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Chapter 10 IA3 by Millan

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Alysa Paglinawan
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3K views30 pages

Chapter 10 IA3 by Millan

Uploaded by

Alysa Paglinawan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF or read online on Scribd
  • Introduction
  • Cash Basis vs Accrual Basis
  • Illustrations
  • Problems
  • Multiple Choice
to Accrual Basis of Accounting ' a SE = Chapter 10 cash Basis to Accrual Basis of Accounting amning Objectives e Le pifferentiate cash basis and accrual basis of accounting. "Restate account balances from the cash basis to the accrual " pasis of accounting. Accrual basis of accounting The Standards provide that under the accrual basis of accounting, aghe effects of transactions and other events are recognized when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.” ~ In other words, under the accrual basis of accounting, income is recognized when earned regardless of when cash is _ received and expense is recognized when incurred regardless of when cash is paid. i Cash basis of accounting Under the cash basis of accounting, income’ is recognized only when cash is received and expense is recognized only when cash ispaid. ; Entities applying full PFRSs and entities qualifying as SMEs are required under the Standards to use accrual basis of accounting when preparing financial statements. In everyday transactions though, strict compliance with ‘ccrual basis is sometimes impracticable. In practice, many entities Use the “Income method” and “Expense method” of initial "eording of income and expenses. These methods are ‘PPlications of the cash basis of accounting. For example, rent "tived is initially credited in full to rent income and payment for tance is initially debited in full to insurance expense (cash nt LePe, y ‘or to the preparation of financial stat de for any unearned income ang 7 ey, expense in order to translate the accounts into the accrua] bea When an entity uses cash basis in everyday transac, s, .d to convert from cash to accrual basis pri Ons jg basis). Howevet, pri adjustments are ma On erred ts in order t oF 0 preparation of financial statemen| fo comply with the PFRSs. Cash basis vs. Accrual basis Item Cash basis Accrual basis Sales Cash sales plus cash Cash sales plus Sales collections on trade on account receivables plus advances received from customers Purchases Cash purchases plus Cash purchases plus . payments on trade purchases on payables plus account. advances paid to suppliers Cost of goods sold Cash basis purchases | Accrual basis adjusted for changes | purchases adjusted in beginning and for changes in ending inventories. | beginning and ending inventories. oe items of Income includes only | Income includes all income those that are items earned received in cash. regardless of whether or not ca 7 is received. panda ag Expense includes} Expense includes! only those that are _| items incurred paid in cash. regardless of | whether or not cas | is paid. js 1 Acernal Basis of Accounting 491 expense Income txexpenseis | nome ax opens] joe recognized only for | is recognized payments made. sidering deferred _ | tax expense (ben | —< Jan1 Income tax payments __ 1,000,000 | 1,200,000 Current tax expense (squeeze) Dee. 31 200,000 Income tax expense is computed as follows: Income tax expense 1,300,000 (squeeze) Increase in DTL (900,000 - 300,000) (600,000) Increase in DTA 500,000 Current tax expense 1,200,000 (start) Illustration 6.1: Comprehensive illustration On January 1, 20x1, ABC Co. started its operations with initial cash investment of P100,000. ABC provided P300,000 of services in January and received full payment in April. ABC incurred expenses of P120,000 in January which were paid in March. During March, dividends of P50,000 were paid. | > Requirements: Compute for profit o loss for the first quarter under _ ®)cash basis and (b) accrual basis. 02 Solution: Cash b. Revenues : Expenses (120,000) Profit (loss) (120,000) No revenue is recognized under the cash basis in the first 300,000 (220,000) 180,000 | quarter because collections were made only on April. However, the expenses paid during March are recognized. Mlustration 6.2: Comprehensive illustration ABC Co. reported profit of P800,000 in 20x1 under cash basis. The following items are relevant in converting the cash basis profit into accrual basis. : Inventory, January 1 Inventory, December 31 Receivables, January 1 Receivables, December 31 Payables increased by 1,000,000 ,000 300,000 900,000 500,000 Requirement: Compute for the profit'under accrual basis. Solution: For the problem above, we will use the following formula: Accrual basis profit Add: —_ Non-cash expenses Less: Non-cash income Add: Decreases in current assets Less: Increases in current assets Add: Increases in current liabilities Less: Decreases in current liabilities Cash basis profit xx xx (xx) xx Cc) XX cos | yr ch Bass Accrual Basis of Accounting a Observe the following from the formula above: @ The effects of non-cash items on the accrual basis profit are eliminated. Non-cash expenses decreased accrual basis profit put do not affect cash basis profit so they are added back. Non- cash income increased accrual basis profit but do not affect cash basis profit so they are deducted. @ For current assets, there is inverse relationship, ie., increases jn current assets are deducted. @ For current liabilities, there is direct relationship, i.e., increases in current liabilities are added. @ Notice that the procedures described above are similar to the procedures in the preparation of statement of cash flows. This is because “Cash basis to Accrual basis” is just the opposite of the preparation of the operating activities section of the statement of cash flows which is “Accrual basis to Cash basis”. “olution: Accrual basis profit 500,000 (squeeze) ‘Add: Non-cash expenses e Less: Non-cash income : Add: Decrease in inventory (1M - 600K) 400,000 Less: Increase in receivables (900K - 300K) * (600,000) ‘Add: Increase in payables 500,000 Cash basis profit : 800,000_ (start) Illustration 6.3: Comprehensive illustration ABC Co.'s accrual basis profit is computed as follows: Sales 2,500,000 Cost of sales: Inventory, Jan. 1 600,000 Net purchases 1,400,000 Cost of goods available for sale 2,000,000 Inventory, Dec. 31 (400,000) (1,600,000) Gross profit 900,000 Other income 100,000 Operating expenses (700,000) Profit for the year 300,000 504 ch Additional information: © Operating expenses include depreciation of P70,009, © Other income includes interest income of ?80,000, P10, which pertains to amortization of discount on inves bonds. « Accounts receivable decreased by P100,000, prepaiq expense, increased by P50,000; accrued expenses increased by 20,009 and accounts payable decreased by P60,000;. 7 1,000 of tment in Requirement: Compute for ABC’s cash basis profit. Solution: Accrual basis profit 300,000 Add: Depreciation expense 70,000 Less: Amortization of discount on investment in bonds* (10,000) i Add: Decrease in accounts receivable 100,000 | Less: Increase in prepaid expenses (60,000) | Add: Increase in accrued expenses 20,000 | Less: Decrease in payables (60,000) | Add: Decrease in inventory (600,000 - 400,000)** 200,000 Cash basis profit j *Remember “PADD; PDDA”?0¢ Refer to Chapter 6 Statement of Cash “Refer to income statement shown above, Illustration 6.4: Comprehensive illustration ABC Company started its operations-in 20x1. Its income statement Prepared under cash basis of accounting is provided below. ABC Company ® Income statement For the year ended December 31, 20x1 Revenue 2,500,000 Other income 20,000 Equipment (400,000) Salaries expense (300,000) Rent expense (180,000) ig to Accrual Basis of Accounting Bast cost 505 ities ExPENS™ : ale pense (80,000) ie pense (40,000) iss (25,000) ance Cost 30,000) pefore tax ¢ ) PEiypetore ws pro nse z acome axe oe : (400,000) profit for EY" 1,065,000 A ditional information: ‘Amounts due from customers at * his amount, P20,000 is doubtful of year-end were P250,000. Of f collection. b Interest income of P20,000 on a Note receivable from a customer was recognized in other inco amortization of discount on the note not recorded. me. However, an teceivable of P2,000 was ¢, The cost of equipment purchased to be used in business was expensed immediately. The equipment has an estimated useful life of 10 years. ABC uses the straight line method of depreciation. d. Salaries of P30,000 incurred in December 20x1 were paid on January 4, 20x2. e, ABC rents its office space for P12,000 a month, payable quarterly in advance. The contract was signed on December 31, 20x0. f, The bill for December's utility costs of P10,000 was on paid January 9, 20x2. g. A one-year insurance policy was obtained on July 1, 20x1. Premiums are paid annually in advance. h. Commissions of 1% of revenues are paid on the same day cash is received from customers. i, ABC borrowed P1,000,000 for one year on August 1, 20x1. Interest payments based on an annual rate of 12% are made quarterly. }. There are no unpaid income taxes as of year-end. However, deferred tax asset of P3,300 and deferred tax liability of P5,000 were not recognized. Requirement: How much is the basis of accounting? Solutions: a. Revenue - cash basis _ Increase in trade receivable Revenue - accrual basis b. Other income - cash basis Amortization of discount on note receivable Other income - accrual basis a. Bad debt expense c.. Depreciation expense on equipment (400,000 + 10 years) d. Salaries - cash basis Accrued salaries expense Salaries expense - accrual basis e. Rent expense - accrual basis (12,000 x 12 months) £. Utilities expense - cash basis, Accrued utilities expense Utilities expense - accrual basis g. Insurance expense - cash basis Unexpired insurance (40,000 x 6/12) Insurance expense - accrual basis h. Commission expense - cash basis Accrued commissions on credit sales (250,000 - 20,000) x 1% Commission expense - accrual basis i. Interest expense - cash basis Accrued interest - Nov. and Dec, profit for the year under acg TU ‘al 2,500,000 250,000 2,750,000 20,000 2,000 22,000 (20,000) (40,000) 300,000 30,000 (330,000) (144,000) 80,000 10,000 (90,000) 40,000 (20,000) (20,000) 25,000 2,300 7,300) 30,000 yr sis to Accrual Basis of Accounting cast Be 507 1,000,000 x 12% x am vb 29900. ense - accrual basis interest expt (60,000) Income tax expense - accrual (squeeze) : (401,700 * increase in DTL a .700) increase in DTA aE oo Current tax expense Peay ae eae Accdalbacig eee jor the year - Accrual basis FEaann Profit jternative solution: profit for the year - Cash basis 1,065,000 credit sale not recognized, net of bad debts (250K - 20K) 230,000 p, Interest income from discount amortization 2,000 ¢ Equipment erroneously expensed 400,000 cl. Depreciation on the equipment above (40,000) 4, Salaries incurred but not yet paid (0,000) e. Rent paid in advance charged as expense (12K x3 mos) 36,000 {Utility costs incurred but not yet paid (10,000) g. Unexpired portion on insurance premium (40K x62) 20,000 h. Commission on net credit sale [(250K - 20K) x 1%] (2,300) j. Interest expense (IM x 12% x 2/12) (20,000) j Increase in deferred tax liability 6,000) j2 Increase in deferred tax asset 3,300 Profit for the year - Accrual basis 1,649,000 PROBLEMS PROBLEM 1: FOR CLASSROOM DISCUSSION 1. Under the cash basis of accounting, revenues are recordeg a. when they are earned and realized. b. when they are earned and realizable. c. when they are earned. d. when they are realized. (Adapted) 2. When converting from cash basis to accrual basis accounting, which of the following adjustments should be made to cash receipts from customers to determine accrual basis seryicg revenue? a. Subtract ending accounts receivable. b. Subtract beginning unearned service revenue. c. Add ending accounts receivable. d. Add cash sales. (Adapted) 3. When converting from cash basis to accrual basis accounting, which of the following adjustments should be made to cash paid for- operating expenses to determine accrual basis operating expenses? a. Add beginning accrued liabilities, b. Add beginning prepaid expense. c. Subtract ending prepaid expense, d. Subtract interest expense. (Adapted) 4. Information on an entity’s accounts is shown below: Increase in accounts receivable 800,000 Decrease in trade notes receivable 200,000 Collections on trade notes receivable 2,000,000 Recoveries of accounts Previously written-off (inchided in collections) 10,000 Collections on accounts receivable 1,000,000 y to Accrual Basis of Accounting . sis oat B 509 jte-off : 100,000 wees (from credit sales) 20,000 jeoments? Compute for the following: Ni fet sales revenue under the accrual basis of accounting, ® Net sales revenue under the cash basis of accounting. b Information on an entity’s accounts is shown below: jerease jn accounts payable 800,000 crease in inventory 200,000 payments to suppliers ‘ 2,000,000 purchase returns 20,000 Requirements: Compute for the following: a, Cost of goods sold under the accrual basis of accounting. p. Cost of goods sold under the cash basis of accounting. 6, Information on an entity’s accounts is shown below: Prepaid utilities, beg. 100,000 Prepaid utilities, end. 120,000 Accrued utilities payable, beg. 80,000 Accrued utilities payable, end. 50,000 Utilities expense 220,000 Requirement: Compute for the following for the payments for utilities during thé period. 7. Information on an entity’s accounts is shown below: Rent receivable, beg. 1,000,000 _ Rent receivable, end. aoe 80000 | Unearned rent income, beg. 600,000 | Unearned rent income, end. zoe Fr Rent incon’ 2,100,000 | Retuirement:'Compute for the following for the collections of Tals during the period. gio ery 8. A comparative balance sheet for Bell Industries is given below. 20x2 20x Anse ET es Cash , lay 10,000 Accounts receivable 100,000 92,000 Merchandise inventory 30,000 43,000 Land, buildings, and 325,000 200,009 equipment Accumulated depreciation - (75,000) (50,000) buildings and equipment Total assets 420,000 295,000 Liabilities Accounts payable 65,000 75,000 Net assets 355,000 220,000 The entity’s profit under the cash basis of accounting is P70,000. Requirement: Compute for the profit under the accrual basis of accounting. PROBLEM 2: EXERCISES 1. Information on an entity’s accounts is shown below: Increase in accounts receivable 960,000 Decrease in trade notes receivable 240,000 Collections on trade notes receivable 2,400,000 Recoveries of accounts previously written-off (included in collections) 12,000 Collections on accounts receivable 1,200,000 Write-offs : 120,000 Sales returns 24,000 Requirements: Compute for the following: a. Net sales revenue under the accrual basis of accounting: b. Net sales revenue under the cash basis of accounting. to Accrual Basis of Accounting cast formation on an entity’s accounts is shown below: 2 ge it accounts payable i ease i inventory ° sents 10 suppliers pay! ms ase retul purcht nits: Compute for the following: yireme! 511 1,200,000 300,000 3,000,000 30,000 Cost of goods sold under the accrual basis of accounting. hh, Cost of goods sold under the cash basis of accounting. Information on an entity’s accounts is shown below: prepaid utilities, beg. prepaid utilities, end. ‘Accrued utilities payable, beg. ‘Accrued utilities payable, end. Utilities expense 150,000 180,000 120,000 75,000 330,000 Requirement: Compute for the following for the payments for utilities during the period. 4, Information on an entity’s accounts is shown below: Rent receivable, beg. Rent receivable, end. Uneamned rent income, beg. Unearned rent income, end. Rent income 1,800,000 1,440,000 1,080,000 1,296,000 3,780,000 Requirement: Compute for the following for the collections of Tentals during the period. | 4 Acomparative balance sheet for Bill Industries is given below: paste 2x20 Gh and cash equivalents 80,000 120,000 ‘ade and other receivables 300,000 340,000 _hventory i 430,000 380,000 ’aid supplies ~~ 60,000 40,000 512 Property, plant and e uipment So. om Total assets 670,000 Lape | Liabilities : ‘Accounts payable : 65,00 Deferred tax liabilit ,000 1,505,000 Net assets 1.685, ‘Additional information: There are no acquisitions equipment during the year. + The entity’s profit under the 1,000,000. q or disposals of property, plant Iai cash basis of accounting jg Requirement: Compute for the profit under the accrual basis of accounting. PROBLEM 3: MULTIPLE CHOICE - THEORY 1... Under this basis of accounting, the effects of transactions and other events are recognized when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate. a. . cash basis b. accrual basis c. legal basis d. other comprehensive basis of accounting 2. pare this basis of accounting, income is recognized only when cash is received and 7 7 when i expense 4 only W cash is paid. ‘P' is recognize: ly a. cash basis b. accrual basis © legal basis = - d. othe : T comprehensive basis of accounting Fb Accrual Basis of Accounting a1 Compared to the accrual basis of accounting, the cash basis of "accounting understates income by the net decrease d uring the accounting period of : Acco js receivable Accrued expenses "Yes : Yes b. Yes No a No 4.No Yes acer?) 4, White Co. wants to convert its 2003 financial statements from the accrual basis of accounting to the cash basis, Both supplies inventory and office salaries payable increased between January 1, 2003, and December 31, 2003. To obtain 2003 cash , basis net income, how should these increases be added to or deducted from accrual-basis net income? _ Supplies inventory Office salaries payable a, Deducted Deducted. b. Deducted Added c. Added Deducted d. Added Added (Adapted) 5, Before 2003, Droit Co. used the cash basis of accounting. As of ~ December 31, 2003, Droit changed to the accrual basis. Droit cannot determine the beginning balance of supplies inventory. What is the effect of Droit’s inability to determine beginning _supplies inventory on its 2003 accrual basis net income and December 31, 2003 accrual-basis owners’ equity? 2003 net income 12/31/03 owners’ equity a. No effect No effect b. No effect Overstated c. Overstated No effect d. Overstated Overstated (Adapted) | Bee Chapter 19 purity 6. — An entity grants credit sales and purchases on account, Which of the following accounts would most likely have the same carrying amount whether the entity uses the cash basis or the accrual basis of accounting? a, Sales revenue c. Income tax expense b. Cost of sales d, Equipment An entity makes quarterly payments of income taxes during the year. The entity uses nominal accounts to initially recorg receipts and disbursements. The entity does not provide interim financial reports. any year-end adjustments? a. Income tax expense under the cash basis is greater than the income tax expense under the accrual basis. b. Income tax expense under the cash basis is less than the income tax expense under the accrual basis. c. Income tax expense under the cash basis is equal to the income tax expense under the accrual basis. d. I don’t know the answer. Which of the following is true before Which of the following would cause the profit computed under the cash basis of accounting to be greater than the profit computed under the accrual basis of accounting? a. Sales on account are greater than the cash collections on sales. b. The fair value of investment in FVOCI securities decreases during the period. c. The investee in ‘b’ above declares dividends but pays the dividends in the following period. d. The entity records the electricity bill for the current period * but pays the bill in the following period. An entity makes all its purchases on credit. Which of the following is true? a. Cost of goods sold under the cash basis is greater than the cost of goods sold under the accrual basis. yr i rual Basis of Accounti au geet eri Bes of Acounting 56 Cost of goods sold under the cash b 7 cost of goods sold under the accrual ba Cost of goods sold under the cash basis is equal to the cost of goods sold under the accrual basis, 4, Aha! This is a trick question because according to my in depth and very serious analysis, the answer depends on the movements in the accounts Payable and inventory accounts. j sis is less than the 10. An entity makes all its sales on account, The accounts receivable increases during the year. Which of the following statements is true? a, Sales revenue under the cash basis is greater than the sales revenue under the accrual basis. b. Sales revenue under the cash basis is less than the sales revenue under the accrual basis, c. Sales revenue under the cash basis is equal to the sales revenue under the accrual basis. d. I'm tired from my in depth and very serious analysis in the preceding problem. My brain shut down. Help! PROBLEM 4: MULTIPLE CHOICE - COMPUTATIONAL 1, Decker Company assigns some of its patents to other enterprises under a variety of licensing agreements. In some instances advance royalties are received when the agreements are signed, and in others, royalties are remitted within sixty days after each license year-end. The following data are included in Decker’s December 31 balance sheet: 20x2 20x3 Royalties receivable 90,000 85,000 Uneared royalties 60,000 40,000 During 20x3 Decker received royalty remittances of P200,000. In 4 statement of profit or loss for the year ended December 31, *3, Decker should report royalty income of | a. 195,000 b. 215,000 c. 220,000 d 225,009 (aicra) a consultant, keeps her accounting records on : oe pating 20x3, Ward collected 200,000 in fees ine clients, At December 31, 20x2, Ward had accounts Teceivaby of P40,000. At December 31, 20x3, Ward had accoun receivable of P60,000, and unearned fees of P5,000. On Es accrual basis, what was Ward’s service revenue for 20x32 a. 175,000 b. 180,000 c. 215,000 d. 225,000 (AICPA) 3. Cooke Company acquires patent rights from other enterprises and pays-advance royalties in some cases, and in oihers, royalties’ are paid within ninety days after year-end. The ~ following data are included in Cooke’s December 31 balance sheets: 20x2 20x3 Prepaid royalties P55,000 45,000 Royalties payable 80,000 75,000 During 20x3 Cooke remitted royalties of P300,000. In its income statement for the year ended December 31, 20x3, Cooke should report royalty expense of a. 295,000 b. 305,000 c. 310,000 d. 330,000 (AIcPA) 4. Class Corp. maintains its accounting records on the cash basis but restates its financial statements to the accrual method of accounting. Class had P60,000 in cash-basis pretax income for | 20x3. The following information pertains to Class’s operations for the years ended December 31, 20x3 and 20x2: | ; 20x3 20x2 Accounts receivable 40,000 20,000 Accounts payable 15,000 30,000 Under the accrual method, wh at am fi fore taxes should Class report nite pers unt of income be! mber 31, 20x3 income statement? Pr isi me aja to Accrual Basis of Accounting cost Be ig 100 b. 55,000 ; : 3.350 ©. 65,000 98,000 at A small corporation reported revenues of P30,000 using a cash basis accounting system. Total customer payments oli put not earned were P2,100, Services performed but not yet collected amounted to P3,400. Expenses incurred but not es aid totaled P600. Expenses paid but not yet incurred totaled 125. What total revenue amount should the company report under the accrual system? 9.27,900 b. 30,700 c. 31,300 28,100 (aIcPA) 6, Before 20%3, Droit Co, used the cash basis of accounting. As of December 31, 20x3, Droit changed to the accrual basis. Droit cannot determine the beginning balance of supplies inventory. What is the effect of Droit’s inability to determine beginning supplies inventory on its 20x3 accrual basis net income and December 31, 20x3 accrual-basis owners’ equity? 20x3 profit 12/31/x3 owners’ equity a. Noeffect No effect b. No effect Overstated c. Overstated No effect d. Overstated Overstated (AICPA) 7. On Februaty 1, 20x3, Tory began a service proprietorship with an initial cash investment of P2,000. The proprietorship provided P5,000 of services in February and received full payment in March. The proprietorship incurred expenses of 23,000 in February, which were paid in April. During March, Tory drew 1,000 against the capital account. In the proprietorship’s financial statements for the two months ended’March 31, 20x3, prepared under the cash basis method of accounting, what amount should be reported as capital? a. 1,000 b. 3,000 c. 6,000 d. 7,000 (alcpa) information pertains to Eagle Co’s 8. The folldwing Cash sales Gross P 80,000 Returns and allowances 4,000 Credit sales Gross 120,000 Discounts 6,000 | On January 1, 20x3, customers owed Eagle P40,000. On p. 31, 20x3, customers owed Eagle ?30,000. Eagle uses th, writeoff method for bad debts. No bad debts were record, 20x3. Under ‘the cash basis of accounting, what amo: revenue should Eagle report for 20x3? a. 76,000 b. 170,000 c. 190,000 da (AICPA) is 9. Marr Corp. reported rental revenue of P2,210,000 in its ca basis federal income tax return for the year ended November 30, 2003. Additional information is as follows: Rents receivable—November 30, 20x3 P1,060,000 Rents receivable—November 30, 20x2 800,000 Uncollectible rents written off during the fiscal year 30,000 Under the accrual basis, Marr should report rental revenue of a. 1,920,000 b. 1,980,000 2,440,000 —d. 2,500,000 (alcra) 10. Zeta Co. reported sales revenue of P4,600,000 in its income statement for the year ended December 31, 20x3. Additional | information is as follows: = 12/31/x2 12/31/33 ie P1,000,000 1,300.00” Allowance for uncollectible accounts (60,000) (110,000) ba a cues accounts totaling P20,000 during 20s, ca is : 20x3 sales of asis of accounting, Zeta would have TP? a. 4,900,000 A) gy U catcr, . 4,350,000 — ¢. 4,300,000. 4.28008

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