Accounting Documents & Accounting Cycles

It is important that you know the type of documents commonly used to record the occurrence of transactions (Can you think of any examples?). Some of them are:-

  • Official receipts

Normally you will get these when you make payment over the counter to the cashier

  • Cash bills

You seldom get these nowadays. However, if you made purchase of goods from a shop that has no cash register, normally you will get these as proof of payments.

  • Bills

Electricity, water, quit rent & assessment, services. Normally you received these and asked to pay by a specified date.

  • Invoices

Normally you receive these when you purchase physical goods. Same function as bills, invoices ask the recipients to pay by a specified date.

  • Delivery Orders

You get these when you receive the goods that you have ordered previously. However, delivery order is different from invoice, its function is to record the descriptions and quantity of the goods concern, whereas, invoice will state the unit price and also the terms of payments.

The above are the common types of documents you receive when you purchase goods/services (i.e. as a customer/consumer). On the other hand, to the issuing entities, all these documents are issued to their customers when there are sale transactions. Example, for a customer the invoice that he/she received is called specifically as “Purchase Invoices” or “Supplier Invoices”. On the other hand, for a company who sell goods to its customers, the invoices used are referred to as “Sales Invoices”.
  • Purchase Orders

Purchase orders are used to order goods from your suppliers in accordance with your specifications and quantity of the goods.

  • Customer Orders

Customer orders are used for the customers to fill up in ordering the goods.

  • Credit Notes

Credit notes are issued to customers to inform them that their account has been “credited” for the reasons specified in the credit notes (meaning is there is a reduction in the amount that the customer has to pay because of e.g. overcharging of price, defective goods returned, discounts etc.)

  • Debit Notes

Debit notes are issued to customers to inform them that their account has been “debited” for the reasons specified in the debit notes (in contrasts to credit notes, debit notes has the opposite function-the customer is informed that they have to pay more because of e.g. under charging of price, additional charge for miscellaneous services etc.)

  • Payment Vouchers

Payment vouchers are used to record payments made by the business entities in chronological orders, normally in respect of cheque payments.

  • Petty Cash Vouchers

Petty cash vouchers are used to record payments made by the business entities in chronological orders in respect of cash.

  • Goods Received Notes

Goods received notes are used to record receiving of goods purchased. Please take note that the function of Goods Received Notes (GRNs) is different compared to that of the Delivery Orders an entity received from its’ suppliers. Just imagine this – if the entity receives goods from different suppliers, lets say on average of 20 in a day, what would happened if it does not have a systematic way of recording the receiving of goods? HAVOC! However, for many small entities that have minimal purchase transactions, GRNs may not be used as each incident of receiving goods could still be monitored easily. For good control purposes, a receiving logbook is used to record the details of receiving goods (Date, Name of Supplier, Delivery Order Number, Description of goods).

  • Stock Cards & Stock Ledger

Stock cards are used to monitor physical movement of stocks. For better control purposes, stock cards are normally kept and recorded by storekeepers, and only quantity of stocks, stock codes and description of stocks are recorded on the stock cards WITHOUT the unit costs indicated. This is because it is not necessary for storekeepers to know the unit costs of stock (in a way to reduce the risk of pilferage of more expensive stock items). Stock cards are updated based on the evidence of stock-in (goods received notes and delivery orders from suppliers if no goods received notes system practised) and stock-out (delivery orders to customers) In addition to stock cards, some business entities also maintain another type of stock record – stock ledger. Stock ledger is updated with all the details of stocks including the stock code, descriptions, quantity and the total value of each type of stock based on supplier invoices received. At every fixed interval e.g. month end, the quantities of stocks reflected in the stock cards could then be checked and reconciled to the quantities of stocks recorded in the stock ledger and any variances to be investigated and followed-up.

For most business entities, the two most important activities are sales and purchases. And another important accounting cycle, which in a way is related to these two activities, is the cash receipt and payment cycle.A simplified activities chart for a trading company’s sales cycle is as follow:-

Sales Cycle  

saleschart 

 

In each activity, try to list down the type of documents used based on what you know thus far. Compare to the following:-

  • Receive customers’ inquiry

– This can be in many ways, walk-in, telephone, fax, email etc. For internal information record purposes, a separate file to keep track of customers’ inquiry is desirable because any form contact from potential customers should be treated seriously. However, this is not part of the accounting documents because no transactions occurred at this point in time.

  • Check availability of stocks

– Obviously, the store keeper will be contacted to make sure sufficient quantity of stocks are available (stock cards) or else exact date of new arrival of stocks should then be checked and communicated to the customers.

  • Inquire mode of payment

– No documents are used.

  • Check creditworthiness of customer if on credit

– Some form of database of customer maintained by the business entity would be referred to for existing customers. Those with outstanding balances unpaid should be checked as to any outstanding debts exceeding the credit period allowed and also as to the credit limit of the customers. For new customers, details required should be obtained and submitted to the approval of responsible personnel e.g. Sales Manager before accepting orders.

  • Check and agree on pricing

– Approved price list. This is also not part of the accounting documents. Cash purchases normally are cheaper compared to those on credit.

  • Complete customer orders

– Obviously the customer orders. Based on the customer orders, further arrangement such as packing of stocks, transportation arrangement & etc. will be arranged for the delivery of stocks to the customers.

  • Store prepares stocks for delivery

– Initially based on customer orders to prepare stocks. Update stock cards based on actual quantity of stock-out based on delivery orders to customers.

  • Generate delivery orders

– Obviously the delivery orders to customers.

  • Generate sales invoices

– Obviously the sales invoices to customers.

  • Delivery to customers

– The physical stocks together with the delivery orders and the sales invoices to the customers.

Note: Some of the documents generated are made more than one copy. For example, the customer orders could be printed in three copies – the original to the customer, a copy to store and another kept by the sales department. This is dependent on the requirement of each business entity. A document flowchart could also be drawn up to show how the accounting documents are generated and used throughout the whole sales cycle (Not shown here). It is very often that sales invoices are handed over to the customer together with the delivery orders and the goods because payment is expected to be received faster compared to if the sales invoices are generated and given to the customers at a date subsequent to delivery of goods. 

 

Purchases Cycle

A simplified activities chart for a trading company’s purchases cycle (assume purchase on credit term) is as follow:-

PurchasesChart

 

In each activity, try to list down the type of documents used based on what you know thus far. Compare to the following:-

  • Raise purchase requisition

– Dependent on the nature of the businesses, when stocks level reach re-ordering level, for “back-to-back” orders where no stocks are kept, when receiving customers’order.

  • Contact suppliers and obtain quotations

– Dependent on the policy of the business entities concerned, some require minimum three quotations to be obtained from different supplier for comparison.

  • Select supplier in accordance with policy set

– Dependent on the policy of the business entities, selection of supplier may not necessary based the lowest price quoted, past dealings that give indication of quality of goods, speed of delivery & etc. should also be considered in selecting supplier.

  • Generate purchase orders

– Once the supplier is selected, purchase orders are generated.

  • Placing orders with supplier

– Approved purchase order is given to the selected supplier.

  • Receiving goods together with delivery orders and invoices

– Checking the correct specification, condition and quantity of good received by matching to the purchase order raised previously.

  • Generate goods received notes

– Obviously the goods received notes and also update the stock cards.

  • Delivery notes, invoices and goods received notes to Accounts Department for checking and payment

– Delivery notes, supplier invoices and good received notes would be handled over to the Accounts Department for checking and prepare payment. Stock ledger will be updated

Note: Purchase orders are generated in multiple copies – example, the original copy to the supplier, one copy kept by the Purchasing Department, one copy to the Store and one copy to the Accounts Department. Sometimes, the delivery orders and invoices received from the supplier are handed over from the store receiving goods to the Purchasing Department instead of directly to the Accounts Department. The Purchasing Department would perform the checking role on the purchases. Once approved by the Purchasing Department, the Accounts Department would proceed straight to updating stock ledger and payment.

Cash Receipt and Payment Cycle
 
I will not show this cycle in terms of activities chart as the procedures involved are much simpler compared to the sales and purchase cycles. However, the typical procedures in receiving cash and payments would be discussed.

Receiving cash

Dependent on the nature of business, the mode of receiving payment from customers includes cash, cheque, direct deposit to the bank account via wire-transfer & credit card. Can you think of others? The most important control checkpoint in receiving payments from customers is to be able to account for each and every single payment received and ensure that it is deposited into the bank account of the business entity. For this purpose, pre-numbered official receipt is used. For cash collected from customers, it should be counted at the end of the day and be deposited into the bank account of the business entity the soonest possible. A listing of official receipt indicating the total receipts of the day should then be prepared, matched to the bank deposit slips and properly approved. Similarly for other form of receipts, cheques, credit cards, wire transfer & etc. as soon as they are deposited into the bank account of the business entity, checking of the money deposited to the official receipts MUST BE DONE. The most frequent problem that I have encountered in respect of receipts from customers is in the situation whereby customers deposited payment directly into the bank account of the business entity. If no systematic procedures established with regard to this, the result is unidentified receipts appearing in the bank statements and it could result in unnecessary time and effort spent to trace the identity of the payee. Proper deposit form should be distributed to each customer who wish to make payment in this manner and make sure that a copy is completed properly with all the required payment details and forward a copy to the business entity.

Payments

Payments could be made for purchases in the form of cash for small sum and cheques for larger amounts. For cash payments, petty cash vouchers are used and each payment must be supported by the relevant supporting documents such as bills and official receipts. For cheque payments or wire-transfers, payment vouchers are used. All the relevant payment supporting documents such as invoices, bills & etc. must be enclosed together and properly checked and approved.

In addition to the above, can you name the common types of documents that are used by business entities? (different business entities in different industries may have their own special type of documents pertaining to their industries)

Various Types of Transactions – Collection from Other Source of Revenue and Income (Part 4)

As mentioned in my post: Various Types of Transactions – Part 1, Introduction, there were 5 examples of other source of revenue or income highlighted – interest income, dividend income, rental income, proceeds from disposal of assets and compensation received for loss of assets. Please take note that this is not an exhaustive list as there are more types of other source of revenue and income not mentioned. For the purpose of easy understanding and simplicity, I will only discuss these 5 different other source of revenue and income in the following posts:-

Various Types of Transactions – Collection from Other Source of Revenue and Income, Compensation Received for Loss of Assets (Part 4e)

Business entities may encounter some unfortunate events such as fire, flood or others that cause damage to their assets. After assessment of the damages caused, the insurance companies will then pay the relevant compensation to these business entities. If the assets damaged are fixed assets, the relevant double entries involved in the recording of the loss of the assets have been illustrated in my post: Various Types of Transactions – Pat 4d, Collection from Other Source of Revenue and Income (Proceeds from Disposal of Assets).However, if the damaged assets are inventories or stocks, the carrying value of the inventories or stock should be deducted against the compensation received to determine the net loss:-

$

Compensation received

XXXX

Carrying value of inventories

(XXXX)

Loss on damaged inventories

(XXXX)*

*Loss is shown here because the amount of compensation paid by the insurance company would normally not exceed the carrying value of the inventories.

The double entries involved in the recording of the recognition of the loss of damaged inventories are different, depending on the method of recording inventories in the general ledger, i.e. Perpetual Method or Periodic Method. Please refer to my post: Inventories or Stocks – Part 2, Methods of Recording in General Ledger for detailed illustrations of these two methods.

Example

The financial period of ABC Co. Ltd. is from 1 January to 31 December. On 1 January 2006, ABC Co. Ltd paid cash to purchase 1,000 trading goods of $20 each. On 31 July 2006, 800 units were sold at $25 each. On 30 September 2006, 100 units were damaged due to flood. On 15 October 2006, ABC Co. Ltd received a cheque of $1,800 from the insurance company as compensation.

Perpetual Method of recording Inventories

The relevant double entries are:-

1. On 1 January 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Inventories

20,000

Cash at bank

20,000

2. On 31 July 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

20,000

Sales

20,000

Balance Sheet

Income Statement

DR

CR

DR

CR

Cost of sales

16,000

Inventories

*16,000

*800 units X $20 per unit

3. On 30 September 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Loss on damaged inventories

2,000

Inventories

2,000

4. On 15 October 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

1,800

Loss on damaged inventories

1,800

The income statement and extract of the balance sheet of ABC Co. Ltd. are shown below:-

Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2006

$

Sales

20,000

A

Less: Cost of Sales

16,000

B

Gross profit

4,000

C = A – B

Other income

Operating expenses: –
Loss on damaged inventories (2,000 – 1,800)

-200

D

Net profit for the year

3,800

E = C + D

Extract of the Balance Sheet as at 31 December 2006

$

Current assets
Inventories

2,000

Trade receivables

XXXX

Other receivables, deposits & prepayments:

Rental receivable

XXXX

Rental deposit

XXXX

Utility deposit

XXXX

Cash and bank balances

XXXX

XXXX

Periodic Method of recording Inventories

The relevant double entries are:-

1. On 1 January 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cost of sales – Purchases

20,000

Cash at bank

24,000

2. On 31 July 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

20,000

Sales

20,000

3. On 30 September 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Loss on damaged inventories

2,000

Cost of sales – Transfer to loss on damaged inventories

2,000

4. On 15 October 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

1,800

Loss on damaged inventories

1,800

5. On 31 December 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Inventories

*2,000

Cost of sales – Closing inventories

2,000

*This closing inventories balance is usually determined by way of conducting a stock counting exercise at year end – 100 units X $20 each.

The income statement and extract of the balance sheet of ABC Co. Ltd. are shown below:-

Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2006

$

Sales

20,000

A

Less: Cost of Sales
Opening inventories

Purchases

20,000

Transfer to loss on damaged inventories

-2,000

Closing inventories

-2,000

16,000

B

Gross profit

4,000

C = A – B

Other income

Operating expenses
Loss on damaged inventories (2,000 – 1,800)

-200

D

Net profit for the year

3,800

E = C + D

Extract of the Balance Sheet as at 31 December 2006

$

Current assets
Inventories

2,000

Trade receivables

XXXX

Other receivables, deposits & prepayments:

Rental receivable

XXXX

Rental deposit

XXXX

Utility deposit

XXXX

Cash and bank balances

XXXX

XXXX

Various Types of Transactions – Collection from Other Source of Revenue and Income, Proceeds from Disposal of Assets (Part 4d)

When a business entity dispose of its fixed assets or more commonly now referred to as property, plant and equipment, the carrying amount or the net book value of the assets concerned is deducted from the proceeds received at the date of disposal to determine the gain or loss on disposal:-

$

Proceeds from disposal

XXXX

Carrying amount or net book value of fixed assets

(XXXX)

Gain/(Loss) on disposal

XXXX/(XXXX)

Example

The financial period of ABC Co. Ltd. is from 1 January to 31 December. On 1 February 2006, ABC Co. Ltd paid cash to purchase a motor vehicle costing $24,000. The depreciation rate applied to this motor vehicle is 20% per annum (I will have a detailed discussion on depreciation in my future post). On 1 February 2007, ABC Co. Ltd decided to dispose this motor vehicle and sold it for $16,000.The depreciation of this motor vehicle is calculated as follows:-

Cost of motor vehicle = $24,000
Depreciation rate = 20%
Depreciation charge per month = $24,000 X 20% X 1/12
= $400

Financial Year Ended 31 December 2006

The relevant double entries are:-

1. To record the purchase of motor vehicle on 1 February 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Motor vehicle – Cost

24,000

Cash at bank

24,000

2. To record depreciation of motor vehicle from the date of acquisition (1 February 2006) to the end of the financial year (31December 2006)

Balance Sheet

Income Statement

DR

CR

DR

CR

Depreciation – Motor vehicle

*4,400

Motor vehicle – Accumulated depreciation

4,400

*Depreciation is for the period from 1 February 2006 to 31 December 2006, i.e. 11 months. Therefore, total amount of depreciation is $4,400 ($400 per month X 11 months)The income statement and balance sheet of ABC Co. Ltd. before and after recording Entry 1 and 2 above are shown below:-

Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2006

$

Sales

109,270

Cost of Sales

-40,875

Gross profit

68,395

Other income: –
Rental income

12,000

Operating expenses: –
Accountancy fee

-800

Depreciation of property, plant and equipment

-4,400

Donation

-500

Electricity & water

-3,340

Insurance premium

-200

Printing & stationery

-1,697

Rental of premises

-12,000

Salaries

-27,865

Upkeep of office

-3,547

Telephone charges

-1,285

Travelling, petrol & toll charges

-2,648

-58,282

Net profit for the year

22,113

Retained profits B/F

27,654

Retained profits C/F

49,767

Balance Sheet as at 31 December 2006

$

Non-current assets
Property, plant and equipment

19,600

Note 1
Current assets
Inventories 5,000
Trade receivables 32,807
Other receivables, deposits & prepayments:
Rental receivable 3,000
Rental deposit 3,000
Utility deposit 500
Cash and bank balances 29,023
73,330
Current liabilities
Trade payables

-3,588

Other payables and accruals

-46,688

-50,276

Net current assets 23,054
42,654
Financed by: –
Share capital 15,000
Retained profits 27,654
42,654

Note 1: The breakdown of the property, plant and equipment:-

$
Property, plant and equipment – Motor vehicle
Cost

24,000

Accumulated depreciation

-4,400

Carrying amount 19,600

Financial Year Ended 31 December 2007. The relevant entries for the financial year ended 31 December 2007: –

1. To record the depreciation of motor vehicle from the beginning of the financial year (1 January 2007) to the date of disposal (1 February 2007)

Balance Sheet

Income Statement

DR

CR

DR

CR

Depreciation – Motor vehicle

400

Motor vehicle – Accumulated depreciation

400

2. To record the disposal of motor vehicle and recognise the loss on disposal

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

16,000

400

Motor vehicle – Accumulated depreciation

4,800

Motor vehicle – Cost 24,000
Loss on disposal of motor vehicle 3,200

The relevant “T” accounts shown below provide a clearer picture of the relevant figures involved in respect of the depreciation and disposal of the motor vehicle:-

ABC Co. Ltd

General Ledger

Motor Vehicle – Cost (Balance Sheet)
DEBIT

CREDIT

Date

Descriptions

Folio

$

Date

Descriptions

Folio

$

2006 2006
01-Feb Cash at Bank 24,000.00 31-Dec Balance C/F 24,000.00
24,000.00 24,000.00
2007 2007
01-Jan Balance B/F 24,000.00 01-Feb Loss on disposal of motor vehicle 24,000.00
24,000.00 24,000.00
Motor Vehicle – Accumulated Depreciation (Balance Sheet)
DEBIT

CREDIT

Date

Descriptions

Folio

$

Date

Descriptions

Folio

$

2006 2006
31-Dec Balance C/F 4,400.00 28-Feb Depreciation of motor vehicle 400.00
31-Mar Depreciation of motor vehicle 400.00
30-Apr Depreciation of motor vehicle 400.00
31-May Depreciation of motor vehicle 400.00
30-Jun Depreciation of motor vehicle 400.00
31-Jul Depreciation of motor vehicle 400.00
31-Aug Depreciation of motor vehicle 400.00
30-Sep Depreciation of motor vehicle 400.00
31-Oct Depreciation of motor vehicle 400.00
30-Nov Depreciation of motor vehicle 400.00
31-Dec Depreciation of motor vehicle 400.00
4,400.00 4,400.00
2007 2007
01-Feb Loss on disposal of motor vehicle 4,800.00 01-Jan Balance B/F 4,400.00
31-Jan Depreciation of motor vehicle 400.00
4,800.00 4,800.00
Motor Vehicle – Accumulated Depreciation (Income Statement)
DEBIT

CREDIT

Date

Descriptions

Folio

$

Date

Descriptions

Folio

$

2006 2006
28-Feb Depreciation of motor vehicle 400.00 31-Dec To income statement 4,400.00
31-Mar Depreciation of motor vehicle 400.00
30-Apr Depreciation of motor vehicle 400.00
31-May Depreciation of motor vehicle 400.00
30-Jun Depreciation of motor vehicle 400.00
31-Jul Depreciation of motor vehicle 400.00
31-Aug Depreciation of motor vehicle 400.00
30-Sep Depreciation of motor vehicle 400.00
31-Oct Depreciation of motor vehicle 400.00
30-Nov Depreciation of motor vehicle 400.00
31-Dec Depreciation of motor vehicle 400.00
4,400.00 4,400.00
2007 2007
01-Jan Depreciation of motor vehicle 400.00 31-Jan To income statement 400.00
400.00 400.00
Loss on Disposal of Motor Vehicle (Income Statement)
DEBIT

CREDIT

Date

Descriptions

Folio

$

Date

Descriptions

Folio

$

2007 2007
01-Feb Motor vehicle – Cost 24,000.00 01-Feb Motor vehicle – Accumulated depreciation 4,800.00
01-Feb Cash at bank 16,000.00
31-Dec To income statement 3,200.00
24,000.00 24,000.00

The income statement and balance sheet of ABC Co. Ltd. before and after recording Entry 1 and 2 above are shown below:-

Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2007

$

Sales

159,270

Cost of Sales

-90,875

Gross profit

68,395

Other income: –
Rental income

22,500

Operating expenses: –
Accountancy fee

-800

Depreciation of property, plant and equipment

-400

Donation

-500

Electricity & water

-3,340

Insurance premium

-200

Loss on disposal of motor vehicle

-3,200

Printing & stationery

-1,697

Rental of premises

-12,000

Salaries

-35,579

Upkeep of office

-3,547

Telephone charges

-1,285

Travelling, petrol & toll charges

-2,648

-65,196

Net profit for the year

25,699

Retained profits B/F

27,654

Retained profits C/F

53,353

Balance Sheet as at 31 December 2007

$

Non-current assets
Property, plant and equipment

Current assets
Inventories

5,200

Trade receivables

6,000

Other receivables, deposits & prepayments:

Rental deposit

3,000

Utility deposit

500

Cash and bank balances

82,652

97,352

Current liabilities
Trade payables

-3,588

Other payables and accruals:

Other payables

-25,411

-28,999

Net current assets

68,353

68,353

Financed by: –
Share capital

15,000

Retained profits

53,353

68,353

Various Types of Transactions – Collection from Other Source of Revenue and Income, Rental Income (Part 4c)

Rental income is earned by business entities for allowing another party to “use” the resources (assets) of the business entities. For example, letting of property, machinery, equipment & etc. An agreement is usually drafted and agreed by both parties. The terms agreed upon usually include the details or specifications of the assets, date of agreement, period, amount of rental e.g. per month. Many small businesses record rental income on cash basis, i.e. upon receipt. The double entry for recording rental income on cash basis is:-

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

XXXX

Rental income

XXXX

Example

The financial period of ABC Co. Ltd. is from 1 January to 31 December. On 10 January 2006, XYZ Co. Ltd. agreed to rent Level 1 of a 3 levels shop owned by ABC Co. Ltd for 3 years commencing 1 March 2006 at $1,500 per month. 2 months rental and $500 utility deposit are collected by ABC Co. Ltd as security deposits. The following schedule shows the details of the money collected by ABC Co. Ltd. from XYZ Co. Ltd.:-

Date Details

$

10-Jan-06 2 months rental as deposit 3,000
Utility deposit 500
25-Mar-06 March ’06 rental 1,500
03-May-06 April ’06 rental 1,500
20-Jun-06 May ’06 rental 1,500
30-Aug-06 June ’06 rental 1,500
July ’06 rental 1,500
30-Nov-06 August ’06 rental 1,500
September ’06 rental 1,500
05-Dec-06 October ’06 rental 1,500
05-Jan-07 November ’06 rental 1,500
December ’06 rental 1,500
January ’07 rental 1,500
03-Apr-07 February ’07 rental 1,500
17-Jun-07 March ’07 rental 1,500
April ’07 rental 1,500
May ’07 rental 1,500
23-Aug-07 June ’07 rental 1,500
July ’07 rental 1,500
August ’07 rental 1,500
12-Sep-07 September ’07 rental 1,500
11-Oct-07 October ’07 rental 1,500
03-Nov-07 November ’07 rental 1,500
December ’07 rental 1,500
January ’08 rental 1,500

In the books of ABC Co. Ltd.

The rental recorded in the accounts for the year ended 31 December 006 under cash basis of accounting comprised the following:-

Date Details

$

25-Mar-06 March ’06 rental 1,500
03-May-06 April ’06 rental 1,500
20-Jun-06 May ’06 rental 1,500
30-Aug-06 June ’06 rental 1,500
July ’06 rental 1,500
30-Nov-06 August ’06 rental 1,500
September ’06 rental 1,500
05-Dec-06 October ’06 rental 1,500
TOTAL COLLECTED 12,000

The double entries for the recording of the rental deposit, utility deposit and the 8 months rental collected (March ’06 to October ’06) during the year ended 31 December 2006 are:-

1. Rental deposit and security deposits

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

3,500

Refundable deposits:
– Rentals

3,000

– Utility

500

2. 8 months rental (March ’06 to October ’06)

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

12,000

Rental income

12,000

3. Recognition November ’06 and December ’06 rental

The following adjustment is required to recognise the 2 months rental receivable (November ’06 and December ’06):-

Balance Sheet

Income Statement

DR

CR

DR

CR

Rental receivable

3,000

Rental income

3,000

The income statement and balance sheet of ABC Co. Ltd. before and after this adjustment for the recognition of 2 months rental are shown below to illustrate the impact of this adjustment:-

Example of Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2006

BEFORE

Adjustment

AFTER

DR

CR

$

$

Sales

109,270

109,270

Cost of Sales

– 40,875

– 40,875

Gross profit

68,395

68,395

Other income: –
Rental income

12,000

3,000

15,000

Operating expenses: –
Accountancy fee

– 800

– 800

Depreciation of property, plant and equipment

– 2,500

– 2,500

Donation

– 500

– 500

Electricity & water

– 3,340

– 3,340

Insurance premium

– 200

– 200

Printing & stationery

– 1,697

– 1,697

Rental of premises

– 12,000

– 12,000

Salaries

– 27,865

– 27,865

Upkeep of office

– 3,547

– 3,547

Telephone charges

– 1,285

– 1,285

Travelling, petrol & toll charges

– 2,648

– 2,648

– 56,382

– 56,382

Net profit for the year

24,013

27,013

Retained profits B/F

27,654

27,654

Retained profits C/F

51,667

54,667

Balance Sheet as at 31 December 2006

$

$

Non-current assets
Property, plant and equipment

102,500

102,500

Current assets
Inventories

5,000

5,000

Trade receivables

32,807

32,807

Other receivables, deposits & prepayments:

Rental receivable

3,000

3,000

Rental deposit

3,000

3,000

Utility deposit

500

500

Cash and bank balances

29,023

29,023

70,330

73,330

Current liabilities
Trade payables

– 3,588

– 3,588

Other payables and accruals

– 102,575

– 102,575

– 106,163

– 106,163

Net current assets

– 35,833

– 32,833

66,667

69,667

Financed by: –
Share capital

15,000

15,000

Retained profits

51,667

54,667

66,667

69,667

For the financial year ended 31 December 2007, ABC Co. Ltd. would have recorded the following rental collected during the year ended 31 December 2007: –

Date Details

$

05-Jan-07 November ’06 rental 1,500
December ’06 rental 1,500
January ’07 rental 1,500
03-Apr-07 February ’07 rental 1,500
17-Jun-07 March ’07 rental 1,500
April ’07 rental 1,500
May ’07 rental 1,500
23-Aug-07 June ’07 rental 1,500
July ’07 rental 1,500
August ’07 rental 1,500
12-Sep-07 September ’07 rental 1,500
11-Oct-07 October ’07 rental 1,500
03-Nov-07 November ’07 rental 1,500
December ’07 rental 1,500
January ’08 rental 1,500
TOTAL COLLECTED 22,500

The double entry for the recording of these rentals received during the year ended 31 December 2007 is as follows:-

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

22,500

Rental income

22,500

As the November 2006 and December 2006 rental collected should be recognised in the financial year ended 31 December 2006 and not 31 December 2007, the following correction journal adjustments are required:-

1. Correction of rentals incorrectly recognised during the financial year ended 31 December 2007

Balance Sheet

Income Statement

DR

CR

DR

CR

Rental receivable

3,000

Retained profits

3,000

This journal entry is actually the same as the journal entry shown earlier to recognise the rental income in the financial year ended 31 December 2006. In the context of the financial statements of ABC Co. Ltd. for the year ended 31 December 2007, any adjustments made that affect the profit in earlier years, are now required to be adjusted to the retained profits brought forward.

2. Reversal of rental income incorrectly recognised in the income statement of ABC Co. Ltd. for the year ended 31 December 2007 and rental receivable

Balance Sheet

Income Statement

DR

CR

DR

CR

Rental income

3,000

Rental receivable

3,000

3. In addition, the rental of January 2008 collected on 3 November 2007 should only be recognised as rental income in the financial statements for the year ended 31 December 2008. The following correction journal adjustment is required:-

Reversal of January 2008 rental collected incorrectly recognised in the income statement of ABC Co. Ltd. for the year ended 31 December 2007

Balance Sheet

Income Statement

DR

CR

DR

CR

Rental income

1,500

Advance rental collected

1,500

The income statement and balance sheet of ABC Co. Ltd. before and after adjustment No. 1, 2 & 3 are shown below to illustrate the impact of these adjustments: –

Example of Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2007
BEFORE Adjustment AFTER
No. DR No. CR

$

$

Sales

159,270

159,270

Cost of Sales

– 90,875

– 90,875

Gross profit

68,395

68,395

Other income: –
Rental income

22,500

2 3,000

18,000

3 1,500
Operating expenses: –
Accountancy fee

– 800

– 800

Depreciation of property, plant andequipment

– 2,500

– 2,500

Donation

– 500

– 500

Electricity & water

– 3,340

– 3,340

Insurance premium

– 200

– 200

Printing & stationery

– 1,697

– 1,697

Rental of premises

– 12,000

– 12,000

Salaries

– 35,579

– 35,579

Upkeep of office

– 3,547

– 3,547

Telephone charges

– 1,285

– 1,285

Travelling, petrol & toll charges

– 2,648

– 2,648

– 64,096

– 64,096

Net profit for the year

26,799

22,299

Retained profits B/F

51,667

1 3,000

54,667

Retained profits C/F

78,466

76,966

Balance Sheet as at 31 December 2007

$

$

Non-current assets
Property, plant and equipment

100,000

100,000

Current assets
Inventories

5,200

5,200

Trade receivables

6,000

6,000

Other receivables, deposits & prepayments:

Rental receivable

1 3,000 2 3,000

Rental deposit

3,000

3,000

Utility deposit

500

500

Cash and bank balances

52,652

52,652

67,352

67,352

Current liabilities
Trade payables

– 3,588

– 3,588

Other payables and accruals:

Other payables

– 70,298

– 70,298

Advance rental collected

3 1,500

– 1,500

– 73,886

– 75,386

Net current assets

– 6,534

– 8,034

93,466

91,966

Financed by: –
Share capital

15,000

15,000

Retained profits

78,466

2 3,000 1 3,000

76,966

Note 1
3 1,500

93,466

91,966

Note 1:

All adjustments affecting the income statements have to be repeated again and shown as adjustments to the retained profits account in the balance sheet. This is because all adjustments affecting any income statement items and the retained profits brought forward will eventually be included in the retained profits carried forward to the next financial year.

Various Types of Transactions – Collection from Other Source of Revenue and Income, Dividend Income (Part 4b)

For those business entities who have invested in shares of another company, dividends may be received by these business entities as a way of distributing the earnings or profits made by the investee companies to the shareholders. Dividends could take the form of cash or non-cash (e.g. bonus shares, property etc.). I will only discuss the recording of cash dividend income in this post.

Whenever dividends are distributed to the shareholders, enclosed together with the cheques to the shareholders are dividend warrants or vouchers. The dividend warrants or vouchers show the details of the dividends payments.

Dividends are classified into two types: 1. Interim dividends, and; 2. Final dividends. It should be noted that it is the Board of Directors of companies that has the power to determine how frequent to declare and how much to declare interim dividends, NOT the shareholders. However, when interim dividends are paid during the financial year, there is a general expectation that final dividends will be proposed by the Board of Directors in the coming Annual General Meeting of members and subject to approval by the shareholders.

When a company declares and pays dividends, the relevant financial period would be mentioned in the warrant or voucher and usually, the dividends are declared and paid depending on the profits that have been generated during this financial period. However, the Board of Directors of a company making losses in the current financial year could still declare and paid dividends out of the profits retained or accumulated in the previous financial year.

According to International Accounting Standards (IAS) 18, dividends (income) shall be recognised when the shareholders’ right to receive payment is established. This is usually easy to identify as the date of the dividend entitlement is stated clearly on the dividend warrants or vouchers.

Many small businesses record dividend income on cash basis, i.e. upon receipt. The double entry for recording dividend income is:-

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank*

XXXX

Dividend income

XXXX

*Business entities usually receive dividend income by way of cheques and not “hard cash”. Therefore only the cash at bank account is debited and not petty cash.

Example

The financial period of ABC Co. Ltd. is from 1 January to 31 December. On 10 January 2007, ABC Co. Ltd. received $5,000 dividend from XYZ Co. Ltd., a company in which ABC Co. Ltd; paid $80,000 to acquire 80,000 ordinary shares of $1.00 each on 1 January 2006. ABC Co. Ltd. records its transactions using cash basis of accounting, the dividend voucher received:-

XYX CO. LTD.
DIVIDEND NO. TYPE OF DIVIDEND

FOR YEAR ENDED

ENTITLEMENT DATE

DATE OF PAYMENT

01 INTERIM

31 DECEMBER 2006

31 DECEMBER 2006

10 JANUARY 2007

VOUCHER NO. NUMBER OF SHARES HELD OF $1.00 EACH DIVIDEND RATE GROSS DIVIDEND INCOME TAX @ 30% NET DIVIDEND
003 80,000 6.25 CENTS PER SHARE $5,000 TAX EXEMPT $5,000
ABC CO. LTD.
123, GOODLUCK STREET
5678 PROSPER LAND

For the financial year ended 31 December 2006, ABC Co. Ltd. would not have recorded the dividend income because this transaction will be recorded in the accounts of ABC Co. Ltd. upon receiving the income on 10 January 2007. In respect of the $80,000 investment in shares of XYZ Co. Ltd. the double entry is:-

Balance Sheet

Income Statement

DR

CR

DR

CR

Investment in XYZ

80,000

Cash at bank

80,000

The journal adjustment to recognise the dividend income (ABC Co. has the right to receive this dividend on 31 December 2006) is:-

Balance Sheet

Income Statement

DR

CR

DR

CR

Dividend receivable

5,000

Dividend income

5,000

The income statement and balance sheet of ABC Co. Ltd. before and after this adjustment for dividend income recognition are shown below to illustrate the impact of this adjustment: –

Example of Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2006
BEFORE Adjustment AFTER
DR CR

$

$

Sales 109,270 109,270
Cost of Sales – 40,875 – 40,875
Gross profit 68,395 68,395
Other income: –
Dividend income

5,000

5,000

Operating expenses: –
Accountancy fee – 800 – 800
Depreciation of property, plant and equipment – 2,500 – 2,500
Donation – 500 – 500
Electricity & water – 3,340 – 3,340
Insurance premium – 200 – 200
Printing & stationery – 1,697 – 1,697
Rental of premises – 12,000 – 12,000
Salaries – 27,865 – 27,865
Upkeep of office – 3,547 – 3,547
Telephone charges – 1,285 – 1,285
Travelling, petrol & toll charges – 2,648 – 2,648
– 56,382 – 56,382
Net profit for the year 12,013 17,013
Retained profits B/F 27,654 27,654
Retained profits C/F 39,667 44,667
Balance Sheet as at 31 December 2006

$

$

Non-current assets
Property, plant and equipment 12,500 12,500
Investment in XYZ 80,000 80,000
Current assets
Inventories 5,000 5,000
Trade receivables 17,030 17,030
Other receivables, deposits & prepayments:
Dividend receivable

5,000 5,000
Deposits 14,077 14,077
Prepayments 2,200 2,200
Cash and bank balances 30,023 30,023
68,330 73,330
Current liabilities
Trade payables – 3,588 – 3,588
Other payables and accruals – 102,575 – 102,575
– 106,163 – 106,163
Net current assets – 37,833 – 32,833
54,667 59,667
Financed by: –
Share capital 15,000 15,000
Retained profits 39,667 44,667
54,667 59,667

For the financial year ended 31 December 2007, ABC Co. Ltd. would have recorded the $5,000 dividend received on 10 January 2007 as follow: –

Balance Sheet Income Statement
DR CR DR CR
Cash at bank 5,000
Dividend income 5,000

As the dividend income should be recognised in the financial year ended 31 December 2006 and not 31 December 2007, the following correction journal adjustments are required:-

1. Correction of dividend incorrectly recognised during the financial year ended 31 December 2007

Balance Sheet

Income Statement

DR

CR

DR

CR

Dividend receivable

5,000

Retained profits

5,000

Note: This journal entry is actually the same as the journal entry shown earlier to recognise the dividend income in the financial year ended 31 December 2006. In the context of the financial statements of ABC Co. Ltd. for the year ended 31 December 2007, any adjustments made that affect the profit in earlier years, are now required to be adjusted to the retained profits brought forward.

2. Reversal of dividend income incorrectly recognised in the income statement of ABC Co. Ltd. for the year ended 31 December 2007 and dividend receivable

Balance Sheet

Income Statement

DR

CR

DR

CR

Dividend income

5,000

Dividend receivable

5,000

The income statement and balance sheet of ABC Co. Ltd. before and after adjustment No. 1 & 2 are shown below to illustrate the impact of these adjustments: –

Example of Income Statement and Balance Sheet of ABC Co. Ltd.
Income Statement for the year ended 31 December 2007
BEFORE Adjustment AFTER
No. DR No. CR

$

$

Sales 159,270 159,270
Cost of Sales – 90,875 – 90,875
Gross profit 68,395 68,395
Other income: –
Dividend income

5,000

2 5,000

Operating expenses: –
Accountancy fee – 800 – 800
Depreciation of property, plant and equipment – 2,500 – 2,500
Donation – 500 – 500
Electricity & water – 3,340 – 3,340
Insurance premium – 200 – 200
Printing & stationery – 1,697 – 1,697
Rental of premises – 12,000 – 12,000
Salaries – 35,579 – 35,579
Upkeep of office – 3,547 – 3,547
Telephone charges – 1,285 – 1,285
Travelling, petrol & toll charges – 2,648 – 2,648
– 64,096 – 64,096
Net profit for the year 9,299 4,299
Retained profits B/F 39,667 1 5,000 44,667
Retained profits C/F 48,966 48,966
Balance Sheet as at 31 December 2007

$

$

Non-current assets
Property, plant and equipment 10,000 10,000
Investment in XYZ 80,000 80,000
Current assets
Inventories 5,200 5,200
Trade receivables 6,000 6,000
Other receivables, deposits & prepayments:
Dividend receivable

1 5,000 2 5,000

Deposits 14,077 14,077
Prepayments 2,200 2,200
Cash and bank balances 52,652 52,652
80,129 80,129
Current liabilities
Trade payables – 3,588 – 3,588
Other payables and accruals – 102,575 – 102,575
– 106,163 – 106,163
Net current assets – 26,034 – 26,034
63,966 63,966
Financed by: –
Share capital 15,000 15,000
Retained profits 48,966 2 5,000 1 5,000 48,966 Note 1
63,966 63,966

Note 1:

All adjustments affecting the income statements have to be repeated again and shown as adjustments to the retained profits account in the balance sheet. This is because all adjustments affecting any income statement items and the retained profits brought forward will eventually be included in the retained profits carried forward to the next financial year.

The discussions in this post do not include the explanations on the effect of tax on dividends and the dividend imputation system imposed in some countries. Please refer to my post: Dividend Imputation for further details.