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

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

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

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

$

Compensation received

XXXX

Carrying value of inventories

(XXXX)

Loss on damaged inventories

(XXXX)*

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

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

Example

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

Perpetual Method of recording Inventories

The relevant double entries are:-

1. On 1 January 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Inventories

20,000

Cash at bank

20,000

2. On 31 July 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

20,000

Sales

20,000

Balance Sheet

Income Statement

DR

CR

DR

CR

Cost of sales

16,000

Inventories

*16,000

*800 units X $20 per unit

3. On 30 September 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Loss on damaged inventories

2,000

Inventories

2,000

4. On 15 October 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

1,800

Loss on damaged inventories

1,800

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

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

$

Sales

20,000

A

Less: Cost of Sales

16,000

B

Gross profit

4,000

C = A – B

Other income

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

-200

D

Net profit for the year

3,800

E = C + D

Extract of the Balance Sheet as at 31 December 2006

$

Current assets
Inventories

2,000

Trade receivables

XXXX

Other receivables, deposits & prepayments:

Rental receivable

XXXX

Rental deposit

XXXX

Utility deposit

XXXX

Cash and bank balances

XXXX

XXXX

Periodic Method of recording Inventories

The relevant double entries are:-

1. On 1 January 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cost of sales – Purchases

20,000

Cash at bank

24,000

2. On 31 July 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

20,000

Sales

20,000

3. On 30 September 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Loss on damaged inventories

2,000

Cost of sales – Transfer to loss on damaged inventories

2,000

4. On 15 October 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

1,800

Loss on damaged inventories

1,800

5. On 31 December 2006

Balance Sheet

Income Statement

DR

CR

DR

CR

Inventories

*2,000

Cost of sales – Closing inventories

2,000

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

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

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

$

Sales

20,000

A

Less: Cost of Sales
Opening inventories

Purchases

20,000

Transfer to loss on damaged inventories

-2,000

Closing inventories

-2,000

16,000

B

Gross profit

4,000

C = A – B

Other income

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

-200

D

Net profit for the year

3,800

E = C + D

Extract of the Balance Sheet as at 31 December 2006

$

Current assets
Inventories

2,000

Trade receivables

XXXX

Other receivables, deposits & prepayments:

Rental receivable

XXXX

Rental deposit

XXXX

Utility deposit

XXXX

Cash and bank balances

XXXX

XXXX

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

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

$

Proceeds from disposal

XXXX

Carrying amount or net book value of fixed assets

(XXXX)

Gain/(Loss) on disposal

XXXX/(XXXX)

Example

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

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

Financial Year Ended 31 December 2006

The relevant double entries are:-

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Motor vehicle – Cost

24,000

Cash at bank

24,000

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Depreciation – Motor vehicle

*4,400

Motor vehicle – Accumulated depreciation

4,400

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

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

$

Sales

109,270

Cost of Sales

-40,875

Gross profit

68,395

Other income: –
Rental income

12,000

Operating expenses: –
Accountancy fee

-800

Depreciation of property, plant and equipment

-4,400

Donation

-500

Electricity & water

-3,340

Insurance premium

-200

Printing & stationery

-1,697

Rental of premises

-12,000

Salaries

-27,865

Upkeep of office

-3,547

Telephone charges

-1,285

Travelling, petrol & toll charges

-2,648

-58,282

Net profit for the year

22,113

Retained profits B/F

27,654

Retained profits C/F

49,767

Balance Sheet as at 31 December 2006

$

Non-current assets
Property, plant and equipment

19,600

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

-3,588

Other payables and accruals

-46,688

-50,276

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

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

$
Property, plant and equipment – Motor vehicle
Cost

24,000

Accumulated depreciation

-4,400

Carrying amount 19,600

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

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Depreciation – Motor vehicle

400

Motor vehicle – Accumulated depreciation

400

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

16,000

400

Motor vehicle – Accumulated depreciation

4,800

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

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

ABC Co. Ltd

General Ledger

Motor Vehicle – Cost (Balance Sheet)
DEBIT

CREDIT

Date

Descriptions

Folio

$

Date

Descriptions

Folio

$

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

CREDIT

Date

Descriptions

Folio

$

Date

Descriptions

Folio

$

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

CREDIT

Date

Descriptions

Folio

$

Date

Descriptions

Folio

$

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

CREDIT

Date

Descriptions

Folio

$

Date

Descriptions

Folio

$

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

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

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

$

Sales

159,270

Cost of Sales

-90,875

Gross profit

68,395

Other income: –
Rental income

22,500

Operating expenses: –
Accountancy fee

-800

Depreciation of property, plant and equipment

-400

Donation

-500

Electricity & water

-3,340

Insurance premium

-200

Loss on disposal of motor vehicle

-3,200

Printing & stationery

-1,697

Rental of premises

-12,000

Salaries

-35,579

Upkeep of office

-3,547

Telephone charges

-1,285

Travelling, petrol & toll charges

-2,648

-65,196

Net profit for the year

25,699

Retained profits B/F

27,654

Retained profits C/F

53,353

Balance Sheet as at 31 December 2007

$

Non-current assets
Property, plant and equipment

Current assets
Inventories

5,200

Trade receivables

6,000

Other receivables, deposits & prepayments:

Rental deposit

3,000

Utility deposit

500

Cash and bank balances

82,652

97,352

Current liabilities
Trade payables

-3,588

Other payables and accruals:

Other payables

-25,411

-28,999

Net current assets

68,353

68,353

Financed by: –
Share capital

15,000

Retained profits

53,353

68,353

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

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

XXXX

Rental income

XXXX

Example

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

Date Details

$

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

In the books of ABC Co. Ltd.

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

Date Details

$

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

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

1. Rental deposit and security deposits

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

3,500

Refundable deposits:
– Rentals

3,000

– Utility

500

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

12,000

Rental income

12,000

3. Recognition November ’06 and December ’06 rental

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Rental receivable

3,000

Rental income

3,000

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

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

BEFORE

Adjustment

AFTER

DR

CR

$

$

Sales

109,270

109,270

Cost of Sales

– 40,875

– 40,875

Gross profit

68,395

68,395

Other income: –
Rental income

12,000

3,000

15,000

Operating expenses: –
Accountancy fee

– 800

– 800

Depreciation of property, plant and equipment

– 2,500

– 2,500

Donation

– 500

– 500

Electricity & water

– 3,340

– 3,340

Insurance premium

– 200

– 200

Printing & stationery

– 1,697

– 1,697

Rental of premises

– 12,000

– 12,000

Salaries

– 27,865

– 27,865

Upkeep of office

– 3,547

– 3,547

Telephone charges

– 1,285

– 1,285

Travelling, petrol & toll charges

– 2,648

– 2,648

– 56,382

– 56,382

Net profit for the year

24,013

27,013

Retained profits B/F

27,654

27,654

Retained profits C/F

51,667

54,667

Balance Sheet as at 31 December 2006

$

$

Non-current assets
Property, plant and equipment

102,500

102,500

Current assets
Inventories

5,000

5,000

Trade receivables

32,807

32,807

Other receivables, deposits & prepayments:

Rental receivable

3,000

3,000

Rental deposit

3,000

3,000

Utility deposit

500

500

Cash and bank balances

29,023

29,023

70,330

73,330

Current liabilities
Trade payables

– 3,588

– 3,588

Other payables and accruals

– 102,575

– 102,575

– 106,163

– 106,163

Net current assets

– 35,833

– 32,833

66,667

69,667

Financed by: –
Share capital

15,000

15,000

Retained profits

51,667

54,667

66,667

69,667

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

Date Details

$

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

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank

22,500

Rental income

22,500

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

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Rental receivable

3,000

Retained profits

3,000

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

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Rental income

3,000

Rental receivable

3,000

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

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Rental income

1,500

Advance rental collected

1,500

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

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

$

$

Sales

159,270

159,270

Cost of Sales

– 90,875

– 90,875

Gross profit

68,395

68,395

Other income: –
Rental income

22,500

2 3,000

18,000

3 1,500
Operating expenses: –
Accountancy fee

– 800

– 800

Depreciation of property, plant andequipment

– 2,500

– 2,500

Donation

– 500

– 500

Electricity & water

– 3,340

– 3,340

Insurance premium

– 200

– 200

Printing & stationery

– 1,697

– 1,697

Rental of premises

– 12,000

– 12,000

Salaries

– 35,579

– 35,579

Upkeep of office

– 3,547

– 3,547

Telephone charges

– 1,285

– 1,285

Travelling, petrol & toll charges

– 2,648

– 2,648

– 64,096

– 64,096

Net profit for the year

26,799

22,299

Retained profits B/F

51,667

1 3,000

54,667

Retained profits C/F

78,466

76,966

Balance Sheet as at 31 December 2007

$

$

Non-current assets
Property, plant and equipment

100,000

100,000

Current assets
Inventories

5,200

5,200

Trade receivables

6,000

6,000

Other receivables, deposits & prepayments:

Rental receivable

1 3,000 2 3,000

Rental deposit

3,000

3,000

Utility deposit

500

500

Cash and bank balances

52,652

52,652

67,352

67,352

Current liabilities
Trade payables

– 3,588

– 3,588

Other payables and accruals:

Other payables

– 70,298

– 70,298

Advance rental collected

3 1,500

– 1,500

– 73,886

– 75,386

Net current assets

– 6,534

– 8,034

93,466

91,966

Financed by: –
Share capital

15,000

15,000

Retained profits

78,466

2 3,000 1 3,000

76,966

Note 1
3 1,500

93,466

91,966

Note 1:

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

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

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

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

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

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

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

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank*

XXXX

Dividend income

XXXX

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

Example

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

XYX CO. LTD.
DIVIDEND NO. TYPE OF DIVIDEND

FOR YEAR ENDED

ENTITLEMENT DATE

DATE OF PAYMENT

01 INTERIM

31 DECEMBER 2006

31 DECEMBER 2006

10 JANUARY 2007

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

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Investment in XYZ

80,000

Cash at bank

80,000

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Dividend receivable

5,000

Dividend income

5,000

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

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

$

$

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

5,000

5,000

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

$

$

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

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

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

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

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

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Dividend receivable

5,000

Retained profits

5,000

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

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

Balance Sheet

Income Statement

DR

CR

DR

CR

Dividend income

5,000

Dividend receivable

5,000

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

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

$

$

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

5,000

2 5,000

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

$

$

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

1 5,000 2 5,000

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

Note 1:

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

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

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

Interest income is earned usually through deposits placements with financial institutions. Sometimes, it is also earned through lending of money to third parties (some countries have strict laws governing money lending activities). Interest is the price that borrowers pay for enjoying the resources (money) borrowed from the lenders. Usually, the interest rates are made known to the depositors by financial institutions at the time of deposits placement.

A very common practice by small businesses when comes to the timing of recording interest income the accounts is upon receiving the interest income. This is an example of cash basis of recording transactions instead of accrual basis of accounting. Please refer to my post: Cash Basis Vs Accrual Basis of Accounting for further illustrations on this topic

The double entry for recording interest income on cash basis is as follows: –

Balance Sheet

Income Statement

DR

CR

DR

CR

Cash at bank*

XXXX

Interest income

XXXX

*Business entities usually receive interest income directly in their banking accounts upon maturity or by way of cheques, instead of “hard cash”. Therefore, only cash at bank is shown and petty cash account is omitted.

For a detailed illustration on the recording of interest income on accrual basis, please refer to item No. 4, Interest Income, of my post: Cash Basis Vs Accrual Basis of Accounting .

According to International Accounting Standards (IAS) 18 – Revenue, the method used to calculate interest income is the effective interest method. Please refer to my post: Effective Interest? Simple Interest? Compound Interest? Nominal Interest? for further illustrations.