Acct1101 Tutorial Solutions- Week 6 (Tute 5) Chapter 4 PDF

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ACCT1101 Tutorial Solutions – Week 6 (Tute 5) CHAPTER 4 DISCUSSION QUESTION

D1 How is profit determined under (a) the cash basis of accounting and (b) the accrual basis of accounting? (a) Under the cash basis, profit is the excess of cash inflows from revenues over cash outflows for expenses. (b) Under accrual accounting, profit is the excess of recognised revenues over recognised expenses.

Exercise 4.8

Adjusting entry for prepaid insurance

Kreative Kitchens purchased a 1-year insurance policy on 1 March 2017. The entire premium of $9000 was recorded by debiting Prepaid Insurance. Ignore GST. Required A. Give the adjusting entry at 30 June for year ending 30 June 2017. B. What amount should be reported in the 30 June 2017 statement of financial position for Prepaid Insurance? C. If no adjusting entry was made on 30 June, by how much would profit be overstated or understated? Would assets be overstated or understated? Explain. D. What would your adjusting entry in requirement A be if the premium of $9000 was recorded by debiting Insurance Expense? A.

Insurance Expense Prepaid Insurance

3 000 3 000

($3000 = $9000 × 4/12) Insurance expired. Prepaid insurance recorded at $9000 initially. B.

Prepaid insurance $6000 ($9000 – $3000) – current asset.

C.

Profit would be overstated by $3000, because the expense for insurance that had not been recorded. Assets would also be overstated as the correct balance for prepaid insurance should be $6000 and it would have been left at $9 000. Hence it would be overstated by $3000.

D.

Prepaid Insurance

6 000

Insurance Expense Insurance prepaid (thus leaving $3000 in Insurance Expense).

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6 000

Exercise 4.9

Adjusting entry for unearned revenue

Easy Rentals Ltd received 4 months’ rent in advance from tenants on 1 April 2015. The entire amount of $6400 was credited to the Unearned Revenue account at this date. Ignore GST. Required A. Give the adjusting entry at 30 June 2015. B. What amount (if any) should be reported in the statement of financial position at 30 June 2015? C. If no adjusting entry were made on 30 June, by how much would profit be overstated or understated? Would liabilities be overstated or understated? Explain. D. What would your adjusting entry be in requirement A if the amount of $6400 had been credit to Rental Revenue on 1 April 2015?

A.

Unearned Revenue Rental Revenue

4 800 4 800

Rent revenue earned ($6400 × 3/4 = $4800) B.

Unearned Revenue $1600 – current liability in the statement of financial position

C.

Profit understated by $4800, because the rental revenue of $4800 would not have been recognised. Liabilities overstated by $4800 as the Unearned revenue account (a liability representing revenue received in advance of performance) would not have been reduced.

D.

Rental Revenue

1 600

Unearned Revenue

1 600

Unearned rental revenue recognised. $6400 × 1/4 = $1600

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Problem 4.12

Adjusting entries and financial statements

The unadjusted trial balance of the general ledger of Antonio’s Small Appliance Repair Service on 30 June 2016 is presented below: ANTONIO’S SMALL APPLIANCE REPAIR SERVICE Trial Balance as at 30 June 2016 Account Debit $ 37 770 Cash at bank 76 260 Investment in marketable securities 198 850 Accounts receivable 18 860 GST receivable 10 200 Prepaid insurance 360 000 Electrical repair equipment $ Accumulated depreciation – electrical equipment Accounts payable Mortgage payable (due 31 December 2021) GST payable A. Calabrese, Capital 31 540 A. Calabrese, Drawings Small appliance repairs revenue 20 100 Advertising expense 30 750 Other selling expenses 20 100 Electricity expense 39 200 Sundry expenses 19 680 Rent expense 155 800 Wages expense 3 060 Interest on mortgage expense Rent revenue $ 1 022 170 $

Credit

122 500 184 500 61 500 27 100 172 770 434 600

19 200 1 022 170

Additional data for adjustment purposes (a) Supplies on 30 June 2016 were: (i) advertising supplies (originally debited to Advertising Expense), $6900. (ii) store supplies (originally debited to Sundry Expenses), $3600. (b) On 1 January 2016, the business rented half of its shop space to Joshua’s Cafe for 12 months and received a cheque for $19 200 plus GST, representing the entire year’s rental fee. (c) Purchases of electrical repair equipment were as follows, net of GST: Purchase date Cost Useful life 1 January 2011 $280 000 8 years 1 April 2016 $80 000 10 years (d) The Prepaid Insurance account consists of the following, net of GST: Total premiums Life of policy Date of policy Policy number $6200 2 years 1 July 2015 FGK 3457 $4000 1 year 1 January 2016 BKL 5702 (e) Wages earned by employees but unpaid as at 30 June 2016 totalled $5040. (f) Interest on the mortgage payable is $3672 per year, paid in half-yearly instalments on 1 May and 1 November.

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Required A. Journalise adjustments in the general journal of the entity. B. Prepare an income statement and a statement of changes in equity for the year ended 30 June 2016. C. Prepare a statement of financial position (properly classified in narrative form) as at 30 June 2016. D. Present the Interest on Mortgage Expense account showing detailed entries for the year ended 30 June 2016 as it would appear after all adjustments have been made. A. ANTONIO’S SMALL APPLIANCE REPAIR SERVICE

General Journal Date

Particulars

Debit

Credit

Adjusting entries 2016 Jun

30

Advertising Supplies Advertising Expense

6 900 6 900

Advertising supplies not yet used. Stores Supplies

3 600

Sundry Expenses

3 600

Store supplies not yet used Rent Revenue Unearned Rent

9 600 9 600

Rent not yet earned (net of GST) Depreciation – Electrical Repair Equip.

37 000

Accumulated Depreciation – Electrical Repair Equipment Depreciation on equipment ($280 000/8 + $80 000/10 × 3/12) Insurance Expense

37 000

5 100

Prepaid Insurance

5 100

Insurance expired ($6200 × 1/2 + $4000 × 6/12) Wages Expense Wages Payable

5 040 5 040

Accrued wages Interest Expense

612

Interest Payable Interest accrued on mortgage since 1 May. ($3672 × 2/12)

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612

B. ANTONIO’S SMALL APPLIANCE REPAIR SERVICE

Income Statement for the year ended 30 June 2016 INCOME Small appliance repairs revenue Rent revenue

$434 600 9 600 $444 200

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

$13 200 30 750 20 100 19 680 160 840 5 100 37 000 35 600 3 672 325 942 $118 258

PROFIT

ANTONIO’S SMALL APPLIANCE REPAIR SERVICE

Statement of Changes in Equity for the year ended 30 June 2016 A. Calabrese, Capital – 1 July 2015

$172 770

Add: Profit for the period

118 258

Less: A. Calabrese, Drawings

(31 540)

A. Calabrese, Capital – 30 June 2016

$259 488

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C. ANTONIO’S SMALL APPLIANCE REPAIR SERVICE

Statement of Financial Position as at 30 June 2016 CURRENT ASSETS Cash at bank Accounts receivable Prepaid insurance Advertising supplies Store supplies Marketable securities TOTAL CURRENT ASSETS NON-CURRENT ASSETS Electrical equipment Less: Accum. depreciation – electrical equipment TOTAL NON-CURRENT ASSETS TOTAL ASSETS CURRENT LIABILITIES Accounts payable Wages payable Interest payable GST payable Unearned rent TOTAL CURRENT LIABILITIES NON-CURRENT LIABILITIES Mortgage payable TOTAL LIABILITIES NET ASSETS

$37 770 198 850 5 100 6 900 3 600 76 260 $328 480 360 000 (159 500) 200 500 $528 980

$184 500 5 040 612 8 240 9 600 $207 992 61 500 269 492 $259 488

EQUITY A. Calabrese, Capital TOTAL EQUITY

$259 488 $259 488

D. Interest Expense 2015 Nov 1

Cash

2015 1 836 Jul 1

2016 May 1 Jun 31

Interest payable

612

(reversing entry) Cash Interest payable

1 836 2016 612 Jun 30 $4 284

P/L Summary

3 672 $4 284

Page 6 of 7

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 2016. 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? B. Why do you believe Freda asked Lucia to do this? C. What are the ethical issues involved her? D. Can Lucia defer revenues and accrue as many expenses as possible and still be ethical? A.

The stakeholders are: The manager, Freda Chuse The accountant, Lucia The present and potential shareholders of the entity.

B.

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 $3m. there is no benefit to her in making $3.5m 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 $3m. until the following accounting period to maximise her bonus in that period while having no negative impact on her current period’s bonus.

C.

It is acceptable for Lucia to ensure that all assets, liabilities, income and expenses are recorded in the correct accounting period. It becomes unacceptable, and unethical, if Lucia recognises other assets, liabilities which do not legitimately reflect the entity’s performance and financial position in the current period. Nevertheless, there are several techniques which Lucia could use to manipulate (or ‘massage’) the profit figure e.g. changing the method of calculating depreciation, or changing useful lives of assets. These changes in techniques may be generally acceptable, and quite legal; but are they ethical? It becomes unethical if the manager places so much pressure on Lucia to carry out adjustments that she believes should not be made, on the grounds that the results for the period would become distorted.

D.

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. However, how does Lucia assess that the entity’s results are ‘real’ or ‘distorted and misleading’ to shareholders? Discuss.

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ACCT1101 Tutorial Solutions – Week 7 (Tute 6) CHAPTER 5 DISCUSSION QUESTION

D2.

Compare and contrast the purposes of adjusting entries, closing entries and reversing entries. 





Exercise 5.5

Adjusting entries are made on the last day of each financial/reporting period in order to account for any accruals and deferrals arising from acceptance of the period assumption and the accrual basis of accounting. These entries are necessary to measure correctly the entity’s profits/performance and financial position, as opposed to the entity’s cash performance and cash position. Closing entries are made on the last day of the financial period in order to close off all temporary equity accounts, so that these accounts are given zero balances for the beginning of the new financial period. Temporary equity accounts consist of income (revenue), expenses, and drawings. These temporary accounts are used to determine the total value of such items for the current period. At the end of that period, they are closed into permanent equity accounts (capital or retained earnings) in preparation for the next period. Reversing entries, which are made on the first day of the new accounting period, are not necessary in the accounting cycle; however, they are handy for reversing certain types of adjusting entries where cash is to be received or paid in relation to that adjustment in the next accounting period. The main types of adjustments which benefit from reversing entries are accruals, as, by making reversing entries in relation to accruals, the entries for cash receipts and cash payments in the new period are simplified. Reversing entries are also useful for deferral adjustments where the initial cash transactions are recorded in temporary accounts rather than in permanent accounts. See the discussion in this chapter of the text, under reversing entries, in relation to the handling of an insurance payment as an example where reversing entries can be used for deferrals.

Closing entries and post-closing trial balance

Michael Rau founded Michael’s Fishing Supplies on 1 July 2016. The adjusted trial balance at 30 June 2017 (the end of the financial year) is shown on page 216. Required A. Prepare closing entries to be made on 30 June 2017. B. Prepare a post-closing trial balance as at 30 June 2017. MICHAEL’S FISHING SUPPLIES Adjusted Trial Balance as at 30 June 2017 Account Debit Cash at bank $ 12 400 Accounts receivable 25 200 GST receivable 2 160 Fishing supplies 6 000 Prepaid insurance 3 000 Boat 36 000 Accumulated depreciation – boat Accounts payable Salaries payable Interest payable

Page 1 of 9

Credit

$ 18 000 6 000 2 040 3 120

Mortgage payable Unearned revenue GST payable Michael Rau, Capital Michael Rau, Drawings Sales Salaries expense Insurance expense Interest expense Depreciation expense Fishing supplies expense Rent expense

7 800 6 720 3 600 18 000 14 400 60 640 14 040 1 080 600 4 200 2 040 4 800 $125 920

$125 920

A. General Journal Closing entries Particulars

Debit

Credit

2017 June 30

Sales

$60 640

Profit or Loss Summary Close income accounts to Profit or Loss Summary Profit or Loss Summary

$60 640

26 760

Salaries Expense

14 040

Insurance Expense Interest Expense

1 080 600

Depreciation Expense

4 200

Fishing Supplies Expense Rent Expense

2 040 4 800

Close expense accounts to Profit or Loss Summary Profit or Loss Summary

33 880

Michael Rau, Capital

33 880

Close Profit or Loss Summary to Capital Michael Rau, Capital

14 400

Michael Rau, Drawings Close Drawings to Capital

14 400

Page 2 of 9

B. MICHAEL’S FISHING SUPPLIES Post Closing Trial Balance as at 30 June 2017 Account

Dr

Cash at bank

Cr

$12 400

Accounts receivable

25 200

GST receivable

2 160

Fishing supplies

6 000

Prepaid insurance

3 000

Boat

36 000

Accumulated depreciation – boat

$18 000

Accounts payable

6 000

Salaries payable

2 040

Interest payable

3 120

Mortgage payable

7 800

Unearned revenue

6 720

GST payable

3 600

Michael Rau, Capital

37480 $84 760

Page 3 of 9

$84 760

Exercise 5.8

Reversing entries – accrued expense

On 30 June 2017, the accountant for Nigel the Maintenance Man calculated that 1 month’s interest of $420 had accrued on a bank loan. An interest payment of $1600 was made on 30 September 2017. Required A. Give the adjusting entry needed on 30 June 2017. B. Give the closing entry. C. Give the reversing entry that could be made on 1 July 2017 and the subsequent entry to record the payment of 30 September 2017. D. Assuming that no reversing entry was made, give the entry to record the interest payment on 30 September 2017. General Journal Date

A.

B.

C.

2017 June 30

June 30

July 1

Sept. 30

D.

Sept. 30

Particulars

Debit

Interest Expense Interest Payable Accruals of interest

Credit

$420 $420

Profit or Loss Summary Interest Expense Close interest expense account

420

Interest Payable Interest Expense Reverse adjusting entry for accrual

420

420

420

Interest Expense Cash at Bank Payment of interest

1 600

Interest Payable Interest Expense Cash at Bank Payment for interest (if no reversing entry).

420 1 180

1 600

1 600

Page 4 of 9

Problem 5.9

Adjusting and reversing entries

The records of Townsville Ltd contain the following information at 31 December, the end of the year. Ignore GST. 1. Wages earned but not paid total $2050. 2. Depreciation on the office equipment is $13 020. 3. Interest of $740 has accrued on a loan payable. 4. Services performed for clients, but not yet recorded, amount to $6528. 5. On 15 September, the company paid $2880 for a 6-month advertising campaign beginning on that date. This transaction was recorded by debiting Prepaid Advertising. At the end of the year, advertising costing $2240 had been consumed. 6. The unearned revenue account has a balance of $1605, recorded when cash was received on 1 November. It was expected the $1605 would be earned equally over November, December and January. 7. The company decided to declare a dividend of $12 000 to its shareholders on 31 December. Required A. Prepare adjusting entries for items 1 to 7. B. Prepare reversing entries where appropriate. Where no reversing entry is required, explain why. A. General Journal Adjusting Entries 1.

2.

3.

4.

5.