ACCT1101 Tutorial 5 Q&A PDF

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ACCT1101 Tutorial Questions – Week 6 (Tute 5) CHAPTER 4 DISCUSSION QUESTIONS

D4.

‘Why are adjusting entries necessary? Surely they cause too much delay in preparing financial statements, and the financial effect of any entries made is immaterial in the long run.’ Respond to this criticism.

Answer: Adjusting entries are necessary in order to ensure that an entity’s income, revenues, expenses, assets and liabilities are recorded in the appropriate accounting period. The volume of work for adjusting entries on balance date can be minimised, in that the accounts and the amount of certain adjusting entries are known prior to balance date. While adjusting entries mist be recorded on balance date, details to make these adjustments can be worked out prior to balance date. Computerisation of the adjusting entries in the accounting system can also reduce the lead-time in preparing financial statements.

EXERCISES Exercise 4.4 Accrual basis income statement Victoria Holmes registered as a financial adviser several years ago. An income statement for the current period, prepared using cash accounting, is presented below. GST is ignored.

Additional data 1. Fees for advice given for the year ended 30 June 2019 for $8000 were collected in the current year and are included above. 2. Fees earned in the current year of $12 000 are expected to be collected in the following year. These have not been included above. 3. Accrued salaries at 30 June 2019 and 2020 are $4000 and $4300, respectively. 4. Depreciation expense of $18 000 is not included in the expenses. 5. Victoria Holmes withdrew $2400 per month to cover personal living expenses. Required (a) Using the above information, prepare an income statement on the accrual basis. Show all calculations. Answer: HOLMES’ FINANCIAL ADVISORY SERVICE Income Statement For the year ended 30 June 2020 Income: Fees Revenue 384000 Less: Other Expenses 304700 Depreciation Expense 18000 Profit 61300

Calculations: Service Fees Revenue Reported 380000 Fees for 2020 to be collected the following year 12000 Fees for 2019 but collected in 2020 (8000) Accrual Basis Revenue 384000 Other Expenses Reported 305000 Accrued Salaries end of 2020 4000 Accrued Salaries end of 2019 (4300) Accrual Basis Expenses 304700 (b) Briefly explain why the revised statement could be considered a better measure of profit. Answer: Under the accrual basis of accounting, income is recognised when the increase in the benefits can be measured at a faithfully representative, verifiable amount, and expenses are recognised when the benefits consumed can be faithfully represented by a verifiable measure. (c) Is it a correct accounting procedure to exclude drawings from expenses? Explain why. Answer: It is correct to exclude drawings from expenses. Drawings are withdrawals of cash or other assets from the business by the owner in anticipation of profits. Neither tax law nor accounting principles recognise the owner of a sole proprietorship as an employee of the firm. Consequently, drawings, even though the owner may call them a salary, are not considered an expense of the business. Exercise 4.14 Adjusting entries Investment Guru provides investment advice to customers for fees. On 30 June 2019, it completed its first year of operations. Some of the ledger account balances of the business, before any year-end adjustments, are given below:

No adjusting entries have been made to these accounts at any time during the year. An analysis of the business records reveals the following. 1. The balance in Advertising Prepaid represents the amount paid for an advertisement in an investment magazine for 1 year. The agreement with the

2.

3.

4.

5.

publisher stipulates the same amount of space each month and covers the period 1 September 2018 to 31 August 2019. The firm’s lease in respect of the premises stipulates a rent of $1440 per month payable on the first day of each month, plus an annual amount equal to 0.5% of the annual fees earned. The extra rental is payable within 15 days of the end of the reporting period. The computer database expense relates to an annual subscription to web based data on the share market and other investments. The subscription was taken out on 1 August 2018. The wages are paid every Friday for a 5-day working week ending on the preceding Wednesday. In 2019, 30 June falls on a Thursday and the wages for the week ended 6 July 2019 amount to $9000. No overtime was worked and all employees worked the normal office hours during the 5-day week. The Electricity Expense ledger balance does not include the amount for June 2019. The account was received during July and amounted to $1250.

Required (a) Journalise the necessary adjusting entries. Answer: Investment Guru General Journal Date Details 2016 June 30 Advertising Expense Prepaid Advertising Advertising expense for 10 months: 10/12 x 1200

Problem 4.27

Debit 1000

Credit 1000

Rent Expense Rent Payable Additional rent owning based on fees earned: 0.5% x 350000

1750

Prepaid Subscription Computer Database Expense Prepaid database subscription: 12 240/12

1020

Wages Expense Wages Payable Wages owning at 30 June: 1/5 x 9000

1800

Electricity Expense Electricity Account Payable Electricity owning for June

1250

1750

1020

1800

1250

Adjusting entries and financial statements Non-GST version The unadjusted trial balance of the general ledger of Antonio’s Small Appliance Repair Service on 30 June 2019 is presented below (ignore GST).

Additional data for adjustment purposes 1. Supplies on 30 June 2019 were: (i) advertising supplies (originally debited to Advertising Expense), $6900. (ii) store supplies (originally debited to Sundry Expenses), $3600. 2. On 1 January 2019, the business rented half of its shop space to Joshua’s Café for 12 months and received a cheque for $19 200, representing the entire year’s rental fee. 3. Purchases of electrical repair equipment were as follows.

4. The Prepaid Insurance account consists of the following.

5. Wages earned by employees but unpaid as at 30 June 2019 totalled $5040. 6. Interest on the mortgage payable is $3672 per year, paid in half-yearly instalments on 1 May and 1 November. Required (a) Journalise adjustments in the general journal of the entity. Answer: Antonio’s Small Appliance Repair Service General Journal Date Details Debit 2019 June 30 Advertising Supplies 6900 Advertising Expense Advertising supplies not yet used Stores Supplies Sundry Expenses Store supplies not yet used

3600

Rent Revenue Unearned Rent Rent not yet earned

9600

Depreciation: Electrical Repair Equip Accumulated Depreciation: Electrical Repair Equipment Depreciation on equipment (280000/8 + 80000/10 x 3/12)

37000

Credit 6900

3600

9600

37000

Insurance Expense 5100 Prepaid Insurance 5100 Insurance expired (6200 x ½ + 4000 x 6/12) (b) Prepare an income statement and a statement of changes in equity for the year ended 30 June 2019. Answer: Antonia’s Small Appliance Repair Service Income Statement For the year ended 30 June 2019 Income Small appliance repairs revenue 434600 Rent revenue 9600 444200 Expenses

Advertising expense Other selling expense Electricity expense Rent expense Wages expense Insurance expense Depreciation of store equipment Sundry expense Interest expense

13200 30750 20100 19680 160840 5100 37000 35600 3672 325942 118258

Profit

Antonia’s Small Appliance Repair Service Statement of Changes in Equity For the year ended 30 June 2019 A. Calabrese, Capital – 1 July 2018 181010 Profit for the period 118258 A. Calabrese, Drawings (31540) A. Calabrese, Capital – 30 June 2019 267728 (c) Prepare a statement of financial position (properly classified in narrative form) as at 30 June 2019. Answer: Antonio’s Small Appliance Repair Service Statement of Financial Position As at 30 June 2016 Current Assets Cash at Bank 37770 Account Receivable 198850 Prepaid Insurance 5100 Advertising Supplies 6900 Store Supplies 3600 Marketable Securities 76260 Total Current Assets 328480 Non-Current Assets Electrical Equipment 360000 Accumulated Depreciation (159500) -Electrical Equipment Total Non-Current Assets 200500 Total Assets 528980 Current Liabilities Account Payable Wages Payable Interest Payable Unearned Rent Total Current Liabilities Non-Current Liabilities Mortgage Payable

184500 5040 612 9600 199752 61500

Total Liabilities Net Assets

261252 267728

Equity A. Calabrese, Capital 267728 Total Equity 267728 (d) Present the Interest on Mortgage Expense account showing detailed entries for the year ended 30 June 2019 as it would appear after all adjustments have been made. Answer: Interest Expense 2015 November 1 2016 May 1 June 31

2015 Cash

1836

July 1

Interest Payable (reversing entry)

612

2016 Cash 1836 Interest 612 Payable 4284

June 30

P/L Summary

3672 4284

Ethics and Governance

The impact of a bonus incentive scheme on the financial statements

Lucia works as an accountant for a motor vehicle engine parts manufacturer called Vroom Ltd, owned by an international car firm. Her manager, Freda Chuse, is paid a bonus depending on the profitability of the company. If Vroom Ltd makes $1 million profit, Freda receives a bonus of $20 000 that increases progressively to $30 000 for a $3 million profit. If the profit of Vroom Ltd exceeds $3 million, Freda receives the maximum bonus of $30 000. Vroom Ltd currently receives a grant from the government of $100 000 per year to employ and train apprentice mechanics. At the end of May, it appears that Vroom Ltd will make a profit of approximately $3.5 million for the year ending 30 June 2019. Freda approached Lucia and said that if the company made too much profit then the government may stop paying Vroom Ltd the grant for training apprentice mechanics, and it would lose the $100 000 tax-free cash inflow. Freda instructed Lucia to find ways of deferring recognition of as much revenue as possible until the following financial year, for which the forecasts for the industry were quite poor, and to accrue as many

expenses as possible at the end of the current accounting period when it came to making the end-of-period adjustments. Although Lucia was not happy with this instruction, she did not want to risk her own opportunities for promotion by upsetting her manager. Required (a) Who are the stakeholders in this situation? Answer: The Manager, The Accountant, The present and potential shareholders of the entity (b) Why do you believe Freda asked Lucia to do this? Answer: Freda may well be asking Lucia to reduce the reported profit in an attempt to avoid losing the government grant for employing and training apprentice mechanics. It may also be that as Freda’s bonus is maximised when the firm earns 3 million there is no benefit to her in making 3.5 million profit. However, if Freda believes that the following accounting period is not likely to make as much profit it is in her best interests to defer the recognition in excess of 3 million until the following accounting period to maximise her bonus in that period while having no negative impact on her current period’s bonus. (c) What are the ethical issues involved her? Answer: It is unethical, if Lucia recognises other assets, liabilities which do not legimately reflect the entity’s performance and financial position in the current period. Also, there are several ways which Lucia could use to manipulate the profit figure. It also becomes unethical if the manager places so much pressure on Lucia to carry out adjustments that she believes should not be made, on the ground that the results for the period would become distorted. (d) Can Lucia defer revenues and accrue as many expenses as possible and still be ethical? Answer: Lucia can accrue all possible incomes and defer all possible expenses through adjusting entries, but should not be involved in going so far as to distort the financial performance and financial position of the entity so as to mislead present and potential shareholders....