Missing Items in the Operating Income Account - lesson five
Again, in this lesson, the objective is to demonstrate to the entrepreneur/learner on the approach to determine the missing items related to the operating income account. The question that arise here is which are this missing items? This can be any component or element that forms a particular income account. For instance, the common items one may be required to establish at the end of the financial period are; accrued income which appear as debit balance b/d or income in advance which appear as credit balance b/d and the per annum amount of income 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 received for that particular period of time.
To start this discussion, it’s much in order to note that sometimes, the management may advocate keeping of operating income accounts separately for each case such as rent income account, commission income account or membership subscription income account and any other type of operating income 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 income, commission income and member subscription income 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 cash receipt timing for there may be cases where one of the components of income are received in arrears, other amounts in advance or in other cases, the amount for one of the income component may be received for the exact financial period of one year. This mixed transactions result to difficulties in distinguishing the operating income component which had either an accrual or advance 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 income account.
Step by step missing item technique procedure;
This procedure is similar to that of operating expense only that this time the focus is on business gains. There we go…..
Step one; Consider operating income 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 income account. Such that, if it is an accrued income, then post it on the debit side of the respective operating income account and if it is income in advance, post it on the credit side of the respective ledger account.
Step three; post the cash received in the course of the financial period to the respective income account. The entrepreneur need to note that the cash received could be a cocktail of cash for income in arrears or for the current year’s income or income in advance. Whichever the case, the accounting entry will be;
DR Cashbook
CR Operating income account
Step four; from the information provided, post the balances brought down of accrued income account 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 income accrual 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 income 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 income 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 income received in advance 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 income 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 income 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 as the balancing figure.
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 profit and loss account as the year’s operating income.
ILLUSTRATION ONE
The following information was provided to you by the accountant of Your co ltd. The management keeps a combined rent and commission income account.
Additional information;
The following transactions took place in 2019
Cash received from tenants $35,000 by check
Cash received as commission $60,000
Bal c/d (debit) for rent income $4,000
Bal b/d (debit) for commission income $ 15,000
Required;
i) Determine the income amount for rent and commission (as one account) 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 income amount for rent and commission to be closed to profit and loss account
The entrepreneur/learner need to understand that this operating income account is a joint one whereby the rent and commission income account are taken as one. Therefore, the individual entry balances are considered in isolation but the amount of cash received (95,000)and charged to P&L account (85,000) is only one figure.
Note the following;
1. The closing current asset (accrued income) and liabilities (income in advance) amounts in the previous statement of financial position are posted in the right hand side of the rent and commission income account as balance brought forward (abbreviated as bal. b/f)
2. After posting the total cash paid in the rent and commission income 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 rent income 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 and commission income 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 rent and commission income 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 rent income in advance.
If the aspect of commission income 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 and commission income account and it represents accrued income. At the same time the same amount is further posted on the opposite credit side of that rent and commission income account before the totals as balance c/d as the balancing figure.
ii) Extract the profit and loss account for the year end 31st/12/2019
iii) To extract the statement of financial position for Your co. ltd as at 31/12/2019
