financial accounting (3)
TRANSCRIPT
Adjustments
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In order to ascertain the fair and true results of a business for a particular
period, it is essential that all the expenses, revenues related only to that period
or year should be considered
If Financial Statement for 2011 are prepared, then the expenses and revenues
related to 2010 and 2012 should not be considered, the focus will be on 2011
incurred expenses and earned revenues
Every adjusting entry will include one income statement account and one
balance sheet account
Cash is not adjusted at the end of the accounting period, thus should not use
cash in the adjusting process
Accruals
Before to an accrual adjustment, the expense account (and the
related liability account) or the revenue account (and the related
asset account) are understated
Thus, the adjusting entry for accruals will increase both a balance
sheet and an income statement account
Accruals fall into two categories
o Accrued Expenses
o Accrued Revenues
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Accrued Expenses
Accrued Expenses or Outstanding Expenses or Expenses Payable
Expenses incurred but not yet paid or recorded are called accrued
expenses. Interest, taxes, utility bills and salaries are common
examples of accrued expenses
For example, salary for December is generally paid till the 2nd
and 3rd January next
When books of account are closed and Financial Statements are
prepared the amount of staff salary for December is treated as an
“Outstanding Salaries”.
Example # 3.1: At December 31, 2010, Company expects to pay
employees’ salaries of Rs. 8,400 as a result of work performed since
the last pay day
Accrued Revenue
Revenue earned but not yet received in cash in accounting year
Revenues earned but not yet recorded at the statement date are
accrued revenues
Accrued revenues may accumulate (accrue) with the passing of
time, as in the case of interest revenue. These are unrecorded
because the earning of interest does not involve daily transactions.
Companies do not record interest revenue on a daily basis because
it is often impractical to do so
Example # 3.2: Rs. 100,000 fixed deposits amount in bank in July 01,
2007 and contract is to earn 10% per annum at the end of contract year.
So in this case we will receive Rs. 10,000 at June 2008, but we have
earned interest of six months in this period 2007, so pass adjusted entry
Prepayments
Prepayments are also called Deferrals.
Costs or revenues that are recognized at a date later than the point
when cash was originally exchanged
Companies make adjusting entries for prepayments to record the
portion that was incurred as an expense or earned as revenue
during the current accounting period. The two types are:
Prepaid expenses/ Unexpired expenses
Unearned revenues
Prepaid Expenses
Expenses are paid in advance are called prepaid expenses or
unexpired expenses
Expenses paid in cash and recorded as assets until they are used
or consumed
Prepaid expenses are costs that expire with the passage of time (i.
e. rent and insurance) or through use (i. e. supplies)
Examples of common prepayments are insurance, supplies,
advertising, and rent.
Example 3.3: For example, on September 1, 2010 full year insurance paid of Rs. 24,000. We will utilize this expense for 12 months and we have 4 months expense for 2010 and remaining for 2011. Prepaid expenses has two case on the basis of journal entry and trial balance presentation
Case 1: Expense Method
The effect of above regular entry in end of year trial balance is presented below
So adjusting entry at December 2010 in order to adjust the balance
Unearned Revenue
Income received in advance but has not been earned in accounting period is
called unearned revenue
Example # 6.8: For example, rent received for four year in January 01, 2010 of Rs.
80,000. At the end of 2010 accounting period only one year rent is recognized as
revenue and remaining liability for next accounting year
There are some items of income statement such as interest, rent, discount etc.
which might have been received in advance for which the services in full has not
been given so for
Accrued …. Expenses…….. Liability…… Unrecorded expenses (expenses incurred,
but cash not yet been paid
Accrued ……… Revenue ………. Assets ….. Unrecorded revenues (revenues earned,
but cash not yet received
Prepaid………….... Expenses…………….. Assets ……………..…. Unexpired
costs or deferred
Deferred…..…………Revenue ……………..Liability ………………. Unearned
or Cash received in advance of performing services or selling goods
Irrecoverable Debts
For achieving the maximum sales, goods are often sold to known customers
on credit
Since of these customers fails to pay their debts due to insolvency or any
other factor
It should be noted here that no adjustment is required for any bad debt which
is appearing already in the Trial Balance. The bad debt appearing in the trial
balance shows as expense in the income statement only
Three procedures used in this context methods are Write-off Method,
Allowance and Recovery
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Direct Write-Off
When a specific account is determined to be uncollectible, the loss is charged to
bad debts expense or Irrecoverable debt expense account
Bad debts expense will show only actual losses from uncollectible
Using the direct write-off method, entries to record write-offs are often made in
a period following sales rather than in the period in which the sales were made.
Therefore, there is no matching of expenses with the revenue Use of the direct write-off method can reduce the usefulness of both the income
statement and balance sheet
Unless bad debt losses are insignificant, the direct write-off method is not
acceptable for financial reporting purposes
Example # 3.4: Based on an analysis the bad debts expense adjustment
for the year 2008 is Rs. 1,000 for Ali and Sons
Write-Off
When a specific account is determined to be uncollectible, the loss of bed debts
is charged to allowance
This is the case where allowance already maintained and reflected in balance
sheet
Write-off against allowance is acceptable for financial reporting purposes
Under this, every bad debt write-off is debited to the allowance account (not to
Bad Debt Expense) and credited to the appropriate Account Receivable
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Allowance
Allowance or Provision is liability of uncertain timing or amount
The accounting for allowance involves estimating uncollectible accounts at the
end of each period
It provides better matching of expenses and revenues on the income statement
and ensures that receivables are stated at their cash (net) realizable value on the
balance sheet
The allowance method is required for financial reporting purposes when bad
debts are material
The credit balance in the allowance account will absorb the specific write-offs
when they occur
Example # 3.5: Assume Abbottabad Furniture has credit sales of Rs. 1,200,000 in 2011, of which Rs. 200,000 remains uncollected at December 31st. The credit manager estimates that Rs. 12,000 of these sales will prove uncollectible. Pass the adjusting entry to record the allowance
Assume that the vice-president of finance on March 1, 2012, authorizes a write-off of Rs. 500 balance owed by R. A. Sons. Pass the adjusting entry to record the write-off
Recovery
When a customer pays after the account has been written off, two entries are :1. The entry made in writing off the account is reversed to reinstate the
customer’s account2. The collection is journalized in the usual manner
The recovery of a bad debt, like the write-off of a bad debt, affects only balance sheet accounts
When R. A. Sons pays Rs. 500, two journal entries are required to record the collection:
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MCQ 1Rent paid on 1 October 2002 for the year to September 2003 was
£600 and rent paid on 1 October 2003 for the year to 30 September
2004 was £800. Rent payable, as shown in the profit and loss account
for the year ended 31 December 2003, would be?
(a) £600
(b) £800
(c) £650
(d) £750
(c) £650
MCQ 3A decrease in the provision for doubtful debts would result in?
(a) An increase in liabilities
(b) A decrease in working capital
(c) A decrease in net profit
(d) An increase in net profit
(d) An increase in net profit
MCQ 4Which of the following transactions would result in an increase in
capital employed?
(a) Selling inventories at a profit
(b) Writing off a bad debt
(c) Paying a payable in cash
(d) Increasing the bank overdraft to purchase a non-current asset
(a) Selling inventories at a profit
MCQ 5 What is cash discount?
(a) When payment is made in cash
(b) When payment is made by cheque
(c) When payment is made before due date
(d) When purchases are made in bulk
(c) When payment is made before due date
MCQ 6What is the double entry for discount allowed?
(a) Dr Debtors Cr Discount allowed
(b) Dr Debtors Cr Discount received
(c) Dr Discount allowed Cr Debtors
(d) Dr Discount allowed Cr Supplier
(c) Dr Discount allowed Cr Debtors
MCQ 7Where is discount allowed disclosed?
(a) Trading account
(b) Profit and loss account
(c) Trial balance
(d) Balance sheet
(b) Profit and loss account
MCQ 8What is the double entry for discount received?
(a) Dr Supplier Cr Discount received
(b) Dr Discount received Cr Supplier
(c) Dr Discount received Cr Customer
(d) Dr Customer Cr Discount received
(a) Dr Supplier Cr Discount received
MCQ 9Where is discount received disclosed?
(a) Profit and loss account
(b) Trading account
(c) Balance sheet
(d) Trial balance
(a) Profit and loss account
MCQ 10What is trade discount?
(a) Discount as bulk purchases
(b) Discount when paying in cash
(c) Discount as early settlement of invoice
(d) Discount if you trade overseas only
(a) Discount as bulk purchases
MCQ 11What is the double entry for trade discount?
(a) Dr Sales Cr Trade discount
(b) Dr Trade discount Cr Sales
(c) Dr Purchases Cr Trade discount
(d) No double entry
(d) No double entry
MCQ 12Where is carriage inwards disclosed?
(a) Profit and loss account
(b) Balance sheet
(c) Trading account
(d) Trial balance
(c) Trading account
MCQ 13What does carriage inwards effect?
(a) Sales
(b) Purchases
(c) Drawing
(d) Capital
(b) Purchases
MCQ 14Carriage outwards is disclosed in
(a) Balance sheet
(b) Profit and loss account
(c) Trading account
(d) Trial balance
(b) Profit and loss account
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Pay
Gross Pay or Employer’s Payment a. Basic pay b. Allowancesc. Bonuses and commissiond. Other pay
Net Pay or Take Home Pay Net pay is equal to Gross pay minus Total Deductions Deductions are two type i.e. Statutory and Non-Statutory Deductions Statutory deductions are deductions from pay that are made by state or law
o Income tax o Social security tax (SS)
Non-statutory deductions are voluntary deductions from pay that the employee chooses to make
Contributions by the employee to a pension scheme Any advance taken by employee Insurance etc.
An employee has a gross monthly salary of $1,000. In September the
tax deducted was $200, the employee‘s social security tax was $60,
and the employer‘s social security tax was $100. What was the
charge for salaries in the income statement? $.........................
MCQ 17
$ 1,100
Accounting for Sales Tax
In the UK this is ‘VAT’ and in France ‘TVA’. In this session we shall use the generic name ‘sales tax’
As a consequence the amount that they charge their customers for goods and services supplied will increase by the addition of sales tax
The rate of sales tax varies between countries and will also vary between the nature of the goods and services supplied
The sales tax collected does not belong to the organisation that charges and collects it and the tax must therefore be remitted to the tax authorities on a regular basis (liability for organization)
Sales tax received can be referred to as ‘output’ sales tax, and sales tax paid can be referred to as ‘input’ sales tax
The sales tax paid to suppliers is therefore an asset (receivable) and the amount received from customers is a liability (payable)
The double-entry bookkeeping records need to show the goods and sales tax values separately so that the purchases and sales are posted net (i.e. without the addition of sales tax) and the sales tax amounts are posted to a separate sales tax account
Example 6.3: During October, W had the following credit transactions:
October
1 Purchased goods from H $360 subject to 20 per cent trade discount
3 Sold goods to HG for $80
5 Sold goods to PL for $15
8 Bought goods from KJ for $4,000 subject to 10 per cent trade discount
12 Received a credit note from KJ for goods returned valued at $1,200 list price
15 Sold goods to RW for $2,000
18 Issued credit note for $500 to RW for goods returned
All of these transactions are subject to sales tax at the rate of 17.5 per cent
MCQ 19Calculate the VAT on £100 at standard rate?
(a) £17.50
(b) £14.89
(c) £117.50
(d) Nil
(a) £17.50
MCQ 20How much is the VAT amount, if gross sales were £100?
(a) £17.50
(b) £14.89
(c) £117.50
(d) Nil
(b) £14.89
MCQ 21X purchased goods costing £500 from Z Ltd (before VAT). Z gave X
a trade discount of 20%, calculate the net amount after discount.
(a) £470.00
(b) £400.00
(c) £587.50
(d) £340.43
(b) £400.00
MCQ 22As per Mcq 21 above, calculate VAT on purchases after trade
discount.
(a) £87.50
(b) £70.00
(c) £17.50
(d) £82.25
(b) £70.00
MCQ 23As per Mcq 22 above, what would be the final double entry after
calculation of trade discount and VAT?
MCQ 24The sales account is
(a) Credited with the total of sales made, including VAT
(b) Credited with the total of sales made, excluding VAT
(c) Debited with the total of s ales made, including VAT
(d) Debited with the total of sales made, excluding VAT
(b) Credited with the total of sales made, excluding VAT
