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 |
|
|
|
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 |
|
|
|
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 |
|
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.