When will Assets be recognized

There maybe some who are asking when will assets be recognized in the Financial Statement. Maybe asking how do we record it and what are the characteristics of an asset to be recognized. Before we dig in to that deeper, let us first try understand what are assets.

Assets are resources we owned. Meaning, those items whom the we have the legal right and ownership. Like for example, you have purchase a television, literally you have every right on that item already when the purchase is done.

There is no difference when the accounting point of view is concerned. Assets, in accounting, are economic resources owned by the company used in the the normal operating cycle of the business and those that can be measured reliably.

When do we recognize an Asset?

In order for an asset to be recognized in the financial position, the following criteria must be met;

• There must be an expected future economic benefit that will be derived from the item.
• The company must have legal ownership and right over the asset. and
• It can be measured reliably.

When the following characteristics were met, an asset account must be debited to reflect its effect of the Statement of Financial Position or Balance Sheet. Assets maybe in the form of Cash, Accounts Receivable, Supplies and many others. Each of them have their own unique recognition criteria. 

Can we recognize an asset not owned by the company?

The answer to this question is very simple. No, you cannot recognize an asset that you do not owned. Its like claiming that you have written a book that has been written by another author. Or owning the right to an invention that is invented and patented by the inventor. 

In the case of a Finance Lease, the lessee already has the legal ownership over the asset being leased. Remember that the lessor and the lessee have an agreement that the asset will be transferred to the lessee when the contract is finished. So, legally, the right and ownership over the asset is already transferred. The lessor can no longer cancel the lease agreement when there is no breach of contract on the part of the lessee. Meaning, the lessor is bound to transfer the right on the asset when the contract is finished. 

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Understanding the Income Statements

What is income Statement?

An Income Statement or the Statement of Financial Performance is a formal statement showing the financial performance of certain business organization. It provides measurement of income earned by the entity through the effective and efficient use of the company's resources for a given period of time.

Approaches to Income Statement measurement

There are basically two approaches on how income statements are being measured. These are the Capital Maintenance Approach and Transaction Approach. When we say Capital Maintenance Approach, it means that net income occurs only after the capital used from the beginning of a particular period is maintained. Meaning, under this method, we have to first set aside an amount equal to the capital used before we distribute the remaining profit. This is why, the same is also called the Net Assets Approach.

Traditional Approach, on the other hand, is the conventional or traditional way of measuring the Net Income of a particular company. It follows the financial reporting standard. The approach requires the determination of how much income were gained during the period and how much expense were incurred in earning the income.

Sales                                 xxx

COGS                             (xxx)

Gross Profit                      xxx

Operating Expenses        (xxx)

Net Income                      xxx 

Purpose of Notes to Financial Statements

There are some transactions that cannot be understand by merely looking on the Balance Sheet and Income Statement alone. Because of this, companies preparing financial statements must also includes disclosure of these transactions for users to easily understand the effects of these particular transactions. These Disclosures are called notes to financial statements.

What is the purpose of Notes to Financial Statement

The purpose of the notes to financial statements is "to provide necessary information or disclosures required by the reporting standards to help users of the financial statements to understand the effects of some transactions that cannot be understood by merely looking on the physical report".

Accordingly, the notes to financial statements shall present the basis of the preparation of the financial statements, disclose information not reported elsewhere in the financial statements, and information that is necessary to the fair presentation of the report. 

Order of Notes to Financial Statements

• Statement of Compliance with Financial Reporting Standards
• Summary of significant accounting policies
• Supporting computation for the items of financial statements; and
• Other disclosures, necessary to the fair presentation of the financial statements.

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Principle of Debit and Credit

Accounting starts from the understanding of the rule on debit and credit. But what is really a debit and a credit of accounting transaction?

What is debit and credit?

The term "Debit" refers to the left side of an account whereas the term "Credit" refers to the right side. When both the left side and right side of an account are totaled and the smaller amount is deducted from the of the higher one, the remaining amount is referred to as the "Balance of an Account".

What is NORMAL BALANCE

Every account has its normal balance. Meaning, the balance it which a particular account would increase. For example, Cash has a normal balance of debit because it will increase when debited and decrease when credit. 

There are those who think that Debit always means increase and credit always means decrease. This article will clarify this mistake. Not all debits means increase and not all credits will mean decrease. The status of whether the account will decrease or not is depending on what particular account is being debited or credited for that matter.

Effects of transactions

      ACCOUNT            NORMAL BALANCE             BALANCE INCREASED BY              BALANCE DECREASED BY

       Asset                                Debit                                                  Debit                                                                 Credit

       Liability                          Credit                                                Credit                                                                 Debit

       Equity                              Credit                                                Credit                                                                 Debit

       Revenue                          Credit                                                Credit                                                                 Debit

       Asset                                Debit                                                  Debit                                                                 Credit

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Prepaid Expense Journal Entry - Explained

Companies usually makes payment of some of their expenses in advance. This is done maybe because of a policy that needs to be followed or just because the paying company want to avoid making monthly payments. An example of prepaid expense is the payment of rent for an office space to be used for the next 12 months. As a result, the lessee records prepaid expense journal entry with a prepaid expense account and the lessor will have an Unearned Income Account.

The Prepaid Expense account is an asset as to the tenants point of view is concerned. This account is credited upon expiration of the period being paid in advance. On the other hand, Unearned Income Account is a liability on the part of the landlord.

Prepaid Expense Journal Entry 

Assume: ABC Company rented an Office Space to XYZ Company to. The monthly payment for the rent is $500.00. Supposed that on January 25, 2016, ABC Company pays $1,000.00 for the rent for the month of February and March.

On January 25, the following entries were created:

ABC Company Book

Dr.     Prepaid Rent                      1,000.00

Cr.     Cash                                      1,000.00

XYZ Company Book

Dr.      Cash                                    1,000.00

Cr.      Unearned Rent Income   1,000.00

After a month, the rent for February has lapsed. Therefore, there is a need to prepare an adjusting entry to show the correct balance of prepaid rent account. The following entries were to be made: 

ABC Company Book

Dr.     Rent Expense                    500.00

Cr.     Prepaid Rent                     500.00

XYZ Company Book

Dr.     Unearned Rent Income    500.00

Cr.     Rent Income                        500.00

The balance of the Prepaid Rent Account and Unearned Rent Income Account on February 2016 will be $500.00. This is the Rent for the month of March that is still outstanding as of the end of february.

Why Do we need to have a prepaid expense journal entry?

Prepaid expense journal entry is created for advance payment of expenses. This entry is made to ensure that the accounting practice is in accordance with the generally accepted accounting principles.

These entries are corrected by preparing an adjusting entry just like we have made in the illustration. This method is done to show the amount that should have to be recorded in the books of account of the company.

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Concept of Depreciation

What is Depreciation?

Depreciation is the systematic allocation of the Depreciable cost, Cost less salvage value, of property plant and equipment items over its estimated useful life. Its objective of computing the depreciation is to match the benefits received from using the asset to the expense associated from the use of such asset. In other words, any benefits we get has a corresponding expense incurred from gaining the benefit.

Kinds of depreciation

There basically two kinds of depreciation. Physical Depreciation and Economic Depreciation. The only difference on the two lies on the way how they are arrived.

Physical Depreciation

This type of depreciation is related to the wear and tear of the asset or its deterioration over a particular period of time. It includes:

1. Wear and tear due to frequent use
2. Passage of time due to non-usage
3. Accident such as flood, fire, and etc.

Economic Depreciation

Economic Depreciation, on the other hand, relates to the assets technical obsolescence and inadequacy to perform efficiently.

Obsolescence may arise from the following:

• When there is no future demand for the product being produced by the asset.
• When new and better asset becomes available in the market.

Inadequacy arises when the asset can no longer meat the demand for the product's production. For example, ABC Company is using an old machine that manufactures 5,000 bottles of soft drinks. The old machine is in its maximum production capacity. However, because of increasing market size, the demand for the soft drinks have increase by 45% of the normal production. Because of this increase, the old machine can no longer supply the demand of the market. Therefore, the company needs to buy a new machine with a bigger manufacturing capacity. 

Methods of computing depreciation

1. Straight Line
2. Declining Balance Method
3. Sum of the Years Digits
4. Output Method

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Variable Costing and Absorption Costing

Variable Costing and Absorption Costing are two different method of presenting the income statement. Each of this two has its own advantages and disadvantages. These two methods are widely use by different companies and called for different names.

Variable Costing is also referred to as direct costing or marginal costing. This is so called direct costing because only the direct cost is added to the product cost. Meaning, when we compute for the unit cost of a product,  we only add the direct cost which includes the Direct Materials, Direct Labor and the Variable Manufacturing Overhead Cost. This method is used by management for decision making purposes.

Absorption Costing, on the other hand, is also called the traditional costing. Product cost is computed by adding the cost of Direct Material, Direct Labor, Variable Manufacturing Overhead and Fixed Manufacturing Overhead. Unlike the variable costing method, the information provided by absorption costing is used by both internal and external parties.

Difference of Variable and Absorption Costing

As to the treatment of cost, the only difference is with the Fixed Manufacturing Overhead Cost. In variable costing, it is treated as Period cost while in absorption costing, it is a Product Cost.

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