Tutorial work - Week 5 - 7 with solutions PDF

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Adjusting the accounts, preparing financial statements and completing the accounting cycle

Revision - Accounting Equation All assets accounts = All liability accounts + All equity accounts Dr Cr Dr Cr Dr Cr Debit to increase

Credit to decrease

Debit to decrease

Normal balance

Debit to decrease

Credit to increase

Normal balance

Normal balance

Expense accounts Dr Cr Debit to increase Normal balance

Credit to decrease

Credit to increase

=

Revenue accounts Dr Cr Debit to decrease

Credit to increase Normal balance

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Revision • The nature & purpose of transactions • The effects of business transactions on the accounting equation: A = L + E • The rules of debit and credit used in double entry accounting

• New terminology: – General journal – Ledger accounts – General ledger – Chart of accounts – Trial balance University of Adelaide

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Revision • The accounting cycle - so far: – Record transactions in a general journal – Post the journal entries to a general ledger – Calculate the closing balance for each ledger account – Transfer the closing balances to a trial balance – Prepare financial statements

• How to correct errors in the journal and general ledger • The GST and how to account for it University of Adelaide

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What we will cover in this topic The accounting cycle: – Record transactions in a general journal – Post the journal entries to a general ledger – Calculate the closing balance for each ledger account – Transfer the closing balances to an ‘unadjusted’ trial balance – Record adjusting entries – Prepare an ‘adjusted’ trial balance – Prepare financial statements – Closing entries – Post-Closing Trial Balance – Reversing entries

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What we will cover in this topic • The cash basis and the accrual basis of measuring net profit

• End-of-period accounting adjustments with the different types of adjusting entries: –Deferrals –Accruals

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What we will cover in this topic • Adjusted trial balance • How to prepare Financial statements from an adjusted trial balance • Financial statements from a worksheet • Closing entries and the closing process • Reversing entries • Owners’ equity accounts

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Measurement of Net Profit • Cash basis – Revenues recorded when cash received – Expenses recorded when cash paid

• Accrual basis – Transactions are recognised when they occurred; they are recorded and reported in the financial statements they relate to.

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Lecture Example 1 - Welsh Designers cash profit vs accrual-basis profit 1. –

2.

Fees of $82,000 were collected during the year $82,000 included in both cash and accrual profit measurement

$6,000 in receivables for services performed on credit – $6,000 included on accrual-basis only, – But not a cash measurement of profit: – the revenue is earned, but not yet received

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Adjusting Entries • The need for adjusting entries • Classification – Deferrals – prepaid expenses – unearned revenue

– Accruals – accrued expenses – accrued revenue

– See p.134, Fig. 4.2 in the text book University of Adelaide

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Prepaid Expenses • Amounts paid before the benefit is consumed ASSET ACCOUNT Prepaid Expenses Initial cost Debit

EXPENSE ACCOUNT

Adjusting entry Credit

Adjusting entry Debit

cost used up, incurred or expired

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Prepaid Insurance • On 3 June a 24-month insurance policy was purchased for $1,056 (including GST). Initially recorded as: June 3 Prepaid Insurance 960 GST Receivable 96 Cash at Bank 1 056 to record purchase of 24 month policy

• Initially recorded as an asset • Will need to be converted to an expense as it is consumed University of Adelaide

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By 30 June, the period end, we need to adjust prepaid insurance a/c to reflect the consumption June 30

Insurance Expense Prepaid Insurance

40 40

adjusting entry to record expiration of one month’s insurance

Insurance Expense

Prepaid Insurance Initial cost 960

Adjusting entry 40

Adjusting entry 40

cost used up, incurred or expired University of Adelaide

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Prepaid Expenses - Depreciation ASSET ACCOUNT Initial cost Debit

CONTRA ASSET ACCOUNT Accumulated Depreciation Adjusting entry Credit

EXPENSE ACCOUNT Adjusting entry Debit

cost used up & allocated to current period University of Adelaide

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Unearned Revenue • Amounts received before service is performed LIABILITY ACCOUNT Unearned Revenue Adjusting entry Debit

REVENUE ACCOUNT

Cash receipt

Adjusting entry Credit

revenue earned during the current period

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Accrued Expenses • Expenses consumed but not yet paid for LIABILITY ACCOUNT Expense Payable

EXPENSE ACCOUNT

Adjusting entry Credit

Adjusting entry Debit

expenses incurred

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Accrued Expenses

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Accrued Revenue • Amounts due for services performed but not yet received

ASSET ACCOUNT Accounts receivable

REVENUE ACCOUNT

Adjusting entry Debit

Adjusting entry Credit

revenue earned but not yet received University of Adelaide

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Lecture Example 2 Adjusting entries for prepaid insurance One-year insurance policy bought on 1 October 20X3 ($5 000) – recorded as prepaid insurance: Dr Prepaid Insurance

$5 000

Cr Cash at Bank

$5 000

 $5,000 insurance policy per year,  $3 750 expense for 9 months ($5 000 x 9/12)  Now do the adjusting entry for 30 June 20X4

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Lecture Example 2 Adjusting entries for unearned revenue Six months rent ($9 600) received in advance on the 1 May 20X2 and credited to unearned revenue Dr Cash at Bank Cr Unearned Revenue

$9 600 $9 600

– $3 200 is earned as revenue up to 30 June 20X2 ($9 600 x 2/6) – Now do the 30 June 20X2 adjusting entry

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Adjusted Trial Balance • Reflects balances in ledger accounts after end-of-period adjusting entries

• Debits must still equal credits!

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Preparation of Financial Statements • Income Statement – Prepared before the balance sheet (statement of financial position) to determine profit or loss – Reflects entity’s performance

• Balance Sheet – Summarises all asset, liability & equity accounts – Reflects entity’s financial position

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Using Worksheets • Assembles all information needed to adjust the accounts and prepare financial statements • Aids in the preparation of interim financial statements when adjusting and closing entries are not required • Contains information needed to close off profit and loss accounts for the period

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Worksheet Preparation 1. Enter ledger account titles and balances in the account title and unadjusted trial balance columns 2. Enter the adjustments in the adjustment column 3. Prepare an adjusted trial balance 4. Extend adjusted balances to the income statement and the balance sheet columns 5. Find the difference between the two columns of the income statement to determine the profit or loss 6. Enter the profit or loss as a balancing amount in one column of the balance sheet

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Lecture Example 3 Complete Gardening Services Expired insurance is $1 500 – ‘Prepaid insurance’ reduced – ‘Insurance expense’ increased (new account must be added to the worksheet) Accrued wages $3 800 – ‘Wages expense’ increased – ‘Accrued wages’ increased (a new account) Depreciation of office equipment $6 000 – ‘Depreciation expense’ increased (a new account) – ‘Accumulated Depreciation’ increased University of Adelaide

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The Complete Accounting Cycle General journal

5. Determine adjusting entries and/or journalise

General ledger (accounts adjusted)

6. Post adjusting entries to general ledger

7. Prepare adjusted trial balance of GL (adjusted)

Trial balance (adjusted)

8. Journalise closing entries

General journal

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Continued next slide

The Complete Accounting Cycle 9. Post closing entries to GL

GL - temp. a/c’s closed

10. Prepare post closing TB

TB (post closing)

11. Prepare financial statements

work sheet

Financial statements

12. Journalise reversing entries

General journal

13. Post reversing entries to GL

GL - temp. a/c’s opened

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Closing Temporary or Nominal Accounts • Revenue & expense accounts – must be closed at the end of each period to determine profit/loss for the period – begin and end each accounting period with a zero balance • ‘Profit & loss Summary’ account used to facilitate closing process & the determination of profit or loss University of Adelaide

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Using the Worksheet • Revision: – Gathers information together in one place – Enables preparation of interim financial statements – Adjusting entries easily reflected

• Using income statement columns of the worksheet facilitates closing journal preparation

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FLOWCHART of CLOSING PROCESS (CLOSE REVENUE ACCOUNT)

REVENUE 12,000 7,500 9,000

28,500

SALARY EXP 1,500 1,800

3,300

(CLOSE EXPENSE ACCOUNTS)

P&L SUMMARY 4,450

28,500

24,050

24,050

(CLOSE P & L SUMMARY)

CAPITAL ACCOUNT 2,500

24,050

RENT EXP 800

800

DRAWINGS SUPPLIES EXP 350 University of Adelaide

350

2,500

2,500

(CLOSE DRAWINGS ACCOUNT)30

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The Closing Process • Revenue accounts closed to Profit & Loss Summary debit Revenue credit Profit & Loss Summary

• Expense accounts closed to Profit & Loss Summary debit Profit & Loss Summary credit Expense

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The Closing Process Profit & Loss Summary account – balances to determine profit (loss) – then closed to capital account debit P & L summary (assuming a profit) credit capital account

Drawings account – closed to capital debit capital account credit drawings account University of Adelaide

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After the Closing Process All revenue accounts have nil balances

All expense accounts have nil balances The drawings account has a nil balance The capital account has been increased/decreased by the profit/loss & decreased by the owner’s drawings University of Adelaide

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Post Closing Trial Balance Reflects all accounts with balances after the closing process – Assets – Liabilities – Equity (eg Owners’ capital)

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Lecture Example 4 Closing entries and post-closing trial balance Closing revenue: Dr Framing Revenue 62 400 Dr Commission Revenue 1 800 Cr P & L Summary

64 200

An example of closing expenses - salaries: Dr P & L Summary Cr Salaries Expense

11 700 11 700

The complete entries are on page 18.

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Subsequent periods • End of period adjustments (adjusting entries) include – expenses incurred, not yet paid and – revenue earned, not yet collected

• Cash paid or received in the subsequent period must be allocated to the correct period • Alternatively, reversing entries can be made at the beginning of the next period University of Adelaide

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Reversing Entries Reversal of accrual entries  On 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

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Reversing Entries Salaries of $1,000 accrued to 30 June Adjusting entry: (30 June) Dr Salary Expense $1 000 Cr Salary Payable

$1 000

Reversing entry: (1 July) Dr Salary Payable

$1 000

Cr Salary Expense

$1 000

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Reversing Entries Salaries of $2,500 paid on 8 July If a reversing entry is made: Dr Salary Expense $2 500 Cr Cash at Bank

$2 500

If a reversing entry is not made: Dr Salary Payable

$1 000

Dr Salary Expense

$1 500

Cr Cash at Bank

University of Adelaide

$2 500

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Reversing Entries • Not required for all adjusting entries • Only used where adjustment is temporary – Accrued expenses – Accrued revenue – Prepayments originally recorded as expenses – Unearned revenue originally recorded as revenue

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Lecture Example 5 Reversing entries On 30 June 20X4, one month of interest has accrued on a bank loan

Adjusting entry: Dr Interest Expense Cr Interest Payable

$240 $240

Now, do the reversing entry on 1 July 20X4 The completed answer is on page 19 University of Adelaide

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Lecture Example 5 Reversing entries Telephone answering service fees have accrued on 31 December Adjusting entry: Dr Service Fees Receivable Cr Service Fees Revenue

$4 350 $4 350

Completed answer is on page 20.

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Accounting Procedures Applicable to a Partnership • Separate capital & drawings accounts for each partner • Profit/loss at the end of the period is allocated to each partner in accordance with the partnership agreement • Each drawings account is closed off to the partner’s capital account

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Accounting Procedures Applicable to a Company • Owners are referred to as shareholders • Owners’ interests are called “ share capital” • Not all profits/losses are distributed to shareholders • Profits distributed as “dividends” from the Retained Earnings account University of Adelaide

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Accounting for a Company

Shareholders’ Equity as at 31 December 20X2 Share capital (120 000 shares issued for $1) Retained profits Reserves Total shareholders’ equity

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$120 000 $13 000 $26 000 $159 000

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Next Topic

ACCOUNTING FOR RETAILING

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Topic 6 Solutions Prepare before class 1. Chapter 6, Page 264, Discussion Question 7. (Textbook pp. 244-245, 250) With the growing importance of computerised accounting systems, which inventory system (perpetual or periodic) has become more popular? Explain why. Is this desirable. Why? The perpetual system is more popular in computerised systems because computers have allowed entities to gain better control over inventories by reducing the cost and time required to keep detailed inventory records. The availability of suitable computerised integrated accounting packages for inventory has improved the ability of entities to account for all movements of inventory. The use of optical-scan cash registers at checkouts to read product bar codes means that the cash register of today has become a computer terminal for entering inventory transactions into the accounting records at point of sale. 2. Chapter 6, page 266, Exercise 6.7. The following are selected transactions of Watsonia Stores: July

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Sold goods on account to Viewbank Market for $1,200, terms 2/10, n/30. The cost of the goods sold was $800. 19 Forwarded a credit note for $90 to Viewbank Market covering part of the goods sold on 12 July, which cost $60, that were returned by Viewbank Market as inappropriate. The goods returned were not defective. 21 Received from Viewbank Market a cheque in full settlement of the above transactions. Assume that both businesses are registered for GST (Textbook p. 108 – 110). Required Record the transactions in the general journal of (1) Watsonia Stores and (2) Viewbank Market. WATSONIA STORES July 12

$ Accounts Receivable 1,320 Sales Revenue GST Payable Sold merchandise to Viewbank Market, 2/10, n/30. Cost of Sales Inventory Cost of inventory sold

19

$ 1,200 120

800 800

Sales Returns and Allowances GST Payable Accounts Receivable Viewbank Market returned goods for credit. Inventory Cost of Sales Goods returned placed back into inventory 1

90 9 99 60 60

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$ Cash at Bank 1,196.58 Discount Allowed 22.20 GST Payable 2.22 Accounts Receivable Received amount due from Now Discounters.

$

1,221

2. VIEWBANK MARKET July 12

Inventory GST Receivable Accounts Payable Purchased merchandise from Watsonia Stores.

1,200 120 1,320

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Accounts Payable GST Receivable Inventory Returned goods to Watsonia Stores for credit.

99 9 90

21

Accounts Payable Discount Received GST Receivable Cash Paid amount due to Watsonia Stores.

1,221 22.20 2.22 1,196.58

3. Chapter 6, page 267, Exercise 6.12 Selected accounts and a section of a worksheet for Sunhill Stores are shown below: Worksheet (section only) Adjusted trial Income balance statement Account Inventory Sales Sales Returns and Allowances

Discount Allowed Purchases Purch Returns and Allowances

Discount Received Freight Inwards Income Tax Expense Current Tax Liability

Debit ?

Credit

Debit

Credit

Balance sheet Credi t Debit

$335,400 $6,500 4,910 196,560 3,280 2,610 1,960 13,760 13,760

Required The beginning and ending inventory were $45,760 and $52,420 respectively. Enter the beginning and ending inventory amounts in the appropriate columns and extend the other account balances listed to their appropriate columns.

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Account Inventory Sales Sales Returns & Allowances Discount Allowed Purchases

SUNHILL STORES Worksheet Adjusted Trial Income Statement Balance Debit Credit Debit Credit 45,760 45,760 52,420 335,400 335,400 6,500

6,500

4,910

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