BASIC EARNINGS PER SHARE

The earnings per share figure is the amount attributable to every ordinary share outstanding during
the period.

Ordinary share is an equity instrument that is subordinate to all other classes of equity instruments.

The earnings per share information pertains only to ordinary share.

Public entities are required to present earnings per share.

Nonpublic entities are not required but are encouraged to present earnings per share.

Illustration:
An entity provided the following information for the current year:

Preference share capital, P100 par, 10% cumulative 1,000,000

Ordinary share capital, P100 par, 50,000 share 5,000,000
Income from continuing operations 1,500,000
Income from discontinued operation 500,000
Net income 2,000,000
Basic earnings per share
Income from continuing operations 1,500,000
Preference dividend for current year (10% x P1,000,000) ( 100,000)
Income to ordinary share 1,400,000

Income from continuing operations

(1,400,000/50,000 shares) 28
Income from discontinued operation
(500,000/50,000 shares) 10
Net income 38

Illustration - Participating preference here.

An entity had the following capital structure at the end of the current year:

Ordinary share capital, P100 par, 80,000 shares issued

and outstanding 8,000,000
Preference share capital, P50 par, 40,000 shares issued
and outstanding 2,000,000
Net income for the year 3,000,000

The preference dividend rate is 10% and the preference here is nonconvertible but cumulative and fully
participating.

Computation

After the ordinary share has been paid a dividend of P20 per share, the preference shares shall participate
in any additional dividends on prorate basis with the ordinary share.

Preference Ordinary

Basic dividend
Preference (10% x 2,000,000) 200,000
Ordinary (80,000 x 20) 1,600,000
Balance for participation 240,000 960,000
Total dividends 440,000 2,560,000
Net income 3,000,000
Basic dividend (200,000 + 1,600,000) (1,800,000)
Balance for participation 1,200,000

Amount Fraction Participation

Preference share 2,000,000 2/10 240,000
Ordinary share 8,000,000 8/10 960,000

10,000,000 1,200,000

Basic earnings per share

Preference share ( 440,000/40,000) 11.00

Ordinary share (2,560,000/80,000) 32.00

DILUTED EARNINGS PER SHARE

A potential ordinary share is a financial instrument or other contract that may entitle the holder to
ordinary shares.

3 types of potential ordinary shares are:

a. Convertible bond payable

b. Convertible preference share
c. Share option and warrant

Dilution arises when the inclusion of the potential ordinary shares decreases the basic earnings per
share or increases the basic loss per share.

Antidilution arises when the inclusion of the potential ordinary shares increases basic earnings per
share or decreases basic loss per share.

The computation of the diluted earnings per share is based on the "as if" scenario:

a. “As if” the convertible bond payable is converted into ordinary share.
b. “As if” the convertible preference share is converted into ordinary share.
c. “As if” the share options and warrants are exercised.

Illustration

An entity had the following securities outstanding at the beginning of the current year.

10% convertible bonds payable, each P1000 bond

convertible into 10 ordinary shares 4,000,000
Ordinary share capital, P100 par, 250,000 shares
authorized, 100,000 shares issued 10,000,000

Net income 5,000,000

Income tax rate 25%

Basic earnings per share

Net income 5,000,000

Divide by ordinary shares actually outstanding 100, 000

Basic earnings per share 50

Diluted earnings per share

Net income 5,000,000

Add: Interest expense on bonds payable
(10% x 4,000,000) 400,000
Income tax (25% x 400,000) (100,000) 300,000

Adjusted net income 5,300,000

Ordinary shares actually outstanding 100,000
Assumed issued ordinary shares through
conversion of bonds payable (4,000,000 x 10%) 40,000

Total ordinary shares 140,000

Diluted EPS (5,300,000/140,000) 37.86

CHAPTER 17

STATEMENT OF CASH FLOWS

A statement of cash flows is a component of financial statements summarizing the operating,

investing and financing activities of an entity.

Cash comprises cash on hand and demand deposits.

Cash equivalents are short-term highly liquid investments that are readily convertible

Classification of cash flows

Cash flows are inflows and outflows of cash and cash equivalents.

The statement of cash flows shall report cash flows during the period classified as operating, investing
and financing activities.

Bank overdrafts which are repayable on demand form an integral part of an entity’s cash management.

Operating activities are the cash flows derived primarily from the principal revenue producing
activities of the entity.

Examples of cash flows from operating activities are:

a. Cash receipts from sale of goods and rendering of services

b. Cash receipts from royalties, rental, fees, commissions and other revenue
c. Cash payments to suppliers for goods and services
d. Cash payments for selling, administrative and other expenses
e. Cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities
and other policy benefits
f. Cash payments or refunds of income taxes unless they can be specifically identified with
financing and investing activities
g. Cash receipts and payments for securities held for dealing or trading purposes

Investing activities are the cash flows derived from the acquisition and disposal of long-term assets
and other investments not included in cash equivalent.

Examples of cash flows from investing activities

a. Cash payments to acquire property, plant and equipment, intangibles and other long-term assets.
b. Cash receipts from sales of property, plant and equipment, intangibles and other long-term assets.
c. Cash payments to acquire equity or debt instruments of other entities and interests in joint
ventures.
d. Cash receipts from sales of equity or debt instruments of other entities and interests in joint
venture.
e. Cash advances and loans to other parties other than advances and loans made by financial
institution.
f. Cash receipts from repayment of advances and loans made to other parties.
g. Cash payments for future contract, forward contract, option contract and swap contract.
h. Cash receipts from future contract, forward contract, option contract and swap contract.
Financing activities are the cash flows derived from the equity capital and borrowings of the entity.

In other words, financing activities are the cash flows that result from transactions:

Between the entity and the owners - equity financing

Between the entity and the creditors - debt financing

Examples of cash flows from financing activities

a. Cash receipts from issuing shares or other equity instruments for example, issuance of ordinary
and preference shares
b. Cash payments to owners to acquire or redeem the enterprise’s shares, for example, payment for
treasury shares
c. Cash receipts from issuing debentures, loans, notes, bonds, mortgages, and other short or long
term borrowings
d. Cash payments for amounts borrowed
e. Cash payments by a lessee for the reduction of the outstanding principal lease liability

Illustration – Operating Activities

Simple Company reported the following comparative statement of financial position and income
statement for 2023.

Assets 2023 2022

Cash 3,000,000 2,000,000

Accounts receivable 940,000 350,000
Inventory 175,000 100,000
Prepaid insurance 15,000 20,000
Property, plant and equipment 2,000,000 2,000,000
Accumulated depreciation ( 550,000 ) ( 500,000 )
Patent 40,000 50,000
Total assets 5,620,000 4,020,000

Liabilities and Equity

Accounts payable 170,000 150,000
Accrued salaries payable 25,000 10,000
Accrued interest payable 10,000 15,000
Income tax payable 350,000 250,000
Unearned rent income 10,000 40,000
Mortgage payable 500,000 500,000
Share capital 2,000,000 2,000,000
Retained earnings 2,555, 000 1,055,000
Total liabilities and equity 5,620,000 4,020,000
 Income Statement
Year ended December 31, 2023
Sales 6,500,000
Cost of goods sold:
Inventory – January 1 100,000
Purchases 3,200,000
Goods available for sale 3,300,000
Inventory – December 31 ( 175,000 ) 3,125,000
Gross income 3,375,000
Rent income 80,000
Total income 3,455,000

Expenses:
Salaries 950,000
Insurance 40,000
Other expenses 500,000
Depreciation 50,000
Amortization patent 10,000
Interest expense 55,000 1,605,000
Income before tax 1,850,000
Income tax 350,000
Net income 1,500,000

Direct method
PAS 7, paragraph 18, provides that an entity shall report cash flows from operating activities using
either the direct method or indirect method.
The direct method shows in detail or itemizes the major classes of gross cash receipts and gross cash
payments.

Computation under the direct method

1. Accounts receivable – 2022 350,000
Sales 6,500,000
Total 6,850,000
Accounts receivable – 2023 ( 940,000 )
Collections from customers 5,910,000

2. Rent income 80,000

Unearned rent income – 2023 10,000
Total 90,000
Unearned rent income – 2022 ( 40,000 )
Rent received 50,000
 3. Accounts payable – 2022 150,000
Purchases 3,200,000
Total 3,350,000
Accounts payable – 2023 ( 170,000 )
Payments to merchandise creditors 3,180,000

4. Salaries 950,000
Accrued salaries payable – 2022 10,000
Total 960,000
Accrued salaries payable – 2023 ( 25,000 )
Salaries paid 935,000

5. Insurance 40,000
Prepaid insurance – 2023 15,000
Total 55,000
Prepaid insurance – 2022 ( 20,000 )
Payment for insurance 35,000

6. Other expenses paid 500,000

7. Interest expense 55,000

Accrued interest payable – 2022 15,000
Total 70,000
Accrued interest payable – 2023 ( 10,000 )
Interest paid 60,000

8. Income tax 350,000

Income tax payable – 2022 250,000
Total 600,000
Income tax payable – 2023 ( 350,000 )
Payment for income tax 250,000

Direct method – Operating Activities

Cash received from customers 5,910,000
Rent received 50,000
Cash payments to merchandise creditors ( 3,180,000 )
Salaries paid ( 935,000 )
Insurance paid ( 35,000 )
Other expenses paid ( 500,000 )
Cash generated from operations 1,310,000
Interest paid ( 60,000 )
Income tax paid ( 250,000 )
Net cash provided by operating activities 1,000,000

PAS 7, paragraph 32, provides that interest paid is disclosed separately whether it has been recognized
in profit or loss or capitalized.
Paragraph 35 provides that income tax paid is also disclosed or presented separately.

CHAPTER 2- STATEMENT OF FINANCIAL POSITION

Statement of Financial Position
- A statement of financial position is a formal statement showing the three elements comprising
financial position, namely assets, liabilities and equity.

Investors, creditors and other statement users analyze the statement of financial position to evaluate such
factors as liquidity, solvency and the need of the entity for additional financing.

Liquidity is the ability of the entity to meet currently maturing obligations.

Solvency is the availability of cash over the longer term to meet maturing obligations.

ASSETS- The Revised Conceptual Framework defines an asset as a present economic resource
controlled by the entity as a result of past events.
LIABILITIES- Under the Revised Conceptual Framework, a liability is defined as a present obligation
of an entity to transfer an economic resource as a result of past events.
EQUITY-The term equity is the residual interest in the assets of the entity after deducting all of the
liabilities.

LINE ITEMS - STATEMENT OF FINANCIAL POSITION

PAS 1, paragraph 54, states that as a minimum, the statement of financial position shall include the
following line items:
1. Cash and cash equivalents
2. Financial assets (other than 1, 3 and 6)
3. Trade and other receivables
4. Inventories
5. Property, plant and equipment
6. Investment in associates using the equity method
7. Intangible assets
8. Investment property
9. Biological assets
10. Total of assets classified as held for sale and assets included in disposal group classified as held
for sale
11. Trade and other payables
12. Current tax asset and liability
13. Deferred tax asset and deferred tax liability
14. Provisions
15. Financial liabilities (other than 11 and 14)
16. Liabilities included in disposal group held for sale
17. Noncontrolling interest
18. Share capital and reserves

FORMS OF STATEMENT OF FINANCIAL POSITION

The format of a statement of financial position is not specified in PAS 1.
In practice, there are two customary forms in presenting the statement of financial position, namely:
a. Report Form
This form sets forth the three major sections in a downward sequence of assets, liabilities and equity.
b. Account Form
As the title suggests, the presentation follows that of an account, meaning, the assets are shown on the
left side and the liabilities and equity on the right side of the statement of financial position
ILLUSTRATION- REPORT FORM
SAMPLAR COMPANY
Statement of Financial Position
December 31, 2023
ASSETS
Note
Current assets:
Cash and cash equivalents (1) 500,000
Financial assets at fair value 200,000
Trade and other receivables (2) 700,000
Inventories (3) 900,000
Prepaid expenses (4) 50,000
Total current assets 2,350,000

Noncurrent assets:
Property, plant and equipment (5) 5,000,000
Investment in associate, at equity 1,000,000
Long-term investments (6) 5,100,000
Intangible assets (7) 2,000,000
Other noncurrent assets (8) 100,000
Total noncurrent assets 13,200,000

Total assets 15,550,000

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Trade and other payables (9) 750,000
Note payable short-term debt 400,000
Current portion of bonds payable 200,000
Warranty liability 50,000
Total current liabilities 1,400,000

Noncurrent liabilities:
Bonds payable - remaining portion 1,800,000
Note payable due July 1, 2025 600,000
Deferred tax liability 100,000
Total noncurrent liabilities 2,500,000

Shareholders' equity
 Share capital, P100 par 5,000,000
Reserves (10) 3,000,000
Retained earnings 3,650,000
Total shareholders' equity 11,650,000
Total liabilities and shareholders' equity 15,550,000

Note 1- Cash and cash equivalents

Cash on hand 40,000
Cash in bank 300,000
Petty cash fund 10,000
BSP Treasury bill, purchased on December 1, 2023
and due March 1, 2024 150,000
Total cash and cash equivalents 500,000
Note 2 - Trade and other receivables
Accounts receivable 580,000
Allowance for doubtful accounts (20,000)
Notes receivable 100,000
Accrued interest on notes receivable 10,000
Advances to employees, collectible currently 30,000
Total trade and other receivables 700,000
Note 3-Inventories
Finished goods 300,000
Goods in process 400,000
Raw materials 150,000
Manufacturing supplies 50,000
Total inventories 900,000
Note 4 - Prepaid expenses
Office supplies unused 30,000
Prepaid insurance 20,000
Total prepaid expenses 50,000
Note 5 - Property, plant and equipment
Land 1,500,000
Building 4,500,000
Machinery and equipment 1,000,000
Furniture and fixtures 300,000
Patterns, molds, dies and tools, net 100,000
Total 7,400,000
Accumulated depreciation (2,400,000)
Carrying amount 5,000,000
Accumulated depreciation:
Building 1,900,000
Machinery and equipment 350,000
Furniture and fixtures 150,000
Total accumulated depreciation 2,400,000
Note 6 - Long-term investments
Plant expansion fund 2,000,000
Financial assets at amortized cost 3,000,000
Cash surrender value 100,000
Total other long-term investments 2,400,000
Note 7 - Intangible assets
Patent 500,000
Trademark 1,500,000
Total intangible assets 2,000,000
Note 8 - Other noncurrent assets
Long-term refundable deposit 20,000
Long-term advances to officers 80,000
Total other noncurrent assets 100,000
Note 9 - Trade and other payables
Accounts payable 350,000
Notes payable 150,000
Accrued interest on note payable 15,000
Income tax payable 50,000
Dividends payable 100,000
Accrued expenses 85,000
Total trade and other payables 750,000
Note 10- Reserves
Share premium 2,000,000
Retained earnings appropriated for contingencies 1,000,000
Total reserves 3,000,000

CHAPTER 4: STATEMENT OF COMPREHENSIVE INCOME

Cost of Goods Sold of a Merchandising Entity

Beginning inventory 500,000
Net Purchases 2,000,000
Goods available for sale 2,500,000
Ending inventory ( 300,000)
Cost of Goods Sold 2,200,000
Gross purchases 1,900,000
Freight in 150,000
Total 2,050,000
Purchase returns, allowances and discounts ( 50,000)
Net purchases 2,000,000
Cost of Goods Sold of a Manufacturing Entity
Beginning raw materials 500,000
Net purchases 2,000,000
Raw materials available for use 2,500,000
Ending raw materials ( 300,000)
Raw materials used 2,200,000
Direct labor 3,000,000
Factory overhead 1,300,000
Total manufacturing cost 6,500,000
Beginning goods in process 900,000
Total cost of goods in process 7,400,000
Ending goods in process (1,000,000)
Cost of goods manufactured 6,400,000
Beginning finished goods 1,600,000
Goods available for sale 8,000,000
Ending finished goods (1,500,000)
Cost of goods sold 6,500,000
Line items
PAS 1, paragraph 82, provides that the line items in the statement of comprehensive income are:
a. Revenue, presenting separately interest revenue and insurance revenue
b. Gain or loss from derecognition of financial asset measured at amortized cost
c. Income and expenses from insurance and reinsurance contract
d. Finance income or expenses from insurance and reinsurance contract
e. Finance cost
f. Share of income or loss of associate and joint venture accounted for using the equity method
g. Income tax expense
h. Impairment losses and reversal of impairment losses
i. Gain or loss on reclassification of a financial asset from amortized cost to fair value through
profit or loss.
j. Gain or loss on reclassification of a financial asset from fair value through OCI to fair value
though profit or loss.
k. A single amount comprising discontinued operations
l. Profit or loss for the period
m. Other comprehensive income
n. Comprehensive income for the period
The following items shall be disclosed on the face of the income statement and statement of
comprehensive income:
a. Profit or loss attributable to noncontrolling interest and owners of the parent.
b. Total comprehensive income attributable to noncontrolling interest and owners of the parent.

Functional income statement

EXAMPLAR COMPANY
 Income statement
Year ended December 31, 2023

Note
Net Sales (1) 9,000,000
Cost of goods sold (2) (5,400,000)
Gross Income 3,600,000
Other Income (3) 900,000
Investment Income (4) 500,000
Total Income 5,000,000
Expenses:
Distribution costs (5) 1,350,000
Administrative expenses (6) 1,000,000
Other expenses (7) 320,000
Finance cost (8) 200,000 2,870,000
Income before tax 2,130,000
Income tax expense 580,000
Net income 1,550,000
Note 1 – Net sales
Gross sales 9,300,000
Sales return and allowance ( 100,000)
Sales discount ( 200,000)
Net sales 9,000,000
Note 2 – Cost of goods sold
Inventory, January 1 1,500,000
Purchases 6,000,000
Freight in 300,000
Total 6,300,000
Purchase return and allowance ( 150,000)
Purchase discount ( 250,000) 5,900,000
Goods available for sale 7,400,000
Inventory, December 31 (2,000,000)
Cost of goods sold 5,400,000
Note 3 – Other income
Interest revenue 180,000
Dividend revenue 120,000
Rent revenue 100,000
Gain from expropriation 500,000
Total 900,000
Note 4 – Investment income
Share in net income of associate (25%) 500,000
Note 5 – Distribution costs
Sales salaries 600,000
SSS and Philhealth - sales 20,000
Sales commission 180,000
Advertising 100,000
Store supplies expense 50,000
Delivery expense 250,000
Depreciation - store equipment 150,000
Total distribution costs 1,350,000
Note 6 – Administrative expenses
Office salaries 650,000
SSS and Philhealth - office 30,000
Bonuses 100,000
Office supplies expense 70,000
Taxes and licenses 20,000
Doubtful accounts 40,000
Depreciation - office equipment 90,000
Total administrative expenses 1,000,000
Note 7 – Other expenses
Loss on sale of investment 30,000
Loss on sale of property 120,000
Casualty loss from earthquake 170,000
Total 320,000
Note 8 – Finance cost
Interest expense on bank loan 50,000
Interest expense on bonds payable 150,000
Total finance cost 200,000
Natural income statement
EXAMPLAR COMPANY
Income Statement
Year ended December 31, 2023
Note
Net Sales (1) 9,000,000
Other income (2) 900,000
Investment income (3) 500,000
Total income 10,400,000
Expenses:
Increase in inventory (4) ( 500,000)
Net purchases (5) 5,900,000
Employee benefit costs (6) 1,400,000
Sales commission 180,000
Advertising 100,000
Supplies expense (7) 120,000
 Delivery expense 250,000
Depreciation (8) 240,000
Taxes and licenses 20,000
Doubtful accounts 40,000
Other expenses (9) 320,000
Finance cost (10) 200,000 8,270,000
Income before tax 2,130,000
Income tax expense 580,000
Net income 1,550,000
Note 1 – Net sales
Gross sales 9,300,000
Sales return and allowance ( 100,000)
Sales discount ( 200,000)
Net sales 9,000,000
Note 2 – Other income
Interest revenue 180,000
Dividend revenue 120,000
Rent revenue 100,000
Gain from expropriation 500,000
Total 900,000
Note 3 – Investment income
Share in net income of associate (25%) 500,000
Note 4 – Increase in inventory
Inventory - December 31 2,000,000
Inventory - January 1 1,500,000
Increase in inventory 500,000
Note 5 – Net purchases
Purchases 6,000,000
Freight in 300,000
Purchase return and allowance ( 150,000)
Purchase discount ( 250,000)
Net purchases 5,900,000
Note 6 – Employee benefit costs
Sales salaries 600,000
SSS and Philhealth - sales 20,000
Office salaries 650,000
SSS and Philhealth - office 30,000
Bonuses 100,000
Total employee costs 1,400,000
Note 7 – Supplies expense
Store supplies 50,000
Office supplies 70,000
Total supplies expense 120,000
Note 8 – Depreciation
Depreciation - store 150,000
Depreciation - office 90,000
Total depreciation 240,000
Note 9 – Other expenses
Loss on sale of investment 30,000
Loss on disposal of property 120,000
Casualty loss from earthquake 170,000
Total 320,000
Note 10 – Finance cost
Interest expense on bank loan 50,000
Interest expense on bonds payable 150,000
Total finance cost 200,000

GROUP 5; Operating Segments (PFRS 8)

-is a component of an entity:
 engage in business activities from w/c it may earn revenue & expenses
 regularly reviewed by CODM (chief operating decision manager) to make allocation
decisions
 discrete FS is available

A. Reportable Segment management approach

1) used by management in internal reporting/result of an aggregation
2) qualify quantitative threshold
Two or more segments may be
 Revenue Test- revenue of internal & external segments aggregated into a “single
is 10% of the combined revenue. operating segment” if:
 P/L Test- absolute amt. of 10% of greater bet. profit and  have similar economic
loss characteristics
 Asset Test- asset is 10% of combined asset of the Ope.  share majority of 5 criteria:
Sgmt 1) Name of product or
 Overall size Test- if external revenue of reportable service
segment is ↓75% add unqualified to make it 75% 2) Nature of production
process
3) Type/class of customers
4) Marketing method
5) Nature of regulatory
environment
 B. Non-Reportable Segment
-combined in “other segments” category.

 If reportable segment ceases to be reportable

-continue to be such as long as significant.

 If segment becomes reportable

-data from prior period is restated even if it did not satisfy threshold.

ILLUSTRATION:
Revenue, profit or loss, and assets for each operating segment are as follows:

Based on Revenue Test, A, B, and C are reportable segments because revenue associated with each of
these segments is at least P4,000,000 which is 10% of the total revenue of P40,000,000.

D and E are not reportable segments because revenue of such segments is less than 10% of the total
revenue.

Based on Asset Test, A and B are reportable segments because assets of such segments are at least
P4,500,000 which is 10% of the total segment assets of P45,000,000.

C, D and E are not reportable segments because their assets are less than 10% of the total segment
assets.

Applying the P/L Test, the 10% of profit or loss is somewhat complicated because some segments have
profit and others have losses.

The profit must be combined and the losses must be combined to determine which is greater between the
two.

Because the total profit figure is greater than the total loss figure, P2,400,000 is the basis for
identifying reportable segment.

Any segment with profit or loss of P240,000 or greater (10% of P2,400,000) qualifies as reportable
segment. Therefore, A, B and C are identified as reportable segment under the profit or loss criterion.

In conclusion A, B and C are identified as reportable segments. D and E are not reportable segments
because they do not meet any one of the 10% quantitative thresholds for identification as reportable
segment.
Thus, D and E may be combined for reporting purposes. But A, B and C, being reportable segments, shall
be disclosed separately.

ILLUSTRATION:

An entity has no intersegment sales and has the following operating segments with their corresponding
revenue:
Based on the revenue criterion, the reportable segments are segments 1, 2 and 3. The remaining segments
are not reportable.
Assume that the remaining segments did not also satisfy the other criteria of "profit or loss" and "total
assets".
The total external revenue of the reportable segments is as follows:

Observe that the total percentage of the reportable segments is only 65%.
In this case, we shall apply the Overall size Test thus, an additional operating segment shall be identified
even if they do not meet any of the 10% quantitative thresholds.
Let us assume that Segments 7 and 8 have met the requirements and criteria for aggregation.
Accordingly, Segments 7 and 8 can be aggregated as "one reportable segment" to achieve the 75%
threshold.
Thus, the remaining segments 4, 5 and 6 shall be considered not reportable and lumped in the " other
segments" category.

CHAPTER 14

CASH AND ACCRUAL BASIS

CASH BASIS

Income is recognized when received regardless of when earned, and expense is recognized when
paid regardless of when incurred.

In other words, the cash basis of accounting does not recognize Accounts receivable, accounts
payable, accrued income, deferred income, accrued expense and prepaid expense.

ACCRUAL BASIS

Income is recognized when earned regardless of when received, and expense is recognized when
incurred regardless of when paid.

The essence of the accrual basis of accounting is the recognition of accounts receivable, accounts
payable, accrued income, deferred income, accrued expense and prepaid expense.

Cash Basis versus Accrual Basis

Item Cash Basis Accrual Basis

Sales Cash sales plus collections from Cash sales plus sales on account
customers
Purchases Cash purchases plus payments Cash purchases plus purchases
to trade creditors on account
Income other than sales Items received are considered Items earned are considered as
as income regardless of when income regardless of when
earned received
Expenses, in general Items paid are treated as Items incurred are treated as
expenses regardless of when expenses regardless of when
incurred paid
Depreciation Depreciation is provided Depreciation is provided
normally normally
Bad debts No bad debts are recorded Doubtful accounts are treated
because trade receivables are as bad debts
not recognized
Illutration

ABC Company reported the following data which constitutes condensed description of thebusiness for
the first year of operations ending December 31, 2023.

Cash sales 500,000

Sales on account 3,000,000

Collections from customers 2,800,000

Cash purchases 300,000

Purchases on account 2,000,000

Payments to trade creditors 1,600,000

Salaries paid 650,000

Office supplies paid 200,000

Other expenses paid 50,000

Interest received 40,000

Equipment 400,000
The equipment was acquired on January 1 and had an estimated useful life of 10 years with no residual
value. The following amounts are determined on December 31:

Accrued salaries payable 70,000

Office supplies unused 50,000

Accrued interest receivable 10,000

Doubtful accounts 90,000

Ending inventory 400,000

Comparative income statement

ABC Company

Income Statement

Year ended December 31, 2023

Cash Basis Accrual Basis

Sales 3,300,000 3,300,000

Cost of goods sold:

Purchases 1,900,000 2,300,000

Inventory - December 31 ( 400,000) ( 400,000)

Cost of goods sold 1,500,000 1,900,000

Gross income 1,800,000 1,600,000

Interest income 40,000 50,000

Total income 1,840,000 1,650,000

Expenses:

Salaries expense 650,000 720,000

Office supplies expense 200,000 150,000

Other expenses 50,000 50,000

Doubtful accounts - 90,000

Depreciation 40,000 40,000

Total expenses 940,000 1,050,000

Net income 900,000 600,000

Computation

Cash basis Accrual basis

1. Cash sales 500,000 500,000

Sales on account - 3,000,000

Collections from customers 2,800,000 -

Total sales 3,300,000 3,500,000

2. Cash purchases 300,000 300,000

Purchases on account - 2,000,000

Payments to trade creditors 1,600,000 -

Total purchases 1,900,000 2,300,000

3. Interest received 40,000 40,000

Accrued interest receivable - 10,000

Interest income 40,000 50,000

4. Salaries paid 650,000 650,000

Accrued salaries payable - 70,000

Salaries expense 650,000 720,000

5. Office supplies paid 200,000 200,000

Office supplies unused - ( 50,000)

Office supplies expense 200,000 150,000

6. Depreciation (400,000/10) 40,000 40,000

Accounting problem

More often than not, accounting records are maintained on a cash basis.

At the end of the accounting period, adjustments are made for accruals and prepayments in order to
convert the cash basis records to accrual