjusting entry is needed to update and match the expenses accurately so that the correct total is reported in the financial statements.

The adjusting entry is as follows:

30 April 2006

Dr. Rental expenses Cr. Rental prepayment

RM300*

RM300

Rental paid for 3 months is RM900, which is rental prepayment.

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*One third of the total rental prepayment for a period of one month (April) is:

1/3 x 900 = 300

When the adjusting entry is transferred to ledger, it would involve one account from the income statement (rental expenses account) and one account from the balance sheet (rental prepayment account).

account from the balance sheet (rental prepayment account). Figure 3.1 : Process of transferring adjusting entries

Figure 3.1: Process of transferring adjusting entries to ledger

The adjusting entries that had been transferred to ledger are as follows:

Rental Prepayment Expenses

April 1

2006

Balance

RM

900

600

April 30

2006

RM

300

Rental Expenses Account

April 30

2006

RM

300

The adjusting entries had recognised the rental expenses for a period of one month in April, which is RM300. The rental prepayment account had been credited by RM300, causing the balance in the account to decrease by RM300. Therefore, the rental prepayment account has been updated from RM900 to

RM600.

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3.1.2 Depreciation Expenses

Depreciation expenses are provisions against the cost of fixed assets like plant, equipment and vehicle.
Depreciation expenses are provisions against the cost of fixed assets like plant, equipment and vehicle.
Depreciation expenses are provisions against the cost of fixed assets like plant, equipment and vehicle.
Depreciation expenses are provisions against the cost of fixed assets like plant, equipment and vehicle.

Depreciation expenses are provisions against the cost of fixed assets like plant, equipment and vehicle.

Depreciation expenses are provisions against the cost of fixed assets like plant, equipment and vehicle.

It is an expense throughout the lifespan of the asset. The concept used for asset and depreciation is the same as with prepaid expenses.

Cash paid by the business to acquire the asset is viewed as a prepaid expense. In other words, the cash is paid in advance before the asset is used. Adjusting entries must be recorded as the asset expires or when the asset has been used by the business. The entry is made at the end of the accounting period and acknowledges the usage of the asset as expenses.

Example 3.2

On 1 Jan 2007, Mazni Enterprise purchased a vehicle for office usage valued at RM60,000 by cash. This vehicle is estimated to have a lifespan of 10 years. The journal entries for this transaction are as follows:

1 Jan 2007

Dr.Vehicle

Cr. Cash

60,000

60,000

When the entry is transferred to ledger, the accounts involved will be:

Vehicle Account

 

RM

1

Jan 2007

60,000

Cash Account

 

RM

1 Jan 2007

60,000

An adjusting entry is required at the end of the accounting period to record the expenses for the use of the vehicle, which will be as follows:

31 December 2007

Dr.

Depreciation expenses

Cr. Accumulated Depreciation – Vehicle

6,000*

6,000

*The straight line method was used to calculate the depreciation expenses.

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Formula:

(Cost of Assest - Scrap Value) –––––––––––––––––––––––––– Useful Life

(RM 60,000 – 0/10 year) = RM 6,000 per year

The adjusting entry is then transferred to ledger and will involve one account from income statement (depreciation expenses account) and one account from balance sheet (accumulated depreciation of vehicle account, which is a contra account for asset).

Depreciation Expenses Account

 

RM

31

Dec

2007

6,000

Accumulated Depreciation Account

 

RM

31 Dec

2007

6,000

The debit entry of RM6,000 in the depreciation expenses account reflects the business’ use of the asset for the one year period, while the credit balance in the accumulated depreciation account for vehicle shows the total depreciation on the asset to date. The total accumulated depreciation will be deducted from the total asset to provide the book value or carrying value of the asset:

RM

Vehicle’s cost as at 1 Jan 2007 (-) Accumulated depreciation – vehicle Vehicle’s book value as at 31 December

60,000

(6,000)

54,000

3.1.3 Unearned Revenue (Unearned Income)

Unearned revenue refers to cash which is received in advance before goods or services has
Unearned revenue refers to cash which is received in advance before goods or services has
Unearned revenue refers to cash which is received in advance before goods or services has
Unearned revenue refers to cash which is received in advance before goods or services has

Unearned revenue refers to cash which is received in advance before goods or services has been provided.

Unearned revenue refers to cash which is received in advance before goods or services has been

This is an obligation or liability to the business entity. Cash received cannot be recognised as revenue for that period because the goods or services will only be provided at a future date.

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Example 3.3

On 1 December 2007, Ayu Beauty Company received RM800 cash from a customer. This payment was for services that the Company will provide on 1 January 2008. The journal entry is as follows:

1 December 2007

Dr. Cash Cr. Unearned revenue

800

800

When the entry is transferred to ledger, the accounts involved will be:

Cash Account

 

RM

1

Dec 2007

800

Unearned Revenue

 

RM

1 Dec 2007

800

On 31 December 2007, a liability of RM800 was created for Ayu Beauty Company because cash was received while the services had not yet been provided. The liability will cease to exist and the revenue can be recognised once the company had provided the services on 1 January 2008. The adjusting entry to recognise the revenue is as follows:

1 January 2008

Dr. Unearned revenue Cr. Service revenue

800

800

The adjusting entry is then transferred to ledger and will involve one account from income statement (service revenue account) and one account from balance sheet (unearned revenue account).

Unearned Revenue Account

 

RM

 

RM

1 Jan

2008

800

31 Dec

2007

800

Service Revenue Account

 
   

RM

1 Jan

2008

800

When unearned revenue account is debited, the business entity ceases to have the liability and the revenue is recognised as the services which is now being provided.

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3.1.4 Accrued Expenses

Accrued expenses refer to all expenses incurred but have not yet been paid or recorded
Accrued expenses refer to all expenses incurred but have not yet been paid or recorded
Accrued expenses refer to all expenses incurred but have not yet been paid or recorded
Accrued expenses refer to all expenses incurred but have not yet been paid or recorded

Accrued expenses refer to all expenses incurred but have not yet been paid or recorded because there was no cash outflow from the business entity.

all expenses incurred but have not yet been paid or recorded because there was no cash

Accrued expenses are a liability as an obligation exists that must be settled by the business. At the end of the accounting period, the business entity must record/ recognise all expenditure even though no cash outflow occurred. Examples of accrued expenses are salary payable, rental payable, interest payable and tax payable.

Example 3.4

Haruman Company has not paid its staff salary for the month of December 2006 totalling RM4,500 due to financial problems. However, the company promised to pay the salary in January 2007. On 31 December 2006 the adjusting entry will be as follows:

31 December 2000

Dr. Salary Expenses Cr. Salary Payable

4,500

4,500

The adjusting entry is then transferred to ledger and will involve one account from income statement (salary expenses account) and one account from balance sheet (salary payable/ salary accrued account).

Salary Expenses Account

31 Dec 2006

RM

4,500

Salary Payable Account

 
   

RM

31 Dec 2006

4,500

This adjusting entry will recognise the salary expenses for the period even though cash outflow from the business has not occurred while the salary payable/salary accrued is a liability to the business entity at that date.

3.1.5 Accrued Revenue

Accrued revenue refer to the revenue that had been obtained but there is no cash
Accrued revenue refer to the revenue that had been obtained but there is no cash
Accrued revenue refer to the revenue that had been obtained but there is no cash
Accrued revenue refer to the revenue that had been obtained but there is no cash

Accrued revenue refer to the revenue that had been obtained but there is no cash inflow into the business entity.

Accrued revenue refer to the revenue that had been obtained but there is no cash inflow

This happens when the goods or services were provided to the customer but the customer has not paid for it yet.

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Accrued revenue is an asset as the benefit in the form of cash will be obtained by the business entity in the future. Examples of accrued revenue are rental revenue receivable, service revenue receivable and interest receivable.

Example 3.5

Geelang Company rented out a section of its building at the monthly rate of RM1,200 which must be paid at the end of the month. However, the tenant failed to pay the rental for the month of December 2008 but promised to settle the rental in the month of January 2009. The adjusting entry required for Geelang Company would be:

31 December 2008

Dr. Rental receivable Cr. Rental revenue

1,200

1,200

The adjusting entry is then transferred to ledger and will involve one account from income statement (rental revenue account) and one account from balance sheet (rental receivable or rental revenue accrued account).

Rental Receivable Account

 

RM

31 Dec

2008

1,200

Rental Revenue Account

 

RM

31 Dec

2008

1,200

At the end of the accounting period, revenue that has been recorded or recognised totalled RM1,200 even though there is no cash inflow while asset increased by RM1,200 when rental receivable was debited.

If there is no adjustment, the account balances presented in the financial statements will not comply with the principle of revenue recognition and principle of matching. Therefore the financial statements published were presented without complying with the GAAP (Generally Accepted Accounting Principles).

All the adjustments made to the account balances in the trial balance will produce the Adjusted Trial Balance. The Adjusted Trial Balance will be used as the basis in the preparation of the financial statements. The Adjusted Trial Balance will be discussed next. To ensure that you understand what you have learned, answer the following questions:

TOPIC 3 COMPLETING THE ACCOUNTING CYCLE 93 EXERCISE 3.1 Explain the meaning for each of
TOPIC 3
COMPLETING THE ACCOUNTING CYCLE
93
EXERCISE 3.1
Explain the meaning for each of the following:
(a)
Accrued Revenue
(b)
Accrued Expenses
(c)
Prepaid Expenses
(d)
Unearned Revenue

3.2

PREPARATION OF ADJUSTED TRIAL BALANCE

This section will expose you to the process of preparing the Adjusted Trial Balance. The Adjusted Trial Balance is a trial balance which is prepared after taking into account all the adjusting entries that have been journalised and transferred. The Adjusted Trial Balance will also show the balance of all the accounts irrespective of whether they were involved in the adjustment. The accounts involved in the adjustment will show the updated or adjusted balance.

The purpose of preparing the Adjusted Trial Balance is to show the effect of all financial events that had occurred in the accounting period. The Adjusted Trial Balance is to verify that the total debit and total credit are equal for all the accounts in the ledger after the adjustments.

You must refer to the information in the Unadjusted Trial Balance for Reen Cyber Service in Topic 2 (Figure 2.7: Trial Balance) for the preparation of this Adjusted Trial Balance. For students’ reading convenience, the unadjusted balance had been included in Table 3.2.

Additional information relating to adjustments for Reen Cyber Service are as follows:

(a)

The supplies in hand at 31 December 2008 totalled RM1,520.

(b)

The insurance premium that had expired throughout the year totalled

RM200.

(c)

Unearned rental revenue at 31 December 2008 totalled RM480.

(d)

Salary accrued but not yet paid at 31 December 2008 totalled RM500.

(e)

Interest revenue accrued but not yet recorded for the month of December totalled RM1,000.

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(f)

Depreciation for office equipment for the month of December totalled

RM100.

The adjustment entries that must be recorded by Reen Cyber Service as at 31 December 2008 are as per Table 3.1 below:

Table 3.1: Adjustment Entries

 

Date

Description

Reference

Debit

Credit

 

(RM)

(RM)

31

December

Supplies expenses

 

2,480

 
 

Supplies

   

2,480

31

December

Insurance expenses

 

200

 
 

Insurance prepayment

   

200

31

December

Unearned rental revenue

 

240

 
 

Rental revenue

   

240

31

December

Salary expenses

 

500

 
 

Salary accrued

   

500

31

December

Accounts receivable

 

1,000

 
 

Interest revenue

   

1,000

31

December

Depreciation expenses

 

100

 
 

Accumulated depreciation for office equipment

   

100

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Table 3.2: Unadjusted Trial Balance

Reen Cyber Service Trial Balance as at 31 December 2008

Account

 

Debit

Credit

Number

Accounts

(RM)

(RM)

11

Cash

19,130

 

12

Accounts receivable

4,440

 

14

Supplies

4,000

 

15

Insurance prepayment

4,800

 

17

Land

20,000

 

18

Office equipment

3,600

 

21

Accounts payable

 

1,800

22

Notes payable

 

15,000

23

Unearned rental revenue

 

720

31

Capital, Reen

 

30,000

32

Drawings, Reen

8,000

 

41

Interest revenue

 

32,680

51

Salary expenses

8,550

 

52

Rental expenses

3,200

 

53

Utility expenses

1,970

 

54

Supplies expenses

1,600

 

55

Sundry expenses

910

 
 

TOTAL

80,200

80,200

The treatment for each additional item of information are as follows:

(a) The supplies account shown in the Unadjusted Trial Balance is the opening balance at 1 January 2008 which is RM4,000. The additional information stated the current balance, which is the balance at 31 December 2008 totalling

RM1,520.

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Therefore, the difference between both the balances is the supplies expenses that must be recognised/recorded, which is RM2,480.

Supplies Account

Supplies Account

=

Supplies Expenses

(Opening

Balance)

(Current Balance)

RM4,000

RM1,520

=

RM2,480

This adjusting entry affects one account in Income Statement (supplies expenses) and one account in Balance Sheet (supplies account).

The current balance for supplies account is RM1,520, which is RM4,000 (opening balance) – RM2,480 (credit entry from adjustment) which resulted in the same total as stated in the additional information.

(b)

Insurance prepaid account with debit balance totalling RM4,800 showed insurance prepaid for a period of 24 months starting 1 December 2008. Therefore, the insurance expenses at 31 December 2008 that must be recognised total RM4,800 ÷ 24 = RM200.

This adjusting entry causes the insurance prepayment account in the Balance Sheet to have a current balance of RM4,600 (RM4,800 – RM200) while insurance expenses of RM200 will be recognised in the income statement for the period.

(c)

Unearned rental revenue account has a normal credit balance of RM720 which showed total cash for the rental received in advance for three months. Therefore, the rental revenue that need to be recognised for the month of December is 1/3 x RM720 = RM240.

The effect of this adjusting entry is the unearned rental revenue account in the Balance Sheet which will be reduced by RM240 to RM480 while the rental revenue of RM240 will be reflected in the Income Statement .

(d)

Salary accrued or unpaid for the month of December totalled RM500. The salary accrued will increase the total expenditure and is a liability to the business entity. The adjusting entry will recognise this salary expense as an item in the Income Statement and the salary payable/accrued as a balance sheet item totalling RM500 for the period.

(e)

Interest revenue accrued for the business entity but yet to be recognised or recorded totalled RM1,000. This amount is an asset and will increase the total revenue of the business entity. The adjusting entry will recognise the interest revenue as an item in the Income Statement and accounts receivable account in Balance Sheet will show a total of RM1,000 for the period.

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(f) Depreciation of office equipment for the month of December totalling RM100 will increase the total expenditure for that business entity. The adjusting entry will recognise the depreciation as an expenses item in the income statement and will affect one account in balance sheet, the accumulated depreciation account which is a contra account for asset.

The worksheet as per Table 3.3 is used to prepare the Adjusted Trial Balance for Reen Cyber Service for two months ending at 31 December 2008.

Table 3.3: Worksheet

 

Trial Balance

Adjustment

Adjusted Trial

Balance

Name of Account

Dr.

Cr.

Dr.

Cr.

Dr.

Cr.

(RM)

(RM)

(RM)

(RM)

(RM)

(RM)

Cash

19,130

     

19,130

 

Accounts receivable

4,440

 

(5) 1,000

 

5,440

 

Supplies

4,000

   

(1) 2,480

1,520

 

Insurance prepayment

4,800

   

(2) 200

4,600

 

Land

20,000

     

20,000

 

Office equipment

3,600

     

3,600

 

Accounts payable

 

1,800

     

1,800

Unearned rental revenue

 

720

(3) 240

   

480

Notes payable

 

15,000

     

15,000

Capital, Reen

 

30,000

     

30,000

Drawings, Reen

8,000

     

8,000

 

Interest revenue

 

32,680

 

(5) 1,000

 

33,680

Salary expenses

8,550

 

(4) 500

 

9,050

 

Rental expenses

3,200

     

3,200

 

Utility expenses

1,970

     

1,970

 

Supplies expenses

1,600

 

(1) 2,480

 

4,080

 

Sundry expenses

910

     

910

 

Insurance expenses

   

(2) 200

 

200

 

Rental revenue

     

(3) 240

 

240

Salary accrued

     

(4) 500

 

500

Depreciation expenses

   

(6) 100

 

100

 

Accumulated depreciation equipment

     

(6) 100

 

100

 

80,200

80,200

4,520

4,520

81,800

81,800

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You can also prepare the Adjusted Trial Balance for Reen Cyber Service without using the sheet by:

(a)

preparing the adjusting entries.

 

(b)

updating all the account involved with the adjusting entries

 

(c)

entering the current balance that had been adjusted into the Adjusted Trial Balance as below:

 

Table 3.4: Adjusted Trial Balance

 

Reen Cyber Service Adjusted Trial Balance as at 31 December 2008

 

RM

RM

 

Cash

19,130

 

Accounts receivable *

5,440

 

Supplies *

1,520

 

Insurance prepayment *

4,600

 

Land

20,000

 

Office equipment

3,600

 

Accounts payable

 

1,800

Unearned revenue *

 

480

Notes payable

 

15,000

Capital, Reen

 

30,000

Drawings, Reen

8,000

 

Interest revenue *

 

33,680

Salary expenses *

9,050

 

Rental expenses

3,200

 

Utility expenses

1,970

 

Supplies expenses *

4,080

 

Sundry expenses

910

 

Insurance expenses **

200

 

Rental revenue **

 

240

Salary accrued **

 

500

Depreciation expenses **

100

 

Accumulated depreciation equipment **

 

100

 

81,800

81,800

*

Updated accounts New accounts created after the adjusting entries.

 

**

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After the adjustments are made, you will find that the ledger accounts in the Adjusted Trial Balance show the same total debit and total credit. This Adjusted Trial Balance will be used in the preparation of the financial statements, which will be discussed next.

ACTIVITY 2.1 In your opinion, what are the uses of the Adjusted Trial Balance for
ACTIVITY 2.1
In your opinion, what are the uses of the Adjusted Trial Balance for
small businesses? Discuss.
Self-Check 3.1 When is the right time to prepare the Adjusted Trial Balance?
Self-Check 3.1
When is the right time to prepare the Adjusted Trial Balance?

Before we proceed to the next topic, answer the following exercise to test your understanding.

answer the following exercise to test your understanding. EXERCISE 3.2   Information for adjustments is as

EXERCISE 3.2

 

Information for adjustments is as follows:

1. Supplies in hand at 31 December 2007 amounted to RM750. Supplies at 1 January 2007 totalled RM1,000.

2. Depreciation of equipment for the year 2007 totalled RM400.

3. Interest accrued on notes payable totalled RM300.

4. Insurance expired throughout the year 2007 totalled RM1,500.

5. Revenue accrued at 31 December 2007 totalled RM750.

6. Unearned revenue received throughout the year 2007 totalled

RM5,000.

Prepare the adjusting entries at 31 December 2007.

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3.3

PREPARATION OF FINANCIAL STATEMENTS

After studying the preparation of Adjusted Trial Balance, you will now learn how to prepare Financial Statements. The financial statements are prepared after all transactions are recorded or journalized, transferred and summarised in the trial balance. The financial statements are also known as the accounting report that reports the financial status at the end of the accounting period.

This topic will only discuss on the preparation of the financial statements for service-oriented businesses. As you know, the financial statements consist of 4 statements, which are:

• Income Statement;

• Statement of Changes in Owner’s Equity;

• Balance Sheet Statement; and

• Cash Flow Statement.

3.3.1 Income Statement

Income Statement refers to the financial statement which presents the operational results of the business
Income Statement refers to the financial statement which presents the operational results of the business
Income Statement refers to the financial statement which presents the operational results of the business
Income Statement refers to the financial statement which presents the operational results of the business
Income Statement refers to the financial statement which presents the operational results of the business

Income Statement refers to the financial statement which presents the operational results of the business entity for a specific period.

refers to the financial statement which presents the operational results of the business entity for a
refers to the financial statement which presents the operational results of the business entity for a

It is also known as the summary of revenue and expense for a specific period whether it is one month, three months, six months or a year. If the business entity’s total revenue is more than total expenditure, then net profit will be reported in its income statement.

Total Revenue > Total Expense = Net Profit

If the total expense exceeds total revenue, the business entity will report a net loss.

Total Expense > Total Revenue = Net Loss

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The matching process is used to determine the net profit or net loss. The contents in the Income Statement comprise 5 main elements:

(a)

Name of business entity

Example: Noora Jaya Company

(b)

Title of statement, which is Income Statement

(c)

Report period and date.

Example: For the month/year ended 31 December 2008.

(d)

Revenue and expenditure items

(e)

Net profit/loss

Figure 3.2 shows the format for Income Statement

profit/loss Figure 3.2 shows the format for Income Statement Figure 3.2 : Format of income statement

Figure 3.2: Format of income statement for service firms

The revenue and expense items are the main components in the income statement. Revenue is the gross revenue obtained from business activities that were conducted for the purpose of generating revenue. Normally revenue is derived from sales of goods, provision of services, rental of land and loans.

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Figure 3.3 shows examples of revenue sources.

CYCLE Figure 3.3 shows examples of revenue sources. Figure 3.3 : Examples of sources of revenue

Figure 3.3: Examples of sources of revenue

Revenue obtained will increase the total asset and owner equity for a business entity. For example, the main revenue for a car wash business is revenue from the car wash services provided. Other examples of revenue are fees, commission, interest, dividend, royalty and rental.

Expenses are costs to the assets or services used or provided in the process to
Expenses are costs to the assets or services used or provided in the process to
Expenses are costs to the assets or services used or provided in the process to
Expenses are costs to the assets or services used or provided in the process to

Expenses are costs to the assets or services used or provided in the process to generate the revenue.

Expenses are costs to the assets or services used or provided in the process to generate

Expense will reduce the total asset and owner equity. Examples of expense for a car wash business are water, cleaning materials and staff salary.

The steps involved in preparing the Income Statement for Reen Cyber Service are as follows:

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(a) You must analyse the information reported in the following Adjusted Trial Balance:

Reen Cyber Service Adjusted Trial Balance as at 31 December 2008

 

RM

RM

Cash

19,130

 

Accounts receivable

5,440

 

Supplies

1,520

 

Insurance prepayment

4,600

 

Land

20,000

 

Office equipment

3,600

 

Accounts payable

 

1,800

Unearned interest revenue

 

480

Notes payable

 

15,000

Capital, Reen

 

30,000

Drawings, Reen

8,000

 

Interest revenue

 

33,680

Salary expenses

9,050

 

Rental expenses

3,200

 

Utility expenses

1,970

 

Supplies expenses

4,080

 

Sundry expenses

910

 

Insurance expenses

200

 

Rental revenue

 

240

Salary payable

 

500

Depreciation expenses

100

 

Accumulated depreciation

 

100

 

81,800

81,800

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(b)

Extract all the revenue and expense items only because these are the main components in the preparation of Income Statement.

The following are all the revenue and expense items found in the Adjusted Trial Balance for Reen Cyber Service.

 

Interest revenue

 

33,680

 

Rental revenue

 

240

Salary expenses

9,050

 

Rental expenses

3,200

 

Utility expenses

1,970

 

Supplies expenses

4,080

 

Sundry expenses

910

 

Insurance expenses

200

 

Depreciation expenses

100

 
 

19,510

33,920

(c)

Calculate the net profit or loss by adding all the revenue items and deducting all the expense items. If the total revenue exceeds total expenditure, then net profit is obtained. If total expense exceeds total revenue then net loss is obtained.

Total revenue is RM33,920, which includes interest revenue of RM33,680 and rental revenue of RM240. Total expense, which is RM19,510 will be deducted from the total revenue of RM33,920 to generate the net profit of RM14,410.

 

RM

 

Total revenue

33,920

Total expense

19,510

Net Profit

14,410

(d)

Finally, you must enter all the items involved (revenues, expense and net profit) into the income statement format.

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Reen Cyber Service Income Statement For two months ended 31 December 2008

 

RM

RM

Revenue:

Interest revenue

33,680

Rental revenue

240

33,920

Less expenses:

Salary expenses Rental expenses Utility expenses Supplies expenses Sundry expenses Insurance expenses Depreciation expenses

9,050

3,200

1,970

4,080

910

200

100

 

19,510

Net Profit

14,410

This total will be reported in statement of changes in equity

total will be reported in statement of changes in equity 3.3.2 Statement of Changes in Owner’s

3.3.2 Statement of Changes in Owner’s Equity

Statement of changes in owner’s equity is a summary of changes in the owner equity
Statement of changes in owner’s equity is a summary of changes in the owner equity
Statement of changes in owner’s equity is a summary of changes in the owner equity
Statement of changes in owner’s equity is a summary of changes in the owner equity
Statement of changes in owner’s equity is a summary of changes in the owner equity

Statement of changes in owner’s equity is a summary of changes in the owner equity that occurred in a specific period.

Statement of changes in owner’s equity is a summary of changes in the owner equity that
Statement of changes in owner’s equity is a summary of changes in the owner equity that

This statement is related to Income Statement and Balance Sheet (which will be discussed after this) and is prepared at the end of the accounting period.

Equity is the owner’s claim on the total asset. It equals to the total assets
Equity is the owner’s claim on the total asset. It equals to the total assets
Equity is the owner’s claim on the total asset. It equals to the total assets
Equity is the owner’s claim on the total asset. It equals to the total assets

Equity is the owner’s claim on the total asset. It equals to the total assets after deducting all the liabilities.

Equity is the owner’s claim on the total asset. It equals to the total assets after

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Equity is comprised of the following items:

(a)

opening capital;

(b)

the yearly retained profit or loss;

(c)

drawings; and

(d)

closing capital.

Drawings refer to the total cash or goods taken by the business entity’s owner for personal use.

Statement of Changes in Equity for Reen Cyber Service:

Reen Cyber Service Statement of Changes in Owner’s Equity For two months ended 31 December 2008

RM

Capital Reen, 1 November 2008 Net profit Drawings

30,000*

from income statement

14,410

14,410

(8,000)*

Capital Reen, 31 December 2008

36,410 from income statement 14,410 (8,000)* Capital Reen, 31 December 2008 will be reported in the balance

will be reported in the balance sheet

* Total opening capital and drawings were taken from the Adjusted Trial Balance.

Normally this statement is not prepared and is only shown in the notes to the accounts (which will be discussed at the end of this unit). Items in this statement will be shown either in the income statement or in the balance sheet. For example, the yearly retained profit/loss is shown in the income statement while the total closing capital is shown in the balance sheet.

The statement of changes in equity contains the total net profit taken from the income statement that had been prepared previously. From the statement of changes in equity thus prepared, the closing capital is obtained. This total will be reported in the balance sheet statement. Therefore, the statement of changes in equity has linked the income statement with the balance sheet.

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107

3.3.3 Balance Sheet

Balance sheet or statement of financial position is a statement which reports the financial status of the business at a point of time. The financial status of a business entity covers the control on its economic resources, financial structure and sustainability in the long-term. Balance sheet contains three main components, which are:

Self Check 3.4

(a)

Asset Asset is an economic resource owned by a business entity that can bring benefit to the business entity in the future. Asset exists in a business due to past occurrences and transactions. Asset is a valuable resource to the company as it can be used or exchanged to generate products or provide services.

Asset is recorded in the balance sheet based on historical cost, which is the original cost of purchase. Three characteristics that enable a resource to be classified as an asset are:

• The resource can help the business entity to generate cash inflow in the future, whether directly or indirectly.

• The resource must benefit the business entity in the future and the entity has controlling power on the said resource. Controlling power means that the entity can prevent other people from using the said resources.

• Transaction or event that gives the rights to the business entity to control the said resource had occurred. If the transaction of purchasing the resource had not occurred then the resource cannot be considered as an asset to the entity.

Asset consists of current asset and long-term asset.

the resource cannot be considered as an asset to the entity. Asset consists of current asset

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(i) Current Asset Current asset is an asset that is expected to be exchanged for cash or sold or used in a period of one year or in the operating cycle period (whichever is longer).

Operating cycle refer to the time frame taken by the business entity to process as well as to sell the inventory, to collect accounts receivable (AR) as well as to transform the accounts receivable into cash as shown in Figure 3.4.

the accounts receivable into cash as shown in Figure 3.4. Figure 3.4 : Operating cycle Current

Figure 3.4: Operating cycle

Current assets include:

• Cash;

• Trading securities/Short-term investment;

• Items receivable;

• Inventories; and

• Prepayment expenses.

Cash includes cash in hand and cash in saving/current accounts in the bank. Cash that cannot be used immediately is known as cash equivalents. It is also classified under cash items.

Marketable securities or short-term investment comprise of investment in the equity securities (example: investment in stocks) and investment in debt security (example: investment in bonds). Investments in both of these securities are considered current assets because these investments are ready

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109

to be sold or traded. These two types of investments can be exchanged for

cash by the business entity in a period of a year or in the operating cycle period, whichever is longer.

Items receivable is created when the business entity has provided services

or sold goods but the cash is yet to be received. Items receivable are accounts

receivable (AR), notes receivable, interest receivable and fees receivable. Prepaid expenses can also be classified as item receivable, for example rental prepayment, salary prepayment, insurance prepayment.

Inventory for a business entity is different according to the type of business.

A business entity which provides services do not have inventory. This is

different from a business entity that produces/manufactures its goods. It will have raw material inventories, work in process inventories and finished goods inventory (all these types of inventories will be discussed in unit 4). Similarly, businesses that buy and sell goods (trading firms) have inventory for retail stocks.

(ii) Long-Term Asset/Non-curent Asset Long-term asset is an asset that can be used in the business or held for a longer period, usually more than a year. Long-term asset comprises non- current asset, other long-term asset and intangible asset.

Long-Term Asset Land, plant, building and equipment are examples of long-term assets. It has physical form and is used in the operation of the business entity. All these assets must be depreciated, except for land. Land need not be depreciated as its value is always appreciating while plant, equipment and building must be depreciated as the value of the assets will reduce as they get older.

Long-term asset is also known as non-current asset or tangible asset.

In the balance sheet, non-current assets are presented at their original or historical cost less the corresponding accumulated depreciation.

Other Long-Term Asset Other long-term assets include long-term investment, deferred expenditure and amounts that are involved in the long-term such as item receivable.

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These investments consist of investment in securities such as investment in stocks and bonds that would not be exchangeable for cash in the short period. Other long-term investments include investment in property that is held for speculation purposes or for use in future operation and investment in special funds such as pension funds.

Long-term investments are investment held by the business entity for a period of more than one year.

The amount involved in the long-term is amount which is expected to be received after a year. It includes accounts receivable, notes receivable, receivable from director, receivable from transaction between companies and other item receivables.

Deferred expense are prepaid expenses for a long-term period like deferred tax, companies’ restructuring expenses and business’ preliminary expenses.

Intangible/Non-physical Asset Goodwill, patent, copyright and trademark are intangible assets because they lack physical substance. The economic benefits that can be provided by the intangible assets to the business entity in the future are difficult to evaluate. Examples of other intangible assets are franchise, trade names and computer software’s cost. Generally intangible assets are amortised in a period of 5 to 40 years. The intangible asset will be reported in the balance sheet at book value, which is cost less accumulated amortisation expenses. Figure 3.5 shows the types of long-term assets.

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111

TOPIC 3 COMPLETING THE ACCOUNTING CYCLE 111 Figure 3.5 : Long-term assets The following is a

Figure 3.5: Long-term assets

The following is a summary on assets.

Asset

Economic resources that can generate benefit to the entity in the future.

 

Current Assets

 

Long-Term Assets/Non-current Assets

1.

Expected usage within 1 year or operating cycle period

1.

Can be used or held by the business for more than 1 year.

2.

Comprises:

2.

Comprises:

 

(a)

Cash

(a)

Long-term asset/non-current asset

(b)

Trading securities/Short-term

(land, plant, building, equipment)

(c)

Item receivables

(b)

Other long-term assets (long-term investment, deferred expenditure).

(d)

Inventory

(e)

Prepayment expenses

Intangible

asset

(patent,

copyright,

 

trademark)

 

Figure 3.6: Summary of assets

Self-Check 3.2 Describe the difference between current assets with long-term assets and state the items
Self-Check 3.2
Describe the difference between current assets with long-term assets
and state the items contained in these two types of assets.

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(b)

Liability Liability is an obligation or responsibility of a business entity to external parties like creditors or other business entities that have claims on the said business. Liability is presented in the balance sheet to help users of financial statements to measure the extent of the claims of other entities toward the business entity’s resources. Liability is divided into two, which are current liability and long-term liability (non-current liability).

liability and long-term liability (non-current liability). (i) Current Liability Current liability is a

(i) Current Liability Current liability is a responsibility or obligation that is expected to be paid using the current asset or by creating another current liability within the period of one year. Current liabilities include:

• Bank loan or overdraft;

• Item payable;

• Portion of current long-term liability; and

• Deferred revenue.

Bank loan exists when a business entity applies for loan from the bank, which must be settled within a year. Meanwhile, overdraft is a facility given to current account holders to make withdrawal in excess of the savings available.

Item payable consists of accounts payable (AP) and notes payable. It exists when a business entity makes credit purchase from another business entity. AP exists without any written agreement between the two business entities but only via verbal agreement. It is different from notes payable which has written agreement between the two business entities.

Other items payable are salary payable, rental payable, interest payable, which are expenses accrued or payable by the business entity. The service is already received by the business entity but the payment is still outstanding or there is no cash outflow from the business entity.

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Portion of current long-term liability occurs when there is a portion from the long-term liability that must be settled in a year’s period. The total is classified as current liability and not long-term liability. The balance will be classified as long-term liability.

The cash received will be the current liability to the business entity as long as the services have not been provided. Examples of deferred revenue are unearned fees, unearned revenue and deposit from customers.

Deferred revenue refers to the cash received from the customer but the services have not provided yet.

(ii) Long-term Liability/Non-current Liability Compared with current liability, long-term liability is a responsibility or obligation that would not be settled or paid within the period of one year. Long-term liabilities include:

• Bonds payable

• Notes payable

• Inter-company loan

• Secured loan

Bonds payable are long-term liabilities or obligation to a business entity. The entity must settle the total cash received from the bonds issued within a period which may exceed one year, that is upon maturity of the bonds.

Notes payable are transactions involving credit with written agreement between the two business entities. The business entity which received the notes payable with maturity date exceeding one year means that it has a liability/responsibility that must be settle in that period.

Inter-company loan involved obligation or responsibility between companies that must be settled within the specific period which exceeds one year. Secured loan is a liability to a business company towards another party, for example bank or financial institution. The institution will get the business entity’s asset (such as land and building) as security for the loan provided to the company. Figure 3.6 shows a summary of liabilities.

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Table 3.5: Summary of Liabilities

Liabilities

Economic benefit that must be sacrificed by transferring the asset or providing services/goods to another business entity.

Current Liability

Long-Term Liability/Non-current Liability

1. Expected to be paid within a period of one year

1. Expected to be settled within the period > one year.

2. Comprises:

Bank loan Item payable Portion of current long-term liability Deferred revenue

2. Comprises:

Bonds payable Notes payable Inter-company loans Secured loan Contingent liability

(b) Owner’s Equity Owner’s equity means rights or claims against the assets of the business by the owner. Owner’s equity is the excess of total asset against total liability of the business. Owner’ equity for each ownership business structure differ:

• For company, owner’s equity consist of paid-up capital, premium shares, retained earnings and reserve.

• For partnership, owner’s equity consist of total capital account for all partners.

• For sole proprietorship, owner’s equity consist of capital account contributed by its sole owner.

You have know all the items that need to be reported in the balance sheet:

namely asset, liability and owner’s equity. ACTIVITY 3.1 How may a debt be considered as
namely asset, liability and owner’s equity.
ACTIVITY 3.1
How may a debt be considered as a bad debt? If you have your own
business, what is your interpretation on the term of bad debt? Discuss.
Activity 3.2

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115

The following balance sheet statement reports all items of asset, liability and owner’s equity found in the Adjusted Trial Balance and Statement of Changes in owner’s equity for Reen Cyber Service:

Reen Cyber Service Balance Sheet as at 31 December 2008

 

RM

RM

 

RM

Non-current assets:

Land Office equipment Accumulated depreciation

 

20,000

 

3,600

 

(100)

 

3,500

 

23,500

Current assets:

Cash Accounts receivable Suppliers Insurance prepayment

19,130

 

5,440

1,520

4,600

30,690

 

Less: Current Liabilities:

Account payable Salary payable Unearned revenue

1,800

 

500

480

 

(2,780)

 

Net current assets

27,910

51,410

Finance by:

Owner’s Equity Capital, Reen Non-curent liability:

 
Owner’s Equity Capital, Reen Non-curent liability:   36,410*

36,410*

   

Notes payable

15,000

   

51,410

From the statement of changes in owner’s equity

 

• If the statement of changes in equity has not been prepared, all the items in that statement would be shown in the balance sheet for the purpose of reporting the closing capital as at 31 December 2008.

Net assets refer to the difference between net current assets and net current liabilities. This item must be reported according to the regulation and standards approved by the Malaysian Accounting Standards Board (MASB) 1: Presentation of Financial Statements.

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To ensure that you have understood what you have learned, complete the following exercise.

EXERCISE 3.3  

EXERCISE 3.3

 

Information in the adjusted trial balance for KhairunnisaÊ Consulting Services at 30 June 2007 are as follows:

 

Khairunnisa’ Consulting Services Adjusted Trial Balance as at 30 June 2007

 
 

Debit

Credit

 

Cash Accounts receivable Office supplies Rental prepayment Insurance prepayment Office equipment Accumulated depreciation office equipment

56,350

41,600

12,300

4,400

15,100

99,000

 

10,725

Accounts payable Unearned Fees Notes payable long-term Salary payable Capital, KhairunnisaÊ Fees revenue Sundry expenses Rental expenses Utility expenses Salary expenses Supplies expenses Insurance expenses Depreciation expenses

17,600

10,980

100,000

7,100

51,990

119,280

10,700

13,800

4,900

49,600

5,600

3,500

825

Total

317,675

317,675

From the information above,

 

1.

Prepare the income statement for the period ended 30 June 2007 for KhairunnisaÊ Consulting Services.

2.

Prepare the balance sheet as at 30 June 2007.

 

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117

3.3.4 Cash Flow Statement

You will next be exposed to the fourth financial statement, the cash flow statement which summarises the cash received and cash payment for the period. It presents the basic cash information for operating, investing and financing activities. The cash flow statement can help users of accounting information to:

1. evaluate the capability of the company to generate positive cash flow in the future; and

2. evaluate the capability of the company in settling its debts, paying dividends and providing loans to external parties.

Cash flow statement can be classified under three activities, which are operating activities, investing activities and financing activities.

activities, investing activities and financing activities. Figure 3.7 : Cash flow statement (a) Operating Activities

Figure 3.7: Cash flow statement

(a)

Operating Activities Operating activities involve cash transactions that affect the business’ net profit, which are any cash received, such as cash from sales, and any cash payments, such as payment for purchases. Only cash received and payment related to the operation of the company are taken into account. MASB 5 also specified interest and dividend received as part of items from operating activities. However, both these items can also be classified as investing or financing activities, which will be discussed later.

(b)

Investing Activities The second activity is investing activities, and would normally involve long-term asset items, such as purchase and sale of non-current asset. Any profit or loss from the sale of non-current asset will not be included in the calculation of net cash flow from investing activities.

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(c) Financing Activities This activity normally involves long-term liability and equity items such as issuance of share and payment of all debts. If there is profit or loss during the payment of all debts, it will not be taken into account while generating the net cash flow from financing activities.

Examples of Cash Received and Payments for each of the activities are as follows:

Operating Activities

Cash Received From:

Cash Payment For:

Sale of goods

Purchase of goods

Service revenue

Staff wages and salary

Fees revenue

Utility expenses

Rental revenue

Rental expenses

Investing Activities

Cash Received From:

Cash Payment For:

Sale of non-current asset

Purchase of non-current asset

Sale of investment

Purchase of shares (invest)

Collection of loan provided to other entities

Provision of loan to other entities

Financing Activities

Cash Received From:

Cash Payment For:

Loan or debt of the company from external parties

Repayment of loan/debt

Issuance of shares

Share buyback

Examples for each activity above are reported in the Cash Flow Statement shown as follows:

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119

Air Molek Enterprise Cash Flow Statement for the Period Ended 31 December 2007

 

Operating Activities Received:

RM

RM

Collection from customer

6,500

Payment:

Staff salary Net cash flow from operation

(1,200)

(1,200)

5,300

Investing Activities Sale of land Sale of shares Net cash flow from investment

22,000

18,000

 

40,000

Financing Activities Investment by owner

50,000

50,000

Total increase in cash

95,300

Cash balance as at 1 January 2007 Cash balance as at 31 December 2007

 

0

95,300

Cash balance as at 1 January 2007 is zero as the business is newly established.

For your information, the Cash Flow Statement must take into account all cash related transactions. This means that you must refer to Topic 2, which is the recording of information related to incoming or outgoing cash flow.

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Cash Flow Statement for Reen Cyber Service is as follows:

Reen Cyber Service Cash Flow Statement For the Period Ended 31 December 2008

Operating Activities Received:

RM

RM

Cash from customers Payment:

13,960

Cash to suppliers

(2,600)

Expenditure Net cash flow from operation

(15,030)

(17,630)

 

(3,670)

Investing Activities

-

Financing Activities Drawings by owner Total increase/(decrease) in cash

 

(4,000)

(7,670)

Cash balance 1 December 2008 Cash balance 31 December 2008

26,800

19,130

Cash total is the same as the total reported in balance sheet.

Cash total is the same as the total reported in balance sheet.

Notes to Solution:

(i)

Cash from customer total RM13,960, which is the total cash received throughout the month of December. You can refer to the journal entry done in Topic 2 relating to accounts receivable. RM13,960 was total cash received for 1 December for RM720; 16 December for RM6,200; 21 December for RM1,300 and 31 December for RM5,740.

(ii)

Payment to suppliers totalling RM2,600 was for transaction on 11 December 2008 for RM800 and 20 December for RM1,800.

(iii)

Cash for payment of expenditure was from all transactions related to expenses and outgoing cash flow. Examples of expenses involved are rental expenses, insurance expenses, sundry expenses and utility expenses. You can try by using the same way we had derived the total cash from customers. You will find that total for all expenses are RM15,030. Therefore, the net cash flow from the operating activities totalled (RM3,670), which is (RM13,960 –

RM17,630).

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121

(iv)

What had happened to the overall cash flow? The cash flow had decreased by RM7,670 throughout the month of December. This is different from the one reported in the income statement for the period ended 31 December, that is the net profit of RM14,410. This is because the entity had used the accrual basis in recognising the revenue and expenditure, without taking into account the incoming or outgoing cash.

(v)

Total cash balance as at 1 December 2008 which is RM26,800 refer to the cash transaction throughout the month of November 2008.

Self-Check 3.3 Briefly explain the four financial statements which are included in the preparation of
Self-Check 3.3
Briefly explain the four financial statements which are included in the
preparation of financial reports.
3.4
PREPARATION OF CLOSING ENTRIES

In the next section, you will learn how to prepare the closing entry. Drawings account will be closed directly to the capital account.

Closing entry refers to the temporary closing of accounts, where all the accounts in the
Closing entry refers to the temporary closing of accounts, where all the accounts in the
Closing entry refers to the temporary closing of accounts, where all the accounts in the

Closing entry refers to the temporary closing of accounts, where all the accounts in the income statement (revenue and expenses accounts) will be transferred to the revenue summary account.

the accounts in the income statement (revenue and expenses accounts) will be transferred to the revenue

The purpose of closing entry is to measure the profit accurately. It is also for the purpose of making the temporary accounts into zero balance for the next period.

3.4.1 Steps in Preparation of Closing Entries

Temporary accounts are accounts related only to the current accounting period which will be closed, for example expenses accounts and drawings account. The fixed accounts (such as asset, liability and owner equity), however, will not be closed. These accounts are related to one or more accounting periods in the future with its balance reported in the balance sheet. Closing entry is done at the end of the accounting period.

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The steps for making closing entries are as follows:

(a)

All revenue accounts will be debited and revenue summary account will be credited.

(b)

All expenses accounts will be credited and revenue summary account will be debited.

(c)

Transfer balance from revenue summary account into capital account.

(d)

Drawings account will be credited and capital account will be debited.

Figure 3.8 shows the summary of preparing the closing entry.

. Figure 3.8 shows the summary of preparing the closing entry. Figure 3.8 : Summary for

Figure 3.8: Summary for preparation of the closing entry.

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123

Closing entries for Reen Cyber Services as at 31 December 2008 are as follows:

31 December 2008

Dr.

Interest revenue

33,680

Rental revenue

240

 

Cr.

Revenue Summary

33,920

Dr.

(Closing of all revenue accounts) Revenue Summary

19,510

 

Cr.

Salary expenses

9,050

Rental expenses

 

3,200

Utility expenses

1,970

Supplies expenses

4,080

Sundry expenses

910

Insurance prepayment

200

Depreciation (Closing of all expenses accounts)

100

Dr.

Revenue Summary

14,410

 

Cr.

Capital, Reen

14,410

(Closing of revenue summary account)

 

Dr.

Capital, Reen

8,000

 

Cr.

Drawings

8,000

(Closing of drawings account)

Notes to Solutions:

(i)

All revenue accounts will be closed by debiting the specific accounts and creating an revenue summary account. With this all the revenue accounts will have a zero balance while the revenue summary account will have RM33,920 credit balance.

(ii)

All expenses accounts will be closed by crediting the said accounts. With this all the expenses accounts for that period will have a zero balance. Meanwhile the current balance of revenue summary account will become RM14,410 after taking into account the expenses transferred over to this account.

(iii)

Balance in the revenue summary account of RM14,410 will be transferred to the capital account. If it is a credit balance, it would be net profit, while if it has a debit balance, it will be net loss. This balance will be the same net profit reported in the income statement prepared in the previous topic.

124 TOPIC 3 COMPLETNG THE ACCOUNTING CYCLE SELF CHECK 3.4 What are the steps required
124
TOPIC 3
COMPLETNG THE ACCOUNTING CYCLE
SELF CHECK 3.4
What are the steps required to prepare a closing entry?

3.5

PREPARATION OF REVERSING ENTRIES

Reversing entry is a reversal to the adjusting entry from the previous period but only
Reversing entry is a reversal to the adjusting entry from the previous period but only
Reversing entry is a reversal to the adjusting entry from the previous period but only
Reversing entry is a reversal to the adjusting entry from the previous period but only

Reversing entry is a reversal to the adjusting entry from the previous period but only related to accruals, which are accrued revenue and accrued expenses.

adjusting entry from the previous period but only related to accruals, which are accrued revenue and
adjusting entry from the previous period but only related to accruals, which are accrued revenue and

Reversing entry is usually prepared on the first day of the next accounting period. It is to simplify the accounting process because it separates the expenses or revenue for the two accounting periods. However, business entity has a choice on whether to prepare this reversal entry or not.

Example 3.7

At the end of year 2005, Mas Merah Company has accrued salary expenses of RM800. The adjusting entry recorded was:

31 December 2005

Dr. Salary Expenses Cr. Salary Payable

800

800

At 31 December, closing entry must be made to close the salary expenses account as this account is temporary. The entry needed is:

31 December 2005

Dr. Revenue Summary Cr. Salary expenses

800

800

If Mas Merah Company prepares the reversal entry on the first day of the next accounting period, the reversal entry would be:

1 January 2006

Dr. Salary payable Cr. Salary expenses

800

800

At 15 January 2006, Mas Merah Company made an actual salary payment of RM2,000. The journal entry involved would be:

TOPIC 3

COMPLETING THE ACCOUNTING CYCLE

125

15 January 2006

Dr. Salary expenses Cr. Cash

2,000

2,000

After all the journal entries had been transferred to the ledger, the accounts involved are:

Salary Expenses Account

 

RM

 

RM

31

Dec 2005

Adjustment

800

31 Dec 2005

Closing

800

15

Jan 2006

Payment

2,000

1 Jan 2006

Reversal

800

 

Salary Payable Account

 
 

RM

 

RM

31

Dec 2005

Balance c/f

800

31 Dec 2005

Adjustment

800

1 Jan 2006

Reversal

800

1

Jan 2006

Balance b/d

800

Revenue Summary Account

 
 

RM

 

31

Dec 2005

Closing

800

 

Cash Account

 
   

RM

1

Jan 2006

Payment

2,000

Salary expenses account as at 15 January 2006 has a debit balance of RM1,200 (RM2,000 – RM800). This means that this total will be recognised as salary expenses for the accounting period of 2001. Therefore, the role of reversal entry is to separate the expenses for the two accounting period, that is for the years 2006 and 2005.

As at 15 January 2006, the balance for salary payable account will be 0 that is after the reversal entry had been transferred to salary payable ledger. The revenue summary account will be closed by debiting the capital account while cash account will be permanently reported in the balance sheet.

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COMPLETNG THE ACCOUNTING CYCLE

EXERCISE 3.4

EXERCISE 3.4

1. The trial balance for Berkat Enterprise as at 30 June 2006 is as follows:

 

Debit

Credit

Cash

3,425

 

Accounts receivable

7,000

 

Supplies

1,270

 

Insurance prepayment

620

 

Office equipment

EXERCISE 3.4

51,650

 

Accumulated depreciation Office equipment

 

9,700

Salary payable

 

925

Unearned revenue

 

1,250

Capital

 

29,000

Drawings

5,200

 

Service revenue

 

59,125

Salary expenses

22,415

 

Sundry expenses

8,420

 

Total

100,000

100,000

Adjustment information:

(i)

Supplies in hand as at 30 June 2006 totalled RM380.

(ii)

Insurance premium expired for the year totalled RM315.

(iii)

Yearly de[recitation for office equipment totaled RM4,950.

(iv)

Salary accrued but yet to be paid as at 30 June is RM440.

(v)

Service revenue accrued but yet to be recorded totaled RM1,000.

(vi)

Unearned revenue as at 30 June totaled RM750.

From the information provided, you are required to:

(a)

Prepare the journal entries to record all the adjustments.

(c)

Prepare the Income Statement and Balance Sheet at the end of the accounting period.

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127

2. Mekar Serumpun Company paid salary to its workers once in every six days (the salary for Saturday until Thursday will be paid on Thursday). Friday is a holiday for Mekar Serumpun Company. The company pays a daily rate of RM20 as salary to its workers. The company had decided that 31 December is the last day for its accounting period and 31 December 2000 falls on a Wednesday.

Based on the above information, prepare the reversing entries and transfer the entries to the corresponding ledgers for the final week of year 2000.

3. Information in the Adjusted Trial Balance of Moiz Real Estate Company as at 31 December 2004 are as follows:

Moiz Real Estate Company Trial Balance 31 December 2004

 

RM

RM

Cash

6,850

 

Accounts receivable

14,000

 

Supplies

2,540

 

Insurance prepayment

1,240

 

Office equipment

103,300

 

Accumulated depreciation office equipment

 

19,400

Accounts payable

 

1,850

Unearned revenue

 

2,500

Capital, Moiz

 

58,000

Drawings, Moiz

10,400

 

Service revenue

 

118,250

Salary expenses

44,830

 

Rental expenses

8,400

 

Depreciation expenses

5,430

 

Sundry expenses

3,010

 

Total

200,000

200,000

From the information above, you are required to:

(a)

Prepare the income statement, statement of changes in equity and balance sheet statement.

(b)

Prepare the closing entries.

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COMPLETNG THE ACCOUNTING CYCLE

SUMMARY

SUMMARY

• In this topic, you have been introduced to the following items:

– Prepaid expenses

– Depreciation expenses

– Unearned revenue

– Accrued expenses

– Accrued revenue

• The preparation of Adjusted Trial Balance is for the purpose of showing the effect of all financial events that had occurred in the specific accounting period.

• The preparation of Financial Statements is done after the transactions have been recorded, journalised, transferred and summarised in the Trial Balance.

• The Financial Statements prepared for an entity include:

– Income Statement

– Statement of Changes in Equity

– Balance Sheet Statement

– Cash Flow Statement

• The preparation of closing entries must be done for the purpose of measuring the profit accurately and to make the temporary accounts into zero balance for the next accounting period.

• The preparation of reversing entries must be done on the first day of the next accounting period. This is a reversal to the adjusting entries made in the previous period and is related only to accruals (accrued revenue and accrued expenses).

Adjusting Entries Prepaid Expenses Depreciation Expenses Unearned Revenue Current Liability Accrued Expenses Adjusted

Adjusting Entries Prepaid Expenses Depreciation Expenses Unearned Revenue Current Liability

Accrued Expenses Adjusted Trial Balance Current Asset Long-term Asset Long-term Liability