Missing Items in the Operating Expense Account - lesson four
In this lesson, the objective is to demonstrate to the entrepreneur/learner on the approach to determine the missing items related to the operating expense account. The question that arises here is which are these missing items? This can be any component or element that forms a particular expense account. For instance, the common items one may be required to establish at the end of the financial period are; prepayments which appear as debit balance b/d or accrued expenses which appear as credit balance b/d and the per annum amount of expense to be charged in the profit and loss account at the end of the financial period. Also sometimes one may be required to determine the actual cash paid for that particular period of time.
To start this discussion, its much in order to note that sometimes, the management may advocate keeping of operating expenses separately for each case such as rent expense account, salary expense account or insurance expense or/and advertisement expense account. In such a case, determination of missing items is simple. However, when the management adopts a policy of keeping operating expense account in group format such as rent, insurance and salary as one account, then it turns to be troublesome for the entrepreneur/learner to determine the missing items thereof. This is because there may be cases of mismatch on payment timing for there may be cases where one of the components of expenses are paid in arrears, or in advance or in other cases, the amount for one of the expense component may be paid for the exact financial period of one year. This mixed transactions result to difficulties in distinguishing the operating expense component which had either an accrual or a prepayment amounts. To solve this problem, a missing item technique is applied.
Missing item technique is usually used to solve for the missing items or gaps unfilled in the respective operating expense account.
Step by step missing item technique procedure;
Step one; consider operating expense related balances as directly stated or make use of statement of financial position (ie balance sheet). For a new year, the balances are treated as balance brought forward abbreviated as (bal. b/f) which are either of debit or credit nature
Step two; Post the balances brought forward as stated in the information given or from the closing statement of financial position to the respective new operating expense accounts. Such that, if it is a prepayment, then post it on the debit side of the respective operating expense account and if it is an accrual, post it on the credit side of the respective ledger account.
Step three; post the cash payment done in the course of the financial period to the respective expense account. The entrepreneur need to note that the cash paid could be a cocktail of cash for expense arrears or for the current year’s expense or a prepayment whereby all is paid in the current period.
The accounting entry will be;
DR Operating expense account
CR Cashbook
Step four; from the information provided, post the balances brought down of prepayments or accruals at the end of the financial period as supposedly. As the entrepreneur/learner record these balances, the following notes are important. That is;
NB1: If it is a case of prepayment which implies that the balance is a debit balance brought down (ie bal. b/d) then as this figure is being recoded on the debit side of the expense account below the total amount, the entrepreneur/learner should remember to revert that amount as a balance carried down (ie bal. c/d) in the same expense account whereby it should be recorded in the opposite side (credit side) before the totals for it is usually the entry made during the normal balancing of the ledger account as the balancing figure.
NB2: If it is a case of accrued expense which implies that the balance is a credit balance brought down (ie bal. b/d) then as this figure is being recoded on the credit side of the expense account below the totals, the entrepreneur/learner should remember to revert that amount as a balance carried down (ie bal. c/d) in the same expense account whereby it should be recorded in the opposite side (debit side) before the totals for it is usually the entry made during the normal balancing of the ledger account.
Step five; determine the difference between the debit and the credit sides by add the figures on both sides and subtracting the smaller amount from the larger one. The difference represents the exact amount that should be written off to P&L account as the year’s operating expense.
ILLUSTRATION ONE
The following information was provided to you by the accountant of Your co ltd. The management keeps a combined expense account for rent, salary and insurance
Additional information;
The following transactions took place in 2019
Cash payment of rent expense of $35,000 by check
Cash payment of salary $60,000
Cash payment for insurance $55,000
Bal c/d (debit) for salary $4,000
Bal b/d (debit) for rent $ 15,000
Bal c/d (credit) for insurance $2,000
Required;
i)Determine the expense amount for rent, salary and insurance to be closed to profit and loss account
ii) Extract the profit and loss account for the year end 31st/12/2019
iii) Extract the statement of financial position for Your co ltd as at 31/12/2019
Solution
i)Determine the expense amount for rent, salary and insurance to be closed to profit and loss account
Note the following;
1. The closing current asset (ie prepaid expense) and liabilities (accrued expense) amounts in the previous statement of financial position are posted in the right hand side of the rent, salary and insurance expense account as balance brought forward (abbreviated as bal. b/f)
2. After posting the total cash paid in the expense account, the next step is to post the balances brought down (abbreviated as bal. b/d) as per the instructions given. That is;
If the aspect of salary expense had a bal. c/d (debit) of $4,000 it implies that this was the balancing figure and is therefore recorded on the debit side of rent, salary and insurance expense account before we determine the totals on the debit side. At the same time the same amount is further posted on the opposite credit side of that expense account below the totals. Therefore, if the balance brought down (bal. b/d) is on the credit side, it means that it is a case of accrued salary expense.
If the aspect of rent expense had a bal. b/d (debit) of $15,000 it implies that this was the debit balance b/d appearing below the totals of the debit side of rent, salary and insurance expense account and it represents prepaid rent. At the same time the same amount is further posted on the opposite credit side of that expense account before the totals as balance c/d as the balancing figure.
If the aspect of insurance expense had a bal. c/d (debit) of $2,000 it implies that this was the balancing figure and is therefore recorded on the debit side of rent, salary and insurance expense account before we determine the totals on the debit side. At the same time the same amount is further posted on the opposite credit side of that expense account below the totals as balance b/d which represents accrued insurance expense.
ii)Extract the profit and loss account for the year end 31st/12/2019
iii)Extract the statement of financial position for Your co ltd as at 31/12/2019
ILLUSTRATION TWO
The following information was extracted from the books of Your co ltd as at 31/12/2017
Debit bal. b/f-insurance $7,500
Credit bal. b/f-advertisement $12,000
Credit bal. b/f-air time expense $14,000
Debit bal. b/f-gen. expense $3,000
The following payments were made between January and December of 2018
Cash paid for advertisement $100,000
Check paid for insurance $75,000
Cash paid for gen. expenses $36,000
Cash paid for air time expense $43,000
Additional information as at 31/12/2018
Debit Bal. b/d-advertisement $10,000
Credit bal. -Air time expense $ 3,000
Credit bal. -Gen.expense $11,000
Debit Bal. b/d-Insurance $3,500
Required
i) Determine the expense amount for the year ended for advertisement, air time, gen. expense and insurance. (ie to be closed to profit and loss account).
ii) Extract the profit and loss account for the year end 31st/12/2018
iii) Extract the statement of financial position for Your co ltd as at 31/12/2018
Solution
You need to note the following point that the bookkeeping system being used is of separate expense accounts for each category of expenses. Then here we go
i) To determine the expense amount for the year ended for advertisement, air time, gen. expense and insurance. (ie to be closed to profit and loss account).
ii). To extract the profit and loss account for the year end 31st/12/2018
iii) To extract the statement of financial position for Your co ltd as at 31/12/2018
