ACC1105 Lecture Notes PDF

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ACC1105 LECTURE NOTES RECORDING TRANSACTIONS (WEEK 1) Types of Transactions External transactions: involve an outside party exchange of economic resources and/or obligations (sale of inventory, purchase of supplies) Internal transactions: transformation of economic resources (use of office supplies) Non-transactional events: not usually recorded, but may be in the future (receiving an order from a customer) Balance Sheet Accounts Asset accounts: Cash at bank Accounts receivable Other receivables and debtors GST outlays Prepaid expenses Land Building Plant and equipment

Liability accounts: Accounts payable Unearned income Other current liabilities GST payable and receivable (normally one account called GST Net Payable) Mortgage payable Equity accounts: Four main transactions – investment/withdrawal of assets by the owner, income earned, expenses incurred Capital Drawings or withdrawals

Income Statement Accounts Income Revenue: income that arises in the course of ordinary activities (usually through the provision of services or sales) Gain: incomes that does not usually arise in the course of ordinary activities (usually non-recurring) Expenses (The cost of services and economic benefits consumed or lost or liabilities incurred) Profit Loss

ADJUSTING THE ACCOUNTS AND PREPARING FINANCIAL STATEMENTS (WEEK 2) Measurement of profit Cash basis: Income recorded when cash received/expenses recorded when cash paid Accrual basis: Income recognised in the period in which the expected inflow of economic benefit can be reliably measured/ expenses when the consumption of benefits can be reliably measured. Adjusting Entries The need for adjusting entries: Period in which cash is paid or received does not coincide with period in which expense and income are recognised. Two categories – Deferrals: the expenses paid in advance (‘prepaid expenses’) or revenues received in advance (‘unearned revenues’) Accruals: the recognition of expenses incurred but not yet pad for (‘accrued expenses’) Rules o One side of the entry affects an income statement account (revenue/expense) o The other side affects a balance sheet account (asset/liability) o Cash account is never adjusted as the cash glow occurs either before or after the end of the reporting period Adjusting Entries for Deferrals Prepaid Expenses Cash paid before benefits are consumed/expired Initially recorded as an asset At the end of the period the amount consumed/expired is expensed Adjusting Entries for Accruals Accrued or unrecorded expenses Expenses consumed but not yet recorded because payment hasn’t been made Adjusting entry needed to recognise the expense in the period which it is incurred rather than in the period of payment Unrecorded or accrued revenue Usually recorded when service is performed (no adjusting entry would be necessary) Revenue that is unrecorded at the end of the period must be included in the accounting records by debiting a receivable and crediting a revenue account.

Preparation of Financial Statements Income Statement Prepared first to determine profit or loss Reflects entity’s performance for the period Statement of Changes in Equity Profit/loss must be added/subtracted to equity Capital contributions and drawings/dividends recorded Shows details of movements in equity Balance Sheet Reflects entity’s financial position as at the end of the period Three major categories of accounts: Assets Liabilities Equity Statement users find it useful if assets and liabilities are further classified

COMPLETING THE ACCOUNTING CYCLE – CLOSING AND REVERSING ENTRIES (WEEK 3)

The Closing Process Involves1. Closing each income and expense account to the Profit of Loss Summary account 2. The balance of this account is then closed off to the capital account 3. Any drawings made by the owner during the year reflected in the drawings account closed off to the capital account The closing of all temporary accounts is done by making compound general journal entries, and then posting to the relevant accounts. 1. Closing income/revenue accounts An income account normally contains a credit balance, hence to close it, it must be debited for an amount equal to its credit balance. The offsetting credit is made to the Profit or Loss Summary account.

2. Closing the expense accounts Expense accounts normally have a debit balance so is credited for an amount equal to its balance, and the Profit or Loss Summary account is debited for the sum of the individual balances.

3. Closing the Profit or Loss Summary account After the first two closing entries are posted, the balanced formerly reported in the individual income and expense accounts are summarised in the Profit or Loss Summary account. The balance is transferred to the capital accounts.

4. Closing the Drawings account The drawings account is not closed to the Profit or Loss Summary account because the withdrawal of assets by the owner is not an expense of doing business. The balance in the account is transferred directly to the capital account.

Reversing Entries Reversal of accrual entries Dated the first day of the subsequent accounting period. Exactly reverse certain adjusting entries. An accounting technique used to simplify the recording of regular transactions in the next period. Optional but very useful.

Accounting for a company Equity is separated into two main account categories: Share capital – represents the amount of assets invested in the company by the shareholders Retained earnings – which reflect the accumulated profits earned by the company and retained in the business

ACCOUNTING FOR RETAILING – WEEK 4 Simplified income statement for a retail business -

Tax Invoices Required for all sales in excess of $75 Must have: ‘Tax invoice’ stated prominently ABN of entity issuing Sate of issue Name of suppliers Description of items being supplied Invoice over $1000 have additional requirements (show GST separately) Adjustment Notes Are essentially a ‘negative invoice’ and used when All or part of goods sold are returned An allowance (discount) is given The price of supply is changed Part or full amount owing has to be written off Accounting for Sales Transactions Recorded when inventory is transferred from the business to the customer An asset is debited, and the sales account is credited Accounts receivable balance includes GST

Sales Returns and Allowances: Sales Returns and Allowances account is debited for an amount excluding GST Sales Returns and Allowances are subtracted from sales in the income statement in order to show net sales

Cash (settlement) discounts When inventory sold on credit, terms of payment – e.g ‘n/30’ Provides an incentive for the buyer to make payment before the end of the credit period.

GST included in the discount amount must be adjusted on the net amount receivable. Trade discounts A percentage reduction granted from the normal list price Trade discounts not recorded by either the buyer or the seller Freight Outwards Obligations are stated on the invoice issued by the seller. EXW: ex works – buyer covers cost of transport DDP: delivered duty paid – seller covers cost Accounting for Inventory Two distinctively different inventory systems, each will provide different valuations of inventory Perpetual inventory system Periodic inventory system Perpetual inventory system Involves keeping current and continuous records of all inventory transactions Separate computer record or inventory for each type of inventory item held: Quantity, unit cost and total cost for each purchase and each sale Running inventory balance

A physical inventory count is taken only to verify the accuracy of the recorded ending inventory. The balance in the Inventory account is the ending inventory amount.

Periodic inventory system A store operating with high volume may conveniently record the amount of each sale. The unadjusted trial balance debit column is the beginning inventory amount The accounts that affect the cost of net purchases – Purchases, Purchases Returns and Allowances, Discount Received and Freight Inwards It is necessary to remove the beginning inventory balance and record the ending inventory in the Inventory account Profitability Analysis Gross profit ratio: expresses gross profit as a percentage of net sales

Profit margin: reflects the portion of each sales dollar that ends up as final profit. Is considered more informative than simply stating profit in absolute terms.

Expenses to sales ratio: reflects the portion of each sales dollar that is needed to meet the entity’s expenses other than cost of sales

Inventory turnover: used to assess performance in a retail business, indicates the number of times average inventory has been sold during a period

ACCOUNTING SYSTEMS (WEEK 5) The operation of an accounting system has three basic phases: Input Processing Output Phases in the installation or revision of an accounting system

Important Considerations in developing an accounting system Cost versus benefit Compatibility Flexibility/adaptability Internal control Internal Control Two aspects – administrative controls and accounting controls Principles of internal control systems Clearly established lines of responsibility Separation of record keeping Mechanical and electronic devices Adequate insurance Internal auditing Programming controls Physical controls Other controls – use of prenumbered documents, rotation of employees

Manual Accounting Systems Subsidiary ledgers A large amount of detailed information about a certain general ledger account must be kept in a separate ledger called a subsidiary ledger. Total of the balances should equal the related control account in the general ledger The principle of control accounts Accounts payable Inventory Marketable securities Plant and Equipment Investments

Special Journals

Sales Journal: used solely for recording sales of inventory on credit. 1. For each sales invoice, enter the date of the sale, invoice number, customer’s name and amount of sale on a line in the sales journal. 2. At the end of each day, post each sale (GST inclusive amount) to the related customer’s account in the subsidiary ledger 3. At the end of each month, total the accounts receivable column of the sales journal and post the total amount as a debit to the Accounts Receivable Control account in the general ledger 4. Add the account balances of the accounts receivable subsidiary ledger to verify that the total is equal to the accounts Receivable Control account balance in the general ledger

Purchases Journal: records purchases of inventory on credit 1. From the tax invoice received from the supplier, enter the recording date, invoice date, supplier’s name and credit terms 2. At the end of each day, post each purchase for the full amount owing, including GST, to the related supplier’s account in the subsidiary ledger 3. At the end of each month, total the amount columns of the purchases journal and post the total of the accounts payable column as a credit to the Accounts Payable Control account in the general ledger 4. Add the account balances of the accounts payable subsidiary ledger to verify that the total is equal to the accounts Payable Control account balance in the general ledger Cash Receipts Journal: records all transactions involving the receipt of all forms of cash. Debits: Cash at bank, discount allowed, GST payable, Credits: Sales, GST payable, Accounts receivable, Other accounts 1. The entries in the accounts receivable column are posted daily to the subsidiary ledger 2. The credits in the other accounts column are posted daily or at other frequent intervals during the month 3. At the end of the month, the entries in each column are totalled Cash Payments Journal: records all payments of cash Debits: other accounts, accounts payable, purchases, GST receivable Credits: cash at bank, discount received, GST receivable 1. The entries in the accounts payable column are posted daily to the subsidiary ledger 2. The debits in the other accounts column are posted daily or at other frequent intervals during the month

RECEIVABLES AND INVENTORIES – WEEK 9 Types of Receivables Accounts receivable – relates to all accounts for which a business expects to receive money in the near future. Bills receivable – when credit is granted only on receipt of a formal legal instrument such as a bill of exchange or a promissory note Other receivables – loans to directors, managers and employees of the business, interest and rent receivable, short-term deposits Bad and Doubtful Debts Uncollected portion of accounts receivable. No general rule for determining the time at which a receivable actually becomes bad. Allowance method: an estimate of the amount of accounts receivable that is expected to be uncollected is made at the end of the accounting period. Adjusting entry is prepared with a debit to Bad Debts Expense account and a credit to Allowance for Doubtful Debts. Estimating doubtful debts: Percentage of net credit sales method: logic is that credit sales produce the accounts receivable that may become bad debts in the future. Ageing of accounts receivable method: estimate derived from a schedule that analyses and classifies accounts receivable by age. Approximate percentage of each age group that will become bad debts is determined. When an account receivable is determined to be bad it is written off by 1. Debiting the Allowance for Doubtful Debts account 2. Debiting GST payable and crediting Accounts Receivable Control - Issue adjustment note for GST 3. Crediting related account in accounts subsidiary ledger Direct write-off method: No allowance is made for bad debts. Only when an account is determined to be uncollectable is a debit made to Bad Debts Expense and credit to Accounts Receivable Control and the appropriate account in the subsidiary ledger. Receivables Turnover Measures how many times the average receivables balance is converted into cash during the year. It is considered a measure of the efficiency of the credit-granting and collection policies.

Cost of Inventory (Periodic system) Specific Identification Requires each unit sold and each unit on hand to be identified with a specific purchase invoice. Uses form of identification such as serial number or barcode. First-in, First-out (FIFO) Based on the assumption that the cost of the first units acquired is the cost of the first units sold Last-in, first-out (LIFO) The cost of the last units purchased is assumed to be the cost of the first units sold Weighted average Average cost per unit is calculated by dividing the total cost of goods for sale by the total number of units available for sale. The weighted average is then multiplied by the ending inventory to determine cost of ending inventory.

Cost of Inventory (Perpetual) First-in, First out (FIFO) The cost of the units on hand is composed of the most recent purchases. Last-in, First-out (LIFO) The cost of sales is determined at the point of each sale based on the assumption that the last costs acquired are transferred out first. Moving average A new weighted average cost is calculated after each purchase. This is then used to calculate the cost of sales and inventory on hand until additional units are acquired at a different unit price. Estimating Inventories Retail Inventory Method - One approach is to estimate ending inventory - Second approach is to perform a stocktake and value at retail price which is then converted to cost for financial statement purposes. Gross Profit Method Based on the assumption that the gross profit percentage remains approx. the same from period to period. The gross profit percentage for the previous period is used to estimate the value of ending inventory. Effect of Costing Method Due to rising prices the FIFO method produced the highest gross profit ratio and profit margin, and lowest inventory turnover. The LIFO method produced lowest gross profit ration and profit margin, highest inventory turnover. Moving averages lies between the two. With specific id method you can manipulate the three ratios by careful selection of the item sold

NON-CURRENT ASSETS: ACQUISITION AND DEPRECIATION – WEEK 10 Property, Plant and Equipment Future economic benefits contained in property, plan and equipment will be received over two or more accounting periods. To determine the acquisition cost of a plant asset the fair value of the items given up to acquired is measured (not the fair value of the asset being acquired).

Lease Agreement Operating Lease – the lessor retains all the risks and rewards attached to ownership of the leased asset Finance lease – the risks and rewards are transferred from the lessor to the lessee (legal ownership remains with the lessor)

Depreciation Straight-line method: allocates an equal amount of depreciation to each full accounting period in the asset’s useful life. Diminishing balance method: results in decreasing depreciation charge over the useful life.

Sum-of-years’-digits method: determined by multiplying the recorded cost less residual value by successively smaller fractions. Units-of-production method: relates depreciation to use rather than to time. Particularly appropriate for assets where consumption of economic benefits varies significantly from one period to another.

Comparison of Methods Straight-line method produces uniform charges to depreciation (the benefits received from the use of the asset are assumed to be received evenly through the asset’s life). Units-of-production method produces depreciation charges that may vary significantly from one accounting period to another.

Subsequent Costs Subsequent costs should be recognised as an asset only if - It is probable that the future economic benefits associated with the item will flow to the entity - The costs of the item can be measured reliably

Overhauls and replacement of major parts Made to extends an asset’s expected future benefits beyond the original estimate. Assets are normally revalued and the life of the asset reassessed. Leasehold improvements Additional costs to ensure the asset is suitable for its own intended use. The depreciable amount of improvements should be allocated progressively over the unexpired period of the lease or the useful lives of the improvements. Spare parts and service equipment The cost of spare parts and equipment should be treated as a separate item of property, plant and equipment as they may become redundant if the asset is retired.

LIABILITIES – WEEK 11 Liabilities Defined Three essential characteristics o Present obligation o Resulted from past events o Future outflow of resources embodying economic benefits Recognition of Liabilities If liabilities are note recognised the liabilities of the entity will be understated and equity overstated. Should be recognised when it is probable that an outflow of resources will result from settlement of a present obligation; and the amount ca n be measured reliably. Provisions and Contingent Liabilities Provisions: liabilities of uncertain timing or amount. Contingent Liabilities: a possible obligation arising from a past event that will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events that are not wholly in the control of the entity. A liability or provision that does not meet the recognition criteria can also be defined as a contingent liability. Classification of Liabilities Liabilities are classified according to their amount, nature and timing. Current Liabilities o Accounts payable (trade creditors) o Bills payable: differ from accounts payable as evidenced with a bill of exchange or promissory note o Employee benefits o Warranties: establish a provision for warranties as there is no doubt an obligation exists but there is uncertainty re the timing and amount. Involves establishing a liability called ‘Provision for Warranties’ in the year the products are sold. o Onerous contracts: the unavoidable costs of meeting the obligations under the contrac...