ACCT1006 s2 2019 Lecture Week 2 Student 1 slide PDF

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ACCT1006: Accounting and Financial ManagementWeek 2: Accrual Accounting ConceptsTimothy Ganghua WangLearning Objectives/Outcomes Differentiate between the cash basis and the accrual basis of accounting. (R) Explain criteria for revenue recognition and expense recognition. (R) Explain why adjusting e...

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ACCT1006: Accounting and Financial Management Week 2: Accrual Accounting Concepts Timothy Ganghua Wang

Learning Objectives/Outcomes 1. Differentiate between the cash basis and the accrual basis of accounting. (R) 2. Explain criteria for revenue recognition and expense recognition. (R) 3. Explain why adjusting entries are needed and identify the major types of adjusting entries. (R) 4. Prepare adjusting entries for prepayments and accruals. (R) 5. Describe the nature and purpose of the adjusted trial balance. (R) 6. Explain the purpose of closing entries. (New) 7. Describe the required steps of the accounting cycle. (start here) 8. Describe the purpose and basic form of a worksheet (New) – Readings: Chapter 3 The University of Sydney

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LO7 Summary of the Accounting Cycle – Number the steps in the correct order: Steps

Order

Post-closing trial balance Adjusted trial balance Analyse transactions Prepare financial statements Prepare a trial balance Journalise and post adjusting entries Journalise transactions Journalise and post closing entries Post transactions The University of Sydney

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LO1 Accrual versus Cash Basis of Accounting – Cash-based accounting –

recognised when the cash is received.

–

recognised when the cash is paid

–

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is difference between cash in and cash out

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Revenue and Expense recognition – Accrual-based accounting Revenue is recognised when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably – Usually occurs at the time when goods are delivered and services are provided Expenses recognised when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably – Usually occurs when there is a decrease in future economic benefits (decrease in assets or increase in liability) for goods or services received The University of Sydney

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LO2 Relationships Accounting Period concept Economic life of business can be divided into artificial periods for reporting purposes Revenue recognition criteria

Expense recognition criteria

Revenue and expense criteria Form part of generally accepted accounting principles (GAAP)

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Accrual versus Cash Basis of Accounting Blue Chip Painting paints a large building for $80,000 in Yr1. In Yr1 Blue Chip pays expenses of $50,000 for paint & employee’s salaries. At the end of Yr 1, Blue Chip bills the customer but doesn’t receive the money, until Yr2. Activity Accrual basis Cash basis The University of Sydney

Year 1 Purchased paint, painted building, paid employees Revenue Expense Profit/loss Revenue Expense Profit/Loss )

Year 2 Received payment for work done in Year 1 Revenue Expense Profit/loss Revenue Expense Profit/loss Page 7

LO3 Adjusting Entries – Why do we need adjusting entries? – Why wouldn’t the accounts be up-to-date? – How often do we prepare adjusting entries?

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Types of adjusting entries – Prepayments and Accruals Prepayments 1. Prepaid expenses: Cash outflow precedes the entity receiving goods or services 2. Revenue received in advance: Cash inflow precedes the entity supplying goods or services to customers NB: There are alternative ways for the initial recording Accruals 1. Accrued revenues: Amounts not yet received or recorded for which goods or services have been provided 2. Accrued expenses: The receipt of goods or provision of services precedes cash outflow to suppliers

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LO4 Adjusting entries for prepayments – Prepayments are initially either treated as assets or expenses a) Prepaid insurance (initially treated as an asset) – Adjustment is needed for the “expired” future economic benefit Dr Prepaid Insurance Cr Cash at bank Dr Insurance Expense Cr Prepaid Insurance

Prepaid Insurance Unadjusted Credit adjustment balance

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Insurance Expense Debit adjustment

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Adjusting entries for prepayments 1. Prepaid Insurance – On 1 October, $600 Insurance paid for 1 year in advance (initially recorded as an asset) – Insurance for October $600/12 = $50 – By the end of October, $50 is no longer an asset as it provides no future economic benefit. – Record the Adjusting journal entry on 31 October. 31 Oct

Prepaid Insurance 1/10 600 31/10 The University of Sydney

Insurance Expense 31/10 Page 11

Adjusting entries for prepayments – Prepaid Insurance: $600 – Insurance Expense: $50 1/10

Cash at bank

1/11

Opening Balance

31/10

Insurance

Insurance 600 31/10 31/10

Insurance Expense 50

No. 300

No. 630 31/10

1/11

Opening Balance

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1

Adjusting entries for prepayments b) Prepaid insurance (initially treated as an expense) – The adjustment is needed to recognise the future economic benefit that remains in the asset (prepaid insurance). Dr Insurance Expense Cr Cash at bank Dr Prepaid Insurance Cr Insurance Expense

Prepaid Insurance Debit adjustment

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Insurance Expense Unadjusted Credit balance adjustment

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Adjusting entries for prepayments 2. Prepaid Insurance – On 1 October, $600 Insurance paid for 1 year in advance (initially recorded as an expense) – Insurance for October $600/12 = $50 – By the end of October, $50 is no longer an asset as it provides no future economic benefit. – Record the Adjusting journal entry on 31 October 31 Oct

Prepaid Insurance 31/10 The University of Sydney

Insurance Expense 1/10 600 31/10 Page 14

Adjusting entries for prepayments 1. Supplies – Supplies purchased on 5 October for $2,500 originally recorded as an asset – Advertising Supplies on hand 31 October: $1000 – Record the Adjusting journal entry on 31 October.

31 Oct

Advertising Supplies 5/10 2 500 31/10 The University of Sydney

Advertising Supplies Expense 31/10 Page 15

Adjusting entries for prepayments 2. Supplies – Supplies purchased on 5 October for $2,500 originally recorded as an expense – Advertising Supplies on hand 31 October: $1000 – Record the Adjusting journal entry on 31 October.

31 Oct

Advertising Supplies 31/10 The University of Sydney

Advertising Supplies Expense 5/10 2500 31/10 Page 16

Adjusting entries for Revenue Received in Advance c) Revenue Received in Advance (initially treated as a liability) – Adjustment is needed for the Amount of revenue no long in advance Dr Cash at bank Cr Revenue received in advance Dr Revenue received in advance Cr Revenue

Revenue Credit adjustment

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Revenue received in advance Debit Unadjusted balance adjustment

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Adjusting entries for Revenue Received in Advance 1. Revenue Received in Advance – $1200 received 2 October for advertising services to be completed by 30 November – $400 of services were completed in October – Record the Adjusting journal entry on 31 October.

31 Oct

Service Revenue 31/10 The University of Sydney

Revenue Received in Advance 31/10 2/10 1200 Page 18

Adjusting entries for accruals Accrued revenues are revenues that have not been received and are unrecorded at end of reporting period even though the goods have been delivered or services provided to customers. Revenue and a receivable are recorded, when cash is received, the receivable is reduced Accrued expenses are expenses not yet paid or recorded at end of reporting period even though goods have been delivered or services provided by suppliers. – Expense and payable are recorded, when cash is paid, the payable is reduced

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Adjusting entries for accruals 2. Accrued Revenue – Commission Revenue not yet received or recorded at balance date: $200 – Record the Adjusting journal entry on 31 October.

31 Oct

Commission Revenue 31/10 The University of Sydney

Commission Receivable 31/10 Page 20

Adjusting entries for accruals continued Accrued expenses are expenses not yet paid or recorded at balance date 3. Accrued Salaries – Salaries outstanding for October: (salaries total $2000 per week, paid fortnightly)

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Adjusting entries for accruals continued – Journal entry 31 Oct

– General Ledger:

12/10 26/10 31/10

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Salaries Expense 4000 4000

Salaries Payable 31/10

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LO5 The Adjusted Trial Balance and Financial Statements – The adjusted trial balance is prepared after all adjusting entries have been made – It is used to prove the equality of total debit balances and total credit balances after the adjusting entries have been made – The adjusted trial balance is the main basis for preparation of the financial statements

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Preparing financial statements – Statement of Profit or Loss prepared from revenue and expense accounts – Current period profit (or loss) and dividends paid transferred to retained earnings account (part of statement of changes in equity) – Statement of financial position prepared from asset, liability, equity and balance of retained earnings accounts – Remember interrelationships between statements

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LO6 Closing Entries

relate to only one accounting period e.g: revenues, expenses, dividends – are carried forward to future accounting periods e.g: assets, liabilities, equity –

– Closing entries are used to transfer the balances in temporary ledger accounts to a permanent equity account (Retained Earnings or Capital) and to close the temporary accounts (reset them to zero balance) for the new accounting period.

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Preparing closing entries continued – Each revenue and expense account is closed to the , another temporary account – The Profit or Loss Summary account is closed to . – are closed to the Retained Earnings – This will result in all temporary accounts having a closing balance of zero

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Adjusted Trial Balance and Closing Entries Wong PTY LTD Adjusted Trial Balance as at 31 October 2017

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Cash Commissions Receivable Advertising Supplies Prepaid Insurance Office Equipment Accum. Dep. – Office Equipment Accounts Payable Interest Payable Revenue Received in Advance Salaries Payable Bank Loan Share Capital Retained Earnings Dividends Service Revenue Commissions Revenue Salaries Expense Advertising Supplies Expense Rent Expense Insurance Expense Interest Expense Depreciation Expense

Dr 15 200 200 1 000 550 5 000

Cr

40 2 500 50 800 1 200 5 000 10 000 500 10 400 200 5 200 1 500 900 50 50 40 30 190

30 190

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Closing Entries (Revenue) Trial Balance

Dr

Cr

Service Revenue Commissions Revenue

31 Oct

Service Revenue Oct 10 400

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Commission Revenue Oct

Profit or Loss Summary 200

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Closing Entries 2

Closing Entries (Expenses)

31 Oct

Oct

Salaries Expense 5 200

Advertising Supplies Expense Oct 1 500 Oct

Oct

Insurance Expense 50

Oct

Interest Expense 50

Oct

Depreciation Expense 40 Profit or Loss Summary Oct 10 600

Rent Expense 900 The University of Sydney

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Closing Entries (Profit or Loss Summary)

31 Oct

31/10

Profit or Loss Summary 7 740 31/10

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10 600

Retained Earnings 31/10

0

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Closing Entries (Dividends)

31 Oct

Retained Earnings 31/10 31/10

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0 Oct 2 860

Dividends 500

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Preparing a post-closing trial balance – A post-closing trial balance is a list of all permanent accounts and their balances after closing entries are journalised and posted – The purpose of the post-closing trial balance is to prove the equality of the permanent accounts that are carried forward to the next accounting period

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Post Closing Trial Balance Wong PTY LTD Post Closing Trial Balance as at 31 October 2017 Cash Commissions Receivable Advertising Supplies Prepaid Insurance Office Equipment Accum. Dep. – Office Equipment Accounts Payable Interest Payable Revenue Received in Advance Salaries Payable Bank Loan Share Capital Retained Earnings

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Dr 15 200 200 1 000 550 5 000

Cr

40 2 500 50 800 1 200 5 000 10 000

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Learning Objectives/Outcomes 1. Differentiate between the cash basis and the accrual basis of accounting. (R) 2. Explain criteria for revenue recognition and expense recognition. (R) 3. Explain why adjusting entries are needed and identify the major types of adjusting entries. (R) 4. Prepare adjusting entries for prepayments and accruals. (R) 5. Describe the nature and purpose of the adjusted trial balance. (R) 6. Explain the purpose of closing entries. (New) 7. Describe the required steps of the accounting cycle. (start here) 8. Describe the purpose and basic form of a worksheet (New) – Readings: Chapter 3 The University of Sydney

Revise in your own time

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LO8 Purpose and Form of a Worksheet – Worksheets are spreadsheets prepared either manually or electronically to assist in the preparation of the adjusting entries and the preparation of the financial statements – A worksheet is not a permanent accounting record, it is neither a journal nor a part of the general ledger. It is merely a device used to make it easier to prepare adjusting entries and the financial statements.

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Homework: Adjusting entries for prepayments Alternative Treatment : Revenues received in advance – Example – $1200 received 2 October for advertising services to be completed 31 December, initially recorded as revenue. $400 of services were completed in October Journal entry on 31 October 31 Oct

Service Revenue Received in Advance 31/10 The University of Sydney

Service Revenue 31/10 Oct. 2

1 200 Page 37

Adjusting entries for accruals Accrued expenses are expenses where the service has been provided by the supplier but not yet paid or recorded at balance date Accrued interest – Accrued interest owing on loan of $5000 taken out on 1 October. Interest rate: 12% p.a. – Interest owing: $5000 x 12% x 1/12 = $50 Journal entry at 31 October: 31 Oct

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Adjusting entries for prepayments continued 3. Depreciation – Allocation of the cost of the asset to expense over its useful life – Depreciation of office equipment: $480 p.a. or $40 monthly

Journal entry at 31 October: 31 Oct

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Adjusting entries for prepayments continued – General Ledger Office Equipment 2/10 5 000 Accumulated Depreciation - Office Equipment 31/10

Depreciation Expense 31/10

– Statement of Financial Position (Partial) Office Equipment Less: Accumulated Depreciation Carrying Amount The University of Sydney

$ $ Page 40

REVISE: summary of basic relationships – on P.175

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