Accounting for Accruals

3.3. Interest revenue accrual transaction analysis

Event No. 7 in the table shown earlier is the adjusting entry to recognize accrual of interest. The amount is computed by multiplying the face value of the CD by the interest rate by the length of time for which the loan was outstanding:

$1,000 x 6% x (8 ÷ 12) = $40

After all adjusting entries are recorded, it is time to look at the financial statements for Candely Services for the accounting period 20X7.

3.4. Financial statements for the second illustration of accrual accounting

Illustration 13: Income statement for Candely Services for 20X7

Candely Services
Income Statement
For the Period Ended 20X7

 

 

Consulting Revenue

$ 2,700

Interest Revenue

40

Total Revenue

2,740

 

 

Salary Expenses

(1,400)

 

 

Net Income

1,340

There is a new element called interest revenue in the income statement. The interest revenue is the amount we recognized by posting the adjusting entry on December 31, 20X7.

Illustration 14: Statement of changes in equity for Candely Services for 20X7

Candely Services
Statement of Changes in Equity
Period Ended 20X7

 

 

Contributed Capital

$ 3,500

 

 

Beginning Retained Earnings

1,300

Plus: Net Income

1,340

Less: Distribution

(500)

Ending Retained Earnings

2,140

 

 

Total Equity

$ 5,640

While looking at the statement of changes in equity, note that there was a cash distribution to the owner ($500) in this accounting period.

Illustration 15: Balance sheet for Candely Services at 20X7 end

Candely Services

Balance Sheet

For the Period Ended 20X7

Assets

 

Cash

$ 4,800

Accounts Receivable

500

Interest Receivable

40

Certification of Deposit

1,000

Total Assets

6,340

 

 

Liabilities

 

Salaries Payable

700

Total Liabilities

700

 

 

Equity

 

Contributed Capital

3,500

Retained Earnings

2,140

Total Equity

5,640

 

 

Total Liability and Equity (Claims)

6,340

There are two new elements appear on the balance sheet. Interest receivable is the amount due from the borrower of funds (i.e., from the bank) for using Mr. Candely's money (i.e., the certificate of deposit). Certificate of deposit represents the initial amount loaned to the bank that will be returned at the maturity date (April 30, 20X8).

Illustration 16: Statement of cash flows for Candely Services for 20X7

Candely Services
Statement of Cash Flows
For the Period Ended 20X7

Cash Flows from Operating Activities

 

Cash Receipts from Customers

$ 3,000

Cash Payments for Expenses

(1,200)

Net Cash Flow from Operating Activities

1,800

 

 

Cash Flows from Investing Activities

 

Cash Payment to Purchase CD

(1,000)

Net Cash Flow from Investing Activities

(1,000)

 

 

Cash Flows from Financing Activities

 

Cash Payments for Distributions

(500)

Net Cash Flow from Financing Activities

(500)

 

 

Net Increase in Cash

300

Plus: Beginning Cash Balance

4,500

 

 

Ending Cash Balance

$ 4,800

In the statement of cash flows, two new elements are introduced. The first is the cash outflow that occurred as a result of purchasing the certificate of deposit. This is a cash flow for investing activities. The second represents the cash outflow for distributions to the owner, which is an example of financing activities.

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