Abm Acctg2 Reading Materials 2019

 

INTRODUCTION TO FINANCIAL STATEMENT

Financial statements refer to a specific set of reports produced in an entity's accounting system. The objective of these reports is to provide information about the entity. A complete set of financial statements includes 5 components. 1. STATEMENT OF COMPREHENSIVE INCOME The Income Statement, also known as Profit and Loss Statement (P&L Statement), shows the results of operations of an entity over a particular period of time. The income statement presents the period's income and expenses and the resulting net income or loss.

Many large companies today prepare a Statement of Comprehensive Income. The Statement of Comprehensive Income presents a company's results of operations (net income or loss) and its other comprehensive income (OCI). If the company has no other comprehensive income, then the contents of the Income Statement and Statement of Comprehensive Income would be the same. Other comprehensive income include gains and losses that cannot be reported in the Income Statement such as revaluation surplus, translation adjustments, and unrealized gains, for a given  period. Other comprehensive income is covered in higher financial accounting studies. Income Statement INCOME STATEMENT EXAMPLE

Here is a sample income statement of a service type sole proprietorship business. Let us name the company Strauss Printing Services. All amounts are assumed and simplified for illustration  purposes.

Strauss Printing Services Income Statement For the Year Ended December 31, 2016 Service Revenue Less: Expenses Salaries Expense Supplies Expense Rent Expense Utilities Expense Depreciation Expense  Net Incom Incomee

Php 160,000 Php

40,000 26,100 20,500 11,300 5,000

102,900 Php 57,100

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EXPLANATION AND POINTERS 1.  An income statement shows the net income or net loss of a business. This is achieved by deducting all expenses from all income.

2.  A typical income statement starts with a heading, which consists of three lines. The first line presents the name of the company; the second describes the title of the report; and the third states the period covered in the report. 3.   Notice that the third line is worded "For the Year Ended..." This means that the income statement presents information for a specific span of time. In the above example, the  period covers 1 year that th at ends on December 31, 2016. Hence, the amounts presented in in the report are income and expenses from January 1, 2016 to December 31, 2016. 4.  Income accounts are presented before expenses. In the above statement, the income account is Service Revenue. Other income accounts for service type businesses include Professional Fees, Rent Income, Tuition Fees, etc. 5.  Expenses are presented after the income accounts. It is a good practice to arrange expenses according to amount (largest to smallest). Some users who are interested in the company's expenses are concerned about the size of each expense. Arranging the expenses from largest to smallest results in a more useful and organized report.  Nonetheless, Miscellaneous Expense or Sundry Expense is presented last. 6.  If income exceeds expenses, there is a net income. If expenses exceed income, there is a net loss. Notice how computations are presented. A single line is drawn every time an amount is computed. The resulting amount is double-ruled when it is no longer followed  by any operation. For example, P57,100 (the net income). 7.  The income statement complies with the accrual basis of accounting. Income is recognized when earned regardless of when collected. Expenses are recognized when incurred regardless of when paid. 8.  This means that income and expenses presented in the income statement have been earned and incurred, respectively. Nonetheless, it does not mean that they have all been collected or paid. 9.  International accounting standards suggest that companies should present other comprehensive income in their financial statements. A Statement of Comprehensive co ntents of an income statement followed by a list of "other Income shows the contents income".income includes gains and losses that cannot be reported as profit 10. comprehensive Other comprehensive and loss, such as unrealized gains and losses, and revaluation surplus. This is taken up in higher financial accounting studies. 11. When the company does not have other comprehensive income, the contents of the income statement and the statement of comprehensive income are the same. In any case, international accounting standards favor the use of the title "Statement of Comprehensive Income". STATEMENT OF COMPREHENSIVE INCOME

Here's a sample Statement of Comprehensive Income, which includes other comprehensive income.   K-12 ABM ACCOUNTING MATERIALS

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Strauss Printing and Publishing, Inc. Statement of Comprehensive Income For the Year Ended December Decembe r 31, 2016 Php 160,000

Service Revenue Less: Expenses Salaries Expense Supplies Expense Rent Expense Utilities Expense Depreciation Expense  Net Incom Incomee Other Comprehensive Income Revaluation Surplus Unrealized Translation Gain

Php

40,000 26,100 20,500 11,300 5,000

102,900  Php

Php

Total Comprehensive Income

20,000 10,200

57,100

30,200  Php

87,300

2. STATEMENT OF CHANGES IN CAPITAL The Statement of Changes in Capital  (or Statement of Changes in Equity) shows the balance of the capital account at the beginning of the period, the changes that occurred during the period, and the ending balance as a result of such changes. Capital is affected by contributions and withdrawals of owners, income, and expenses.

The title used for this report varies depending upon the form of business ownership. It is called Statement of Owner's Equity in sole proprietorships, Statement of Partners' Equity in  partnerships and Statement of Stockholders' Equity in corporations. A Statement of Owner's Equity shows the changes in the capital account due to contributions, withdrawals, and net income or net loss. Capital is increased by owner contributions and income, and decreased by withdrawals and expenses. The Statement of Owner's Equity, which is prepared for the sole proprietorship type of business, shows the movement in capital as a result of those four elements. STATEMENT OF OWNER'S EQUITY EXAMPLE

Here is a sample Statement of Owner's Equity of a service type sole proprietorship  business, Strauss Printing Services. All amounts are assumed and simplified for illustration  purposes.   K-12 ABM ACCOUNTING MATERIALS

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Assume that the company started the year 2016 with 100,000 capital. During the year, the owner made 10,000 additional contributions and 20,000 total withdrawals. The Statement of Owner's Equity would look like this: Strauss Printing Services Statement of Owner's Equit Equ ity y For the Year Ended December 31, 2016 Strauss, Capital Add: Additional Contributions  Net Incom Incomee Total Less: Strauss, Drawings Strauss, Capital – Dec. 31, 2016

Php 100,000 10,000 57,100  Php 167,100 20,000  Php 147,100

EXPLANATION AND POINTERS

1.  A Statement of Owner's Equity (SOE) shows the owner's capital at the start of the period, the changes that affect capital, and the resulting capital at the end of the period. It is also known as "Statement of Changes in Owner's Equity". 2.  A typical SOE starts with a heading, which consists of three lines. The first line shows the name of the company; second the title of the report; and third the period covered. 3.  The title of the report is Statement of Owner's Equity. This is used for sole  proprietorships. For partnerships, the title used u sed is "Statement of Partners' Equity" and for corporations, "Statement of Stockholders' Equity". 4.   Notice that the third line is worded "For the Year Ended..." This means that the SOE  presents information for a specific span of time. In the above example, the period covers 1 year that ends on December 31, 2016. Hence, the amounts presented pertain to changes to owner's equity from January 1, 2016 to December 31, 2016. 5.  The capital account used in the illustration is Strauss, Capital. 6.  Income increases capital. Expenses decrease it. Net income is equal to income minus expenses. Hence, net income would increase the capital account. If expenses exceed income, there is a net loss. In such case, net loss will decrease the capital account. 7.   Notice that the net income above, 57,100, is the bottom-line amount in the company's Income company's  Income Statement.  Statement.  8.  Strauss, Drawings represents the total withdrawals made by the owner during duri ng the period. The owner made 20,000 total drawings. This amount is deducted to get the capital  balance. 9.  The Statement of Owner's Equity example above shows that the company has 147,100 in capital as a result of the following: 100,000 balance at the beginning of the year, plus 10,000 owner's contributions during the year, plus 57,100 net income, and minus 20,000 withdrawals.

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10. Good accounting form suggests that a single line is drawn every time an amount is computed (it signifies that a mathematical operation has been completed). The bottomline amount is double-ruled, i.e. 47,100. 3. STATEMENT OF FINANCIAL POSITION

A Balance Sheet presents an entity's assets, liabilities, and capital as of a given point in time. This report shows the entity's financial position and condition, hence, also called Statement of Financial Position. All asset amounts are added. All liability and capital accounts are also added. The total amount of assets should be equal to the total amount of liabilities plus capital. Financial position pertains to the resources owned and controlled by the company (assets), and the claims against them (liabilities and capital).  BALANCE SHEET EXAMPLE

Here is a sample balance sheet for Strauss Printing Services, a service type sole  proprietorship business. All amounts are assumed assumed and simplified for illustration purposes. Strauss Printing Services Statement of Financial Positi Pos ition on As of December 31, 2016 ASSETS Current Assets: Cash Accounts Receivable Prepaid Expenses  Non-curren  Non-cu rrentt Asset Assets: s: Property, Plant and Equipment Total Assets

Php

21,000 16,000 4,500

Php

41 41,500

145,000 Php 186,500

LIABILITIES LIABI LITIES AND OWNER'S OWNER 'S EQUITY Current Liabilities: Accounts Payable Rent Payable  Non-curren  Non-cu rrentt Li Liabil ability: ty: Loans Payable Strauss, Capital Total Liabilities and Owner's Equity

Php

8,400 8,000

Php

16,400 23,000 147,100

Php 186,500

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EXPLANATION AND POINTERS

1.  A Balance Sheet shows the financial position or condition of the company; thus, it is also called "Statement of Financial Position". 2.  A typical balance sheet starts with a heading, which consists of three lines. The first line  presents the name of the company; the second describes the title of the report; and the third states the date of the report. 3.   Notice that the third line is worded "As of..." Unlike the other components of the financial statements, which cover a span of time ("For the period ended.."), the balance sheet presents information as of a certain date (at a specific point in time). In the above example, the contents of the balance sheet pertain to the financial condition of the company on December 31, 2016. 4.  A balance sheet summarizes the assets, liabilities, and capital of a company. Assets refer to properties owned and controlled by the company. Liabilities are obligations to creditors, lenders, etc. And capital represents the portion left for the owners of the  business after all liabilities are paid. For detailed lessons about assets, liabilities and capital, check out the Elements the Elements of Accounting.  Accounting.   5.  Assets and liabilities are classified as either current or non-current. Current assets are  properties that will be converted into cash within 12 months o orr within the operating cycle of the business. Current liabilities are due within 12 months or within the operating cycle.  Non-current assets and non-current liabilities are those that do not meet the above qualifications. 6.  "Total assets" and "total liabilities and capital" should always be equal. 7.  The capital amount, 147,100 for Strauss, Capital, was actually taken from the Statement the  Statement of Owner's Equity.  Equity.  8.  The balance sheet may be presented in two forms: account form and report form. In account form, assets are presented on the left side while liabilities and capital are  presented on the right. In report form, assets are presented first and then followed by liabilities and capital. The example above is presented using the report form. 9.  Good accounting form suggests that a single line is drawn every time an amount is computed. It signifies that a mathematical operation has been completed. The "total assets" and "total liabilities and capital" amounts are double-ruled. 4. STATEMENT OF CASH FLOWS The Statement of Cash Flows, or Cash Flow Statement, presents the beginning balance of cash, the changes that occurred during the period, and the cash balance at the end of the period as a result of the changes.

The cash flow statement shows the cash inflows and outflows from three activities: operating, investing, and financing. Operating activities  pertain to transactions that are directly related to the company's main course of business. Investing activities  refer to "where the company puts its money". These activities include long-term investments, acquisition of property, plant and equipment; and other

transactions related to non-current assets. Financing activities  include transactions in which a   K-12 ABM ACCOUNTING MATERIALS

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company acquires its funds. These include loans from banks (long-term liabilities) and contributions from owners. A Statement of Cash Flows (or Cash Flow Statement) shows the movement in the Cash account of a company. Accountants follow the accrual basis in measuring income and expenses. However, some users are particularly interested in the cash transactions of the company; hence the need to present a Statement of Cash Flows. STATEMENT OF CASH FLOWS EXAMPLE

Here is a sample cash flow statement for Strauss Printing Services, a service type sole  proprietorship business. All amounts are assumed assumed and simplified. Strauss Printing Services Statement of Cash Flows For the Year Ended December 31, 2016 Cash Flow from Operati Operating ng Acti Activiti vities: es: Cash received from customers Cash paid for expenses Cash paid to suppliers Cash Flow from Investing Activiti Activities: es: Cash paid to acquire additional equipment Cash Flow from Financing Financ ing Activities: Activities: Cash received from investment of owner Cash received from bank loan Cash paid for bank loan – partial payment Cash paid to owner – withdrawal

Php 14 1 46,000 (81,000) (47,500)  Php

(20,300) Php

10,000 50,000 (27,000) (20,000)

13,000

 Net Increa Increase se (Dec (Decreas rease) e) in in Cash for th the Year  Year  Add: Cash – January 1, 2016 Cash – December 31, 2016

17,500

Php

10,200 10,800 21,000

EXPLANATION AND POINTERS Statement of Cash Flows presents the inflows and outflows of cash in the different activities of the business, the net increase or decrease in cash, and the resulting cash balance at the end of the  period. Cash inflows refer to receipts of cash while cash outflows to payments or disbursements.

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1.  A typical cash flow statement starts with a heading, which consists of three lines. The first line presents the name of the company; the second describes the title of the report; and the third states the period covered in the report. 2.   Notice that the third line is worded "For the Year Ended..." This means that the information included in the report covers a span of time. In the illustration above, the report presents inflows and outflows of cash for 1 year, i.e. from January 1 to December 31, 2016. 3.  Cash inflows and outflows are classified in three activities: operating, investing, and financing. 4.  Operating activities  refer to the main operations of the company such as rendering of  professional services, acquisition of inventories and supplies, selling of inventories for merchandising and manufacturing concerns, collection of accounts, payment of accounts to suppliers, and others. Generally, operating activities refer to those that involve current assets and current liabilities. 5.  Investing activities may be summed up as: "where the company puts its money for longterm purposes", such as acquisition of property, plant and equipment; and investment in long-term securities. Selling these properties are also considered investing activities. In general, investing activities include transactions that involve non-current assets. 6.  Financing activities refer to: "where the company gets its funds", such as investment of the owner/s, and cash proceeds from bank loan and other long-term payables. The  payment of such items (i.e. withdrawal of owner/s and payment of loans) is also financing activities. Generally, financing activities include those that affect non-current liabilities and capital.  7.  All inflows are presented in positive figures while all outflows in negative (in  parentheses). 8.  After inflows and outflows are presented, the net increase or decrease in cash is computed. Then it is added to the beginning balance of cash to get the balance at the end. Easy, right? In simple sense, this report presents the cash balance at the beginning of the period, the changes during the period, and the resulting balance at the end of the period. 9.   Notice that the cash balance at the end, $ 21,000, is the same as the cash balance  presented in the company's Balance company's Balance Sheet.  Sheet.  10. Good accounting formthat suggests that a single line is every time The an amount is computed. It signifies a mathematical operation hasdrawn been completed. computed  balance at the end of the report is double-ruled. 5. NOTES TO FINANCIAL STATEMENTS

The Notes to Financial Statements, or Supplementary Notes, provide information in addition to those presented in the Balance Sheet, Income Statement, Statement of Changes in Equity, and Cash Flow Statement. The notes contain disclosures required by accounting standards, supporting computations, breakdown of line items in the face of the financial statements, and other information that users may be interested in.

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RELATIONSHIP AMONG THE FINANCIAL STATEMENTS

The financial statements contain interrelated information. This is the reason the financial statements are prepared in the sequence presented above. In fact, some of the figures in one financial statement component are actually taken from another component. The net income from the Income Statement is used in the Statement of Changes in Equity. Remember that income and expenses affect capital. The ending balance of capital in the Statement of Owner's/Partners'/SH's Equity is forwarded to the Balance Sheet (under Capital). The Statement of Cash Flows supports the cash balance presented in the Balance Sheet. The ending balance of cash in the Statement of Cash Flows is the same amount presented in the Balance Sheet. The notes to financial statements show-supporting computations of the amounts and additional information about the items presented in the above abov e reports. FINANCIAL STATEMENT ANALYSIS AND INTERPRETATION

When you analyze the financial statements, you get to know about the profitability, liquidity and solvency of the business. Profitability  is not just simply earning more revenues than cost and expenses. Profitability   is the ability of the business to earn a satisfactory rate of return on owner’s capital. It is the objective of profitability to make sure that profit is maximized, for in so doing owner’s wealth is also maximized. Profitability in business is very important for it is a ticket to business growth and expansion. Aside from profitability, other factors that will help predict company’s success is liquidity and solvency. Liquidity enhances financial position of the business with reference to its ability to manage its working capital and pay for its short-term obligations. Solvency  or stability is long term liquidity, which also enhances financial position of the company with reference to how it

manages all its resources and pay for its long-term lon g-term obligations. Financial Statement Analysis (or Financial Analysis) is the process of assessing the financial condition, operating performance and viability of the enter enterprise. prise. It is a powerful and effective measurement tool, which will assist all statement users to make informed judgment and decision. Financial Statement (FS) Analysis  is the process of evaluating risks, performance, financial health, and future prospects of a business by subjecting financial statement data to computational and analytical techniques with the objective of making economic decisions (White et.al 1998).

Just by looking at the financial statements, you will get to know about the amount of sales obtained by the company, the amount of gross profit it has earned, operating expenses incurred, and amount of net profit profit earned, assets owned and liabilities owed. But, it will not give you a complete picture of the company’s financial position and operating performance. Questions such   K-12 ABM ACCOUNTING MATERIALS

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as  –   is the profit adequate? Is the profit a sufficient return on what the owner invested? Is the  profit commensurate to the assets being used by b y the business? Can the business pay pa y on time? Is it safe to borrow some more? These questions can be answered only when you make a good analysis and interpretation of the company’s financial statements . Although it is important to study the raw figures, it also becomes more meaningful when the figured are “standardized” by reducing them to ratios, turnovers and percentages specially when comparing two companies which have different scales of operation. You need to used formulas to convert the absolute amounts into ratios, turnovers and percentages and compare these against the previous year’s figures (intra -comparability) or against the competitor’s figures (inter comparability or benchmarking), to make it more meaningful. Ratio  measures the relationship  between two items, say net income against a gainst net sales (4/20) = .2:1. To get the percentage multiply .2 by 100 = 20%. Efficiency  results when pricing policy is good and the activities are properly monitored so that less time and effort are used thus minimizing the costs or expenses of the company. This is in in turn will translate into profitability. ADVANTAGES OF ANALYZING FINANCIAL STATEMENTS

Through the use of ratios, percentages and turnovers it will enable one to: 1.  Determine whether or not the company is efficient in its operation, which is the greatest contributing factor to its profitability. 2.  Determine whether or not the company’s financial position is strong consid ering liquidity and solvency. 3.  Determine whether or not the company is efficient in using its resources, which is also a contributing factor to its profitability and liquidity. 4.  Spot trends, weaknesses and potential problems. 5.  Use the analyses to forecast exp ectation on company’s future performance.   6.  Create new plans or revise old plans in accordance to one’s goal or objective depending on whether you are the owner, o wner, manager, potential investor, creditor, supplier or customer. COMPARATIVE FINANCIAL STATEMENTS

The first step in analyzing the company’s performance is to place side by side its financial statements for two periods periods or the financial statements ffor or two companies. Comparability makes the financial statements relevant as we spot the differences in the performance or the changetaking place in the company within the increases or decreases in the financial data for two  periods or for two companies. THREE TOOLS USED IN ANALYZING FINANCIAL STATEMENTS

There are three tools used in analyzing the financial statements  –  Horizontal   Horizontal Analysis, Vertical Analysis and Financial Ratio Analysis. The Horizontal Analysis (also known as Trend Analysis) is important because it enables one to draw a picture on what changes are taking place in the financial activities of an enterprise.   K-12 ABM ACCOUNTING MATERIALS

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A Horizontal Analysis is a comparative analysis, which shows the increases and decreases, in absolute amounts and in percentages of financial data for two given periods. Trend Analysis shows the comparison of more than two two periods against a base year. The increase or decrease, especially if material in amount will trigger an inquisition from management to determine what caused the change and whether the change is good for the company. Procedure:  get the difference for two years to arrive at the absolute amount of change and divide the difference by the base amount (which is the year 2015 for the Happy Feet illustration) to arrive at the percentage of change. Below example shows the horizontal analysis for Happy Feet Emporium. Example of Horizontal Analysis  –  Income  Income Statement

Happy Feet Emporium Emporium Horizontal Horiz ontal Analysis Analysis -Income Statements For the Year Ended December 31, 2016 and 2015 In Incr creas easee or (De (Decr creas ease) e)

Sales Less: Cost of Sales Gross Profit Less: Operating Expenses Rent Expense Salaries Expense Gas & O il Expenses Depreciation Expense Utilities Expense Utilities Expense Utilities Expense Total Operating Profit Less: Interest Expenses Net Income

2016  Php 652,250 227,500 424,750

108,750 90,000 46,520 34,000 19,000 11,500 4,330 314,100 110,650 11,250  Php 99,400

2015 In Amount & In Pe rce ntage Php 564,200 Php 88,050 15.61% 188,600 38,900 20.63% 375,600 49,150 13.09%   94,500 14,250 15.08% 76,000 14,000 18.42% 35,500 11,020 31.04% 32,500 1,500 4.62% 15,500 3,500 22.58% 10,000 1,500 15.00% 7,500 (3,170) -42.27% 271,500 42 42,600 15.69% 10 104,100 6,550 6.29% 13,500 (2,250) -16.67% Php 90,600 Php 8,800 9.71%

Interpretation: In the income statement, worth noting is the increase in the revenues by 15.61% but because increase in the cost of sales is much higher at 20.63%, the increase in gross profit is lower at 13.09%. It cautious the company to go over its cost of merchandise and ensure that it is controlled as it is much higher than the increase in in the selling price. Expenses have also gone higher except for supplies hence increase in in operating income is very low at 6.29%. Change in net income has gone higher at 9.71% thanks to the decrease in interest expense.   K-12 ABM ACCOUNTING MATERIALS

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Again it is important to to note that there is a connection between liquidity and profitability profitability.. With loans paid, interest expense has gone down enhancing net income. Recall that financial statements are interrelated. interrelated. The same applies to financial statement analysis; the financial ratios affect both the balance sheet and the income income statement. Working capital in the balance sheet is related to all the accounts in the income statement; owner’s capital in the balance sheet is related to net income. Again analysis is more meaningful when you consider the related accounts in  both the balance sheet and the income statement. Example of Horizontal Analysis  –  Balance  Balance Sheets Happy Feet Emporium Horizontal Analysis - Balance Sheets For the Year Ended December 31, 2016 and 2015 ASSETS Increase or (Decrease) 2016

Current Assets: Cash

Php 85,000

2015

Php 67,500

In Amount & In Pe rce ntage

Php 17,500

25.93%

Accounts Receivable 25,000 13,000 12,000 Merchandise Inventory 70,750 60,000 10,750 Suppliies Suppl 4,500 1,700 2,800 Total Current Assets 185,250 142,200 43,050 Property, Plant and Equipment Cars-Net CarsNet of Accum Accum.. 190,000 220,000 (30,000) Equipment- N Neet of Accum. Depreciation 41,500 29,000 12,500 Fu Furn rniiture ture & Fix Fixture tures-N s-Net et of Acc ccu um. Depre epreci ciat atiion 22,0 22,000 00 23,5 23,500 00 (1,500) Total Property, Plan Plantt & 253,500 272,500 (19,000) TOTAL ASSETS  Php 438,750 Php 414,700 Php 24,050

92.31% 17.92% 164.71 164.71% % 30.27% -13.64% 43.10% -6.38% -6.97% 5.80%

LIABILITIES AND OWNER'S EQUITY

Current Liabilities: Accounts Payable Php 11,000 P Ph hp 15,000 Php ((4 4,000) Rent Payable 10,000 0 10,000 Utilities Payable 7,500 5,500 2,000 Total Current Liabilities 28,500 20,500 8,000 Long-Term Long-Te rm Liabilities: Liabilities: Loans Payable 125,000 150,000 (25,000) Total Liabilities 153,500 170,500 (17,000) Owner's Equity Soriano, Capital 285,250 24 2 44,200 41,050 TOTAL LIABILITIES AND ONWER'S EQUITY  Php 438,750 Php 414,700 Php 24,050

- 26.67% 36.36% 39.02% -16.67% -9.97% 16.81% 5.80%

Interpretation:   K-12 ABM ACCOUNTING MATERIALS

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 Note that all the current assets increased (at an average of 30.27%) specially the accounts receivables and supplies. Even the current liabilities liabilities have increased, increased, except accounts payable, at an average of 39.02%. The increasing amount and percentages of the current assets assets signifies a  building of a working capital. The increase in accounts ac counts receivable and in inventory ventory must be tested for quality use. We will do this in ratio analysis when when we compute for their turnovers. Current assets less current liabilities represent working capital. For the company to be able to operate efficiently it must have adequate working capital. Insufficient working capital will make it difficult for the business to operate smoothly as money will be tied up to the demands of creditors/suppliers. For the the non-current assets, there is only a decrease of 6.97%. The net decreases in cars and furniture represent represent increases in accumulated depreciation. Equipment however, increased by 43.10% representing additional acquisition. The increase in owner’s equity represents increase in net worth because of the increase in net income. Another Example of Horizontal Analysis of the Income Statement and Balance Sheets  

When conducting a horizontal analysis, it is useful to conduct the analysis for all of the financial statements at the same time, so that you can see the complete impact of operational results on a company's financial condition over the review period. For example, in the two examples below, the income statement analysis shows a company having an excellent second year, but the related  balance sheet analysis shows that it is having trouble funding growth, given the decline in cash, increase in accounts payable, and increase in debt. Another Example of Horizontal Analysis of the Income Statement   Horizontal analysis of the income statement is usually in a two-year format, such as the one shown below, with a variance also shown that states the difference between the two years for each line items. An alternative format is to simply add as many years as will fit on the page, without showing a variance, so that you can see general changes by account over multiple years.

Sales Cost of Goods Sold Gross Margin Operating Expenses Salaries and Wages Office Rent Expenses Supplies Expenses Utilities Expenses Other Expenses Total Expenses  Net Profi Profit

20X1

20X2

Variance

1,000,000 400,000 600,000

1,500,000 600,000 900,000

500,000 200,000 300,000

250,000 50,000 10,000 20,000 90,000 420,000 180,000

375,000 80,000 20,000 30,000 110,000 615,000 285,000

125,000 30,000 10,000 10,000 20,000 195,000 105,000

Another Example of Horizontal Analysis of the Balance Sheet Horizontal analysis of the balance sheet is also usually in a two-year format, such as the one shown below, with a variance showing the difference between the two years for each line item.

An alternative format is to add as many years as will fit on the page, without showing a variance,   K-12 ABM ACCOUNTING MATERIALS

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so that you can see general changes by account over multiple years. A less-used format is to include a vertical analysis of each year in the report, so that each year shows each line item as a  percentage of the total assets in that year. ASSETS

Current Assets Cash Accounts Receivable Inventory Total Current Assets Fixed Assets Total Assets

20X1

20X2

100,000 350,000 150,000 600,000 400,000 1,000,000

80,000 525,000 275,000 880,000 800,000 1,680,000

Variance

 

(20,000) 175,000 125,000 280,000 400,000 680,000

LIABILITIES AND OWNER'S EQUITY

Current Li Current Liab abil iliti ities es Accounts Payable Accrued Liabilities Total Current Liabilities  Non-Curren  Non-Curr entt L Liiabil abilities ties  Notes Pay Payable able Total liabilities Owner's Equity Capital Total O wner's Equity Total Liabilities and Own Owner's Equity

180,000 70,000

300,000 120,000

120,000 50,000

250,000

420,000

170,000

300,000 550,000

525,000 945,000

225,000 395,000

450,000 450,000 1,0 ,00 00,00 ,000

735,000 735,000 1,68 ,680,00 ,000

285,000 285,000 680,00 ,000

The Vertical Analysis is another tool used in evaluating the importance (proportion) of individual items to the specific base item, which are the gross sales (in the income statement) and

the total assets assets (in balance sheet). The base item is expressed as 100%. If there are sales returns returns and allowances or sales discounts, then we use net sales as the base item. Over time, when  preparing a comparative comp arative analysis, it shows changes in the relative size (importance) of each item to the specific base and whether it is good or not depends on its effect on the financial position or  performance of the business.

Example of Vertical Analysis of the Income Statement   K-12 ABM ACCOUNTING MATERIALS

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Happy Feet Emporium Vertical Analysis Analysis -Income Statements For the Year Ended December 31, 2016 and 2015 201 5   2016

Sales Less: Cost of Sales Gross Profit Less: Operating Expenses Rent Expense Salaries Expense Gas & O il Expenses Depreciation Expense Utilities Expense Utilities Expense Utilities Expense

 Ph Php p 652,250 652,250 227,500 424,750

Total Operating Profit Less: Interest Expenses Net Income

%

2015

%

100.00% 100.00% 34.88% 65.12%

Ph Php 564,200 564,200 188,600 375,600

100.00 100.00% % 33.43% 66.57%

108,750 90,000 46,520 34,000 19,000 11,500 4,330

16.67% 13.80% 7.13% 5.21% 2.91% 1.76% 0.66%

94,500 76,000 35,500 32,500 15,500 10,000 7,500

16.75% 13.47% 6.29% 5.76% 2.75% 1.77% 1.33%

314,100 110,650 11,250  Ph Php p 99,400 99,400

48.16% 16.96% 1.72% 15.24% 15.24%

271,500 104,100 13,500 Php Php 90,600 90,600

48.12% 18.45% 2.39% 16.06% 16.06%

 

Interpretation:

The income statement shows favorable favorable proportions in 2015 compare to 2016. Cost of sales has increased in size by 1.45% from 33.43% in 2015 to 34.88% in 2016 thus decreasing the share of the gross profit from 66.57% to 65.12%. There was efficient control of expenses as it has maintained in size at an average of 48% for operating expenses and there is a decrease in the  proportion of interest expense from 2.39% to 1.72%. The result is a lower size of income generated by the revenue, gone down from 16.06% in the 2015 to 15.24% in 2016. Again, a word of caution andwhich reviewhas of pricing and costing policy for company is advised.

Example of Vertical Analysis of the Balance Sheet   K-12 ABM ACCOUNTING MATERIALS

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Happy Feet Emporium Vertical Analysis - Balance Sheets For the Year Ended December 31, 2016 and 2015 ASSETS 2016

Current Assets: Cash Accounts Receivable Merchandise Inventory Supplies Total Current Assets Property, Plant and Equipment Ca Carrs-Net -Net of Accu cum m. Equipment- N et of Accum. Depreciation Furniture & Fixtures- Ne Net of Accum. Depreciation Tot otal al Prop Proper ertty, Pl Plan antt TOTAL ASSETS

%

2015

%

Php 85,000 25,000 70,750 4,500 185,250

19.37% 5.70% 16.13% 1.03% 42.22%

Php 67,500 13,000 60,000 1,700 142,200

16.28% 3.13% 14.47% 0.41% 34.29%

190, 190,00 000 0 41,500 22,000 25 253, 3,50 500 0  Ph Php p 438,750

43. 43.30 30% % 9.46% 5.01% 57 57.7 .78% 8% 100.00%

22 220, 0,00 000 0 29,000 23,500 272, 272,50 500 0 Ph Php p 414,700

53. 53.05% 05% 6.99% 5.67% 65.7 65.71% 1% 100.00%

2.51% 2.28% 1.71% 6.50%

Php 15,000 0 5,500 20,500

3.62% 0.00% 1.33% 4.94%

28.49% 34.99%

150,000 170,500

36.17% 41.11%

65.01% 100.00%

244,200 Ph Php p 414,700

58.89% 100.00%

LIABILITIES AND OWNER'S EQUITY Current Liabilities: Accounts Payable Php 11,000 Rent Payable 10,000 Utilities Payable 7,500 Total Current 28,500 Long-Term Long-Te rm Liabili Liabilities: ties: Loans Payable 125,000 Total Liabilities 153,500 Owner's Equity Soriano, Capital 285,250 TOTAL TOT AL LIABILITIES AND ONWER'S EQUITY  Ph Php p 438,750

Interpretation: All the current assets increased in size from 34.29% in 2015 to 42.22% in 2016. Inversely, plant,  property and equipment decreased in size from 65.71% in 2015 to 57.78% in 2016 primarily  because of the provision for depreciation. Total liabilities likewise decreased in size from 41.11% in 2015 to 34.99% in 2016 primarily primarily because of the payment of loans. Owner’s equity increased in size of the current assets is a confirmation of the building up of the working capital of the company and the increase in size of owner’s equity means that company resources are mainly coming from the owner, which spells security secu rity for creditors.

Another Example of Vertical Analysis of the Income Statement and Balance Sheets     K-12 ABM ACCOUNTING MATERIALS

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Another Example of Vertical Analysis of the Income Statement The most common use of vertical analysis in an income statement is to show the various expense line items as a percentage of sales, though it can also be used to show the percentage of different revenue line items that make up total sales. An example of vertical analysis for an income statement is shown in the far right column of the following condensed income statement: Totals

Sales Cost of Goods Sold Gross Margin Operating Expenses Salaries and Wages Office Rent Expenses Supplies Expenses Utilities Expenses Other Expenses Total Expenses  Net Prof Profit

%

1,000,000 400,000 600,000

100% 40% 60%

250,000 50,000 10,000 20,000 90,000 420,000

25% 5% 1% 2% 9% 42%

180,000

18%

The information provided by this income statement format is useful not only for spotting spikes in expenses, but also for determining which expenses are so small that they may not be worthy of much management attention.

Another Example of Vertical Analysis of the Balance Sheet The central issue when creating a vertical analysis of a balance sheet is what to use as the denominator in the percentage calculation. The usual denominator is the asset total, but one can also use the total of all liabilities when calculating all liability line item percentages, and the total of all equity accounts when calculating all equity line item percentages. An example of vertical analysis for a balance sheet is shown in the far right column of the following condensed balance sheet: ASSETS 20X1

Current Assets Cash Accounts Receivable Inventory Total Current Assets Fixed Assets Total Assets

100,000 350,000 150,000 600,000 400,000 1,000,000

%

10% 35% 15% 60% 40% 100%

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LIABILITIES AND OWNER'S EQUITY

Current Liabilities Accounts Payable Accrued Liabilities Total Current Liabilities  Non-Current Li  Non-Current Liabi abilliti ties es  Notes Payabl Payablee Total liabilities Owner's Equity Capital Total Owner's Equity Total Liabilities and Owner's Equity

180,000 70,000 250,000

18% 7% 25%

300,000 550,000

30% 55%

450,000

45%

450,000 1,000,000

45% 100%

The information provided by this balance sheet format is useful for noting changes in a company's investment in working capital and fixed assets over time, which may indicate an altered business model that requires a different amount of ongoing on going funding. Financial Ratios Analysis  –   this is widely used tool in financial statement analysis as they  provide means of measuring and evaluating company performance and financial position. One must know how to use formulas to draw out ratios and percentages and identify relevant relationships among financial financial data. And then again, to be able to arrive at informed judgment, one must use inter-comparability or intra-comparability. Financial Ratio  - may be defined as a relationship between two quantities on a firm’s financial statement or statements, which is derived by dividing one quantity by another. Liquidity is the ability of the business to efficiently manage working capital and ensure that there are adequate assets assets to cover for its current oblig obligations ations as they fall due. Comparing the current assets and the current liabilities and computing for arrive at liquidity: working capital,

current ratio and acid test ratio. To illustrate using Happy Feet Emporium

  Working Capital = Current Asset –  Current  Current Liabilities 

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Year 2016 185,250  –  28,500 = 156,750

Year 2015 142,200  –  20,500  20,500 = 121,700

Working Capital was higher in 2016 at 156,750 against 121,700 in 2015. It supports our claim in the horizontal analysis that working capital is building up.

  Current Ratio = Current Asset / Current Liabilities 

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Year 2016 185,250 / 28,500 = 6.5:1

Year 2015 142,200 / 20,500 = 6.9:1

This means that the business has ₱ 6.50 current assets to pay for a peso of current liability in 2016 against ₱ 6.90 current assets to pay for a peso of current liability in 2015. Both  period show that the company is highly liquid.

  Acid Test or Quick Ratio = Quick Assets / Current Liabilities

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(It is similar to the current ratio except that only quick assets like cash and cash equivalent; receivables and marketable securities are used instead of all the current assets.)

Year 2016 110,000 / 28,500 = 3.86:1

Year 2015 80,500 / 20,500 = 3.93:1

This means that the business has ₱ 3.86 quick assets to pay for a peso of current liability in 2016 whereas in 2015 quick assets were higher at ₱ 3.93 for a peso of current liability in 2015. Ratio based on quick assets the the company is very liquid. Turnover Rates (quality use of assets) Complementing the liquidity ratios are the turnover turnover rates. It signifies signifies efficiency in using using the resources. Turnover gives you the number of times times resources are used to generate generate revenue. Inefficient use of assets can adversely affect liquidity.

  In terms of annual turnovers  –  –  the  the formula for computing annual turnover is:

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Annual Turnover = Annual Net Sales / Accounts Receivable     In Terms of Collection Period  –   it is calculated with the use of the following formula: Collection Period = 360 Days / (Sales / Accounts Receivables ) 1.  Sales To Inventory Ratio  - this ratio is measure of inventory turnover. Firms with excessive inventories will show a low ratio. It is computed as follows: Sales Inventory Ratio = Annual Receipts from Sales / Inventory at the End of Year  

2.  Inventory To Net Working Capital Ratio -this ratio shows the proportion of net current assets tied up in inventory, indicating the potential loss to the company in the event of a decline in inventory values. It is calculated by dividing net working capital into the inventory figures. It is calculated as follows: Inventory to Net Working Capital Ratio = Inventory / (Current Assets Current Liabilities) Profitability is the ability of the business to earn a satisfactory return on owner’s capital.

Ratios indicating profitability consist of the following: 1.  Return on Sales To Inventory Ratio - see liquidity ratios   2.  Profit To Net Sales - this ratio, also called profit margin on sales, computed by dividing net income after the taxes by sales. The result is profit margin expressed in percentage. Profit Margin = Income Sales / Sales   K-12 ABM ACCOUNTING MATERIALS

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3.  Profit To Net Worth - This ratio, also referred to as return on net worth ratio, measures the rate of return on the owner’s investment.  The formula is as follows:   Return on Net Worth = Net Income/Net Worth 4.  Profit To Assets - this ratio is also called return on total assets ratio. It measures the return on total investment in the firm. The formula is as follows: Return on Total Assets = Net Income / Total Assets SOLVENCY RATIOS The solvency ratios include the followings: 1.  Current Ratio - see liquidity ratios   2.  Sales To Inventory Ratio - see liquidity ratios  3.  Inventory To Net Working Capital Ratio  –  see activity ratios  4.  Debt To Net Worth Ratio  –  this ratio shows the relative proportion of debts to equity. In effect, it measures the debts exposure of the firm. The formula is as follows: Debt Net Worth Ratio = Total Debt / Net Worth 5.  Net Worth To Fixed Assets Ratio - this ratio indicates to what extent fixed assets have  been financed by the contribution of the stockholders. The ratio is calculated with the use of a formula as follows: Net Worth To Fixed Assets = Net Worth / Fixed Assets 6.  Sales To Net Worth Ratio - see activity ratios  

Business usually maintain two types of account: (1) savings account, accoun t, and (2) checking or current account. A. SAVINGS ACCOUNTS   These are intended to provide an incentive for the depositor to save money.   The depositor can make deposits and withdrawals using the form provided by the bank.   Banks usually pay an interest rate that is higher than a checking account or a current account.   Some savings accounts have a passbook, in which transactions are logged in a small  booklet that the depositor keep   Some savings accounts charge a fee if the balance falls below a specified minimum 

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 balance B. CHECKING OR CURRENT ACCOUNTS   Money held under a checking account can be withdrawn through issuance of a check   Banks usually allows numerous withdrawals and unlimited deposit under this type of account.   The interest rate for checking account is usually lower as compared to a savings account.   The account holder or depositor of a checking account is normally provided at the end of the month a bank statement showing all the deposits made, checks paid by the bank, and the balance of the account.   The depositor is given easy access to the funds as compared to a savings account. 

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TIME DEPOSIT ACCOUNT (OR A CERTIFICATE OF DEPOSIT ACCOUNT ) which is a type of a savings account that is held for a fixed-term and can be withdrawn only after the lapse   K-12 ABM ACCOUNTING MATERIALS

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of the agreed period and by giving notice to the bank. The account may be withdrawn also anytime however the bank usually charges penalties. This type of account yields high interest. Another type of savings account that is popularly used nowadays is an ATM (AUTOMATED TELLER MACHINE) ACCOUNT  wherein withdrawals can be made through designated machines. This is a 24-hour teller machine and the funds can be withdrawn anytime. The advantage of this account is that even if the banks are closed, you can withdraw your funds. In order to open a particular account, the bank will require individuals certain documents such as valid identification card and will ask you to fill-up the forms prepared by the bank. Upon approval of the application to open an account, the bank will give the depositor his account number. PREPARATION OF BANK DEPOSIT AND WITHDRAWAL SLIPS A withdrawal slip and deposit slip are written orders to the bank. These slips are used to take out money or to put in money to the depositors account. WITHDRAWAL SLIP Without a withdrawal slip, the bank will not allow you to get money from your account. The

required information in-the is:   Account Name thewithdrawal name of theslip depositor   Account Number –  the  the unique identifier given by the bank for every account maintained   Date of the withdrawal   Type of account - savings or current   Currency   Amount to be withdrawn - the amount that the depositor wishes to withdraw from his account. The amounts in words and in figures are indicated.   Signature of the Depositor  –  this   this is the most important part in the withdrawal slip. The signature is a proof that the depositor is authorizing the bank to get money from his account. Usually, the bank compares the signature in the withdrawal slip against the signature in the bank records submitted during the opening of the account. 

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There are instances that the depositor cannot attend personally to withdraw the funds, he may authorize a representative by indicating the name of the representative in the space provided and the representative must sign. There is a need for the representative to bring a valid identification card upon withdrawal otherwise the bank will not approved the withdrawal. DEPOSIT SLIP The bank provides deposit slip that the depositor will fill up every time the depositor will put in money to his account. The Th e usually required information in a deposit slip is:   Account Name –  this  this is the complete name of the depositor that is reflected in the records of the bank. If it has a passbook, the account name is indicated on first page inside the  passbook.   Account Number –  this  this is a unique identifier of the account ac count maintained by the d depositor. epositor. 

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  Date of Deposit

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  Type of Account   Currency   Amount in words and in figures  –   the amount that the depositor wishes to put into his

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account. The amount to be deposited maybe in form of cash or check. If it is a cash deposit, the breakdown of the cash is usually listed in the deposit slip if it is a check deposit, the details of the checks are indicated in the deposit slip, for example: Issuing Bank, Address of the Issuing Bank, date of the check and the amount 3. Identify and prepare check A check is a document that orders a bank to pay a specific amount of money from a person's account to the person in whose name the check has been issued. The person writing the check, the drawer, has a transaction banking account where his money is held. The drawer writes the various details including the monetary amount, date, and a payee on the check, and signs it, ordering his bank, known as the drawee, to pay that person or company the amount of money stated. Checks are a type of bill of exchange and were developed as a way to make payments without the need to carry large amounts of money. The check number is usually indicated in the upper right portion of the check. The following are the parties involved in a transaction that uses check as medium of exchange:   Drawer, the person or entity who makes the check   Payee, the recipient of the money   Drawee, the bank or other financial institution where the check can be presented for  payment. 

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IDENTIFY AND UNDERSTAND THE CONTENTS OF A BANK STATEMENT At the end of every month, the bank furnishes a statement to the depositor showing the movement of the account. It contains all the withdrawals, deposits and balance of your account after every transaction. It may also indicate bank charges that were deducted by the bank automatically. Also, interest earned by the account is likewise reflected. SAMPLE OF A BANK STATEMENT  The date column indicates the date the transaction was made. The check number indicates the details of the check paid by the bank. The transaction code is normally a bank code for the transactions. The Debit column represents all charges or deduction made by the bank to your account. The Credit column represents the deposits or additions to your account that was made  by the bank. The Balance column is the running balance after considering the effect of the transaction to your account. SAMPLES OF DEBIT TRANSACTION    Bank service charge  - monthly fee charged by the bank for its services (Ex. cost of  printing checks writing funds to other locations and other fees) 

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  NSF - (Not Sufficient Fund)  –   Banks also use a debit memorandum when a deposited

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check from a customer “bounces” because of  insufficient   insufficient funds. Nowadays bank refer to this as DAIF (Drawn Against Insufficient Fund) or DAUD (Drawn Against Uncleared Deposits) SAMPLES OF CREDIT TRANSACTIONS    Collection of cash proceeds from notes receivables.   Interest income earned by the deposit. 

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As part of control, the bank statement received from the bank is compared with the accounting records of the business. This process is called bank reconciliation. Together with the bank statements, the banks will include the copies of checks cleared or paid by the bank for that  particular month. 1. NATURE OF BANK RECONCILIATION STATEMENT It is normal for a company's bank balance as per accounting records to differ from the balance as  per bank statement. The difference between these figures is the reasons why companies prepare a  bank reconciliation statement. Bank reconciliation statement is a report, which compares the  bank balance as per company's accounting records with the balance stated in the bank statement. THE TWO COMMON CAUSES OF THE DISCREPANCY IN FIGURES ARE:   Time lags that prevent one of the parties (company or the bank) from recording the transaction in the same period as the other party. 

Example: A bank statement that ends January 30, 2015 and then the company were able to collect cash of P20,000 at 5:00 PM. Bank usually closes at 3:00 PM because of this, the cash collected will not be reflected in the bank as deposit but it is however recorded in accounting records of the company.  by either party in recording transactions   Errors by

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Example: A check was issued to Meralco by the company amounting to P1,000. The company recorded this as P100. When the check was presented, the bank paid Meralco P1,000. In the records of the company it was P100 while in the records of the bank it’s P1,000.   There is in this case an error that will cause the difference between the company’s records and the bank records.

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THE IMPORTANCE OF BANK RECONCILIATIONS ARE AS FOLLOWS:   Preparation of bank reconciliation helps in the identification of errors in the accounting records of the company or the bank.   Cash is the most vulnerable asset of an entity. Bank reconciliations provide the necessary control mechanism to help protect the valuable resource through uncovering irregularities such as unauthorized bank withdrawals. However, in order for the control process to 

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work effectively, it is necessary to segregate the duties of persons responsible for   K-12 ABM ACCOUNTING MATERIALS

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accounting and authorizing of bank transactions and those responsible for preparing and monitoring bank reconciliation statements.   If the bank balance appearing in the accounting records can be confirmed to be correct by comparing it with the bank statement balance, it provides added comfort that the bank transactions have been recorded correctly in the company records.   Monthly preparation of bank reconciliation assists in the regular monitoring of cash flows of a business. There three methods of preparing bank b ank reconciliation statement, namely: a. Adjusted Method wherein the balances per bank and per book are separately determined.  b. Book to Bank Method wherein the book balance is adjusted to agree with the bank  balance. c. Bank to Book Method wherein the bank balance is adjusted to agree with book  balance.

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For the learners, the adjusted method will be used. The two remaining methods will be discussed in higher accounting subjects in case they wish to pursue an accounting degree. In practice anyway, the adjusted method is the commonly used method. 2. Identify common reconciling items and describe each of them. The most common format of a  bank reconciliation statement is shown below:

The key terms to be aware of when dealing with bank reconciliation are:

  Deposits in transit are amounts already received and recorded by the company, but are

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not yet recorded by the bank. For example, a retail store deposits its cash receipts of August 31 into the bank's night depository at 10:00 p.m. on August 31. The bank will process this deposit on the morning of September 1. As of August 31 (the bank statement date) this is a deposit in transit.

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Because deposits in transit are already included in the company's Cash account, there is no need to adjust the company's records. However, deposits in transit are not yet on the  bank statement. Therefore, they need to be listed on the bank reconciliation reconc iliation as an increase to the balance per bank in order to report the true amount of cash. A deposit in transit is on the company's books, but it isn't on the bank statement.  

  Outstanding checks are checks that have been written and recorded in the company's

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Cash account but have not yet cleared the bank account or presented to the bank by the  payee.    payee.   Checks written during the last few days of the month plus a few older checks are likely to  be among the outstanding checks.

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Because all checks that have been written are immediately recorded in the company's Cash account, there is no need to adjust the company's records for the outstanding checks. However, the outstanding checks have not yet reached the bank and the bank statement. Therefore, outstanding checks are listed on the bank reconciliation as a decrease in the balance per bank. Illustration of an Outstanding Check: On January 29, 2015, Juan issued a check to Maria amounting to P2,000. The checks were then recorded by Juan in his books as a deduction to his cash. It so happen that the bank was closed on that day and Maria was able to visit the bank and have it encashed on February 1, 2015 only. In the bank statement received  by Juan from his bank ending January30, 2015, the P2,000 check was not deducted however it was already deducted in the books of Juan on January 29, 2015. The P2,000 check is called an outstanding check.

  Bank errors are mistakes made by the bank. Bank errors could include the bank

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recording an incorrect amount, entering an amount that does not belong on a company's  bank statement, or omitting an amount from a company's bank statement. The company should notify the bank of its errors. Depending on the error, the correction could increase or decrease the balance shown on the bank statement. Since the company did not make the error, the company's records are not changed.

  Bank service charges are fees deducted from the bank statement for the bank's

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 processing of the checking account activity Examples: - accepting deposits, - posting checks, - mailing the bank statement, Other types of bank service charges include the fee charged when a company overdraws its checking account and the bank fee for processing a stop payment order on a company's check.

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The bank might deduct these charges or fees on the bank statement without notifying the company. When that occurs, the company usually learns of the amounts only after receiving its bank statement. Because the bank service charges have already been deducted on the bank statement, there is no adjustment to the balance per bank. However, the service charges will have to  be entered as an adjustment to the company's books. The company's Cash account will need to be decreased by the amount of the service charges.

  NSF check is a check that was not honored by the bank of the person or company writing

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the check because that account did not have a sufficient balance. As a result, the check is returned without being honored or paid.  NSF is the acronym for not sufficient funds. When the NSF check comes back to the  bank in which it was deposited, the bank will decrease the checking account of the company that had deposited the check. The amount charged will be the amount of the check plus a bank fee. Because the NSF check and the related bank fee have already been deducted on the bank statement, is no need to adjust thebalance balancefor perthe thereturned bank. However, if the the bank company has not yetthere decreased its Cash account check and fee, the company must decrease the balance per books in order to reconcile.

  Check printing charges occur when a company arranges for its bank to handle the

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reordering of its checks. The cost of the printed checks will automatically be deducted from the company's checking account. Because the check printing charges have already been deducted on the bank statement, there is no adjustment to the balance per bank. However, the check printing charges need to be an adjustment on the company's books. They will be a deduction to the company's Cash account.   Interest earned will appear on the bank statement when a bank gives a company interest

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on its account balances. The amount is added to the checking account balance and is automatically on the bank statement. Hence there is no need to adjust the balance per the  bank statement. However, the amount of interest earned will increase the balance in the company's Cash account on its books.

  Notes Receivable is assets of a company. When notes come due, the company might ask

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its bank to collect the notes receivable. For this service the bank will charge a fee. The  bank will increase the company's checking checkin g account accoun t for the amount it collected (principal and interest) and will decrease the account by the collection fee it charges. Since these amounts are already on the bank statement, the company must be certain that the amounts appear on the company's books in its Cash account.

  Errors  in the company's Cash account result from the company entering an incorrect

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amount, entering a transaction that does not belong in the account, or omitting a   K-12 ABM ACCOUNTING MATERIALS

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transaction that should be in the account. Since the company made these errors, the correction of the error will be either an increase or a decrease to the balance in the Cash account on the company's books. 3. THE BANK RECONCILIATION PROCESS Step 1. Adjusting the Balance per Bank   The first step is to adjust the balance on the bank statement to the true, adjusted, or corrected  balance. The items necessary for this step are listed in the following schedule:

Step 2. Adjusting the Balance per Books   The second step of the bank reconciliation is to adjust the balance in the company's Cash account so that it is the true, adjusted, or corrected balance. Examples of the items involved are shown in the following schedule:

Step 3. Comparing the Adjusted Balances   After adjusting the balance per bank (Step 1) and after adjusting the balance per books (Step 2), the two adjusted amounts should be equal. If they are not equal, you must repeat the process until the balances are identical. The balances should be the true, correct amount of cash as of the date of the bank reconciliation. The adjusted cash balance will appear as the Cash in Bank in the Statement of Financial Position (Balance Sheet).

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