Accrual

Accounting

Year 12 Accounting
 Balance day adjustments (more than last year)
 Prepaid expenses, accrued expenses, unearned revenues, accrued
revenues
 Inventory discrepancies
 Depreciation
 Provision for Doubtful debts
 Fully classified financial statements

 Criteria: Applied Practical Processes

ACCOUNTING ASSUMPTIONS

 An assumption is something that is generally

accepted or taken for granted.
 Assumptions serve as boundary lines within which all
other accounting concepts are defined and within
profit and financial position are determined.
 They therefore have a great impact on financial
reports.
 The 5 commonly accepted accounting assumptions
are:
1. Accounting entity assumption
2. Monetary assumption
3. Historical Cost
4. Continuity assumption
5. Accounting Period
 Our accounting process to date is now…

Transactions Source Document Journals Ledger and Trial

Balance

Balance Day
Adjustments

•Accrued Revenue
•Accrued Expenses
•Unearned Revenue
•Prepaid Expenses
 Qualitative Characteristics of
Accounting reports
 Relevance
 Financial information must have value in terms of assisting users of
reports. (Eg. Does including items such as ‘Coffee’ assist the user?)
 Reliability
 Financial information must be free from bias and undue errors.
 Materiality
 Financial information is considered ‘material’ if the omission,
misstatement or non-disclosure of the information would have a
significant effect on the use of the financial statements (i.e the info is
important and could have an effect on decisions)
 Presentation of Financial
 Comparability
Information
 Achieved by comparing::
 An entity at one point in time and over time (ie. Comparative statements)
 An entity with other entities at one point and over time
 Understandability
 Financial information must be presented in a form that assists users in understanding (consistent and clear)
Constraints on Qualitative characteristics:
- Timeliness (need to have the information out before it loses relevance)
- Costs versus benefit (will the provision of certain information stimulate more benefits than the costs incurred?)
 Assumptions Underlying Accounting Reports
Assumption Description Example
Accounting Entity Presumes that a business entity has an existence Owners personal assets
Assumption separate from the private financial affairs of its excluded from records
owner/s

Accounting Divides the life of an enterprise into arbitrary time Reports usually completed
Period periods. for one financial year.
Assumption
Monetary Assumes that all transactions can be recorded in All information recorded in
Assumption money terms terms of $ value.

Historical Cost Refers to the recording of items at their original Motor Vehicle value does
Assumption purchase price. not change with Accum.
Depn
Going Concern Accounting reports are prepared under the No change to value of
assumption premise that the entity will continue to operate in assets unless there is
the foreseeable future. conclusive evidence that
the entity will not
continue.
 Presentation and classification of the
Income Statement
 Classification means to arrange items into groups or classes of
similar items (dependent on type, size and activities of a business)
 Selling and distribution expenses: include all expenses
incurred in promotion, selling and distribution
 Promotion (e.g. advertising)
 Actual selling (sales salaries, commission etc)
 Delivery (e.g. delivery van expenses, depreciation on delivery van,
freight outwards etc)
 General and administrative expenses: include all expenses
incurred in running the office and any other general expenses.
 Office expenses (wages, telephone)
 General expenses (insurance, rates, loss on disposal of motor
vehicle)

Finance expenses: include all expenses associated with either

financing the enterprise’s activities or expenses incurred in
collecting cash
 Financing the enterprise (interest on loans, bank charges)
 Collecting cash (bad debts, credit card charges)
Revenue
 Trading industries
 What is the difference between service and trading industries?

Main differences:
- Sales rather than service fees
- Other revenues may include commission and rent
- Cost of goods sold expense
 Presentation and classification of the
Balance Sheet
 Assets
 Current assets: those assets that will be consumed or
converted to cash within one accounting period. i.e. cash,
accounts receivable, inventories, prepaid expenses and
accrued revenues(*listed in order of liquidity).
 Non-current assets: assets retained for longer than one
accounting period.
 Liabilities:
 Current: paid within one accounting period. i.e. bank overdraft,
accounts payable, GST Clearing, short-term loans, accrued expenses,
unearned revenues. *Listed in order of payment
 Non-current: paid over more than one accounting period. i.e
mortgages and long-term loans

Owner’s Equity: same as normal. I.e. Capital + Net Profit – Drawings

 Classifying the IS and BS

 The two financial statements that you will prepare are the
Income Statement and the Balance Sheet. Each of these
reports serves a different purpose and contains different
items.

 The Income Statement contains a businesses revenue and

expense items.

 The Balance Sheet contains a businesses asset, liability and

owner’s equity items.
Remember this?
 BALANCE DAY ADJUSTMENTS
 The major balance day adjustments to account for are:
 Prepaid expenses (A)
 Accrued revenues (A)
 Accrued expenses (L)
 Unearned revenues (L)
 Accumulated depreciation
 Inventory adjustment
 Provision for doubtful debts
 Amortization
 Interest expense
 Interest revenue
 Bad debts
 Bad debts recovered
 Balance Day Adjustment – What you
know to date
PREPAID EXPENSES (A)
 Expenses that have been paid for, but not yet incurred (used). E.g
Registration
 Decrease expenses (Cr)
 Prepaid Expense DR
Expense CR

ACCRUED EXPENSES (L )
o An expense that has been incurred, but not yet paid for. E.g.
Wages
o Increase expense (Dr)
o Expense DR
Accrued Expenses CR
 Balance Day Adjustment – What you
know to date
UNEARNED REVENUE (L)
 Revenue that has been ‘received’ but has not yet been ‘earned’
(performed) . Rent revenue
 Decrease revenue (Dr)
 Revenue DR
Unearned Revenue CR

ACCRUED REVENUE (A)

 Revenue that has been ‘earned’ but not yet received. E.g Interest,
commission
 Increase revenue (Cr)
 Accrued Revenue DR
Revenue CR
 Balance Day Adjustment – What you
know to date

Accumulated Depreciation
Depreciation is the means by which the cost of a non-current
asset is spread over the life of that asset.
 Part of the original cost is matched against the revenue earned in
each financial year of the asset’s life.
 Two methods:
Straight line= (Original cost – residual value) /Useful life (or x rate)
Reducing Balance = (Original Cost – Accum.Depn) X Depn rate
 Balance Day Adjustment – What you
know to date

Accumulated Depreciation
 Depreciation DR
Accumulated Depreciation CR

-Creates new expense account (Depreciation – Income

Statement as an administrative expense – unless its on a
selling item)
-Increases Accumulated Depreciation account (Balance
Sheet as a contra non-current asset. Ie. CR nature)
 Inventory adjustment
 For stock shortages (opposite entry for surpluses)
 Inventory Adjustment DR
Inventory Control CR
(Balance day adjustment)

-Will decrease Gross profit

-Decrease inventories control account

Income Statement (extract)

$ $
Sales x
Less Cost of Goods Sold x
Inventory adjustment x x
x
 DOUBTFUL DEBTS

In each accounting period, an estimate is made of the amount of debt

that will not be received – “Doubtful debts”
 Is created to record the expense of the amount estimated amount of bad debt
from the current accounting period
 It is an expense a/c and therefore appears in the Income Statement.
It also known as a ‘provision’ because we are providing an estimate of
possible bad debt - “Provision for Doubtful debts”
 is created to reduce the value of the accounts receivable control account
(negative asset – CR) before knowing which of the individual a/c receivables
will not pay, which makes the figure in the balance sheet more realistic.
 DOUBTFUL DEBT – WHY?

 The inclusion of doubtful debt allows for the

matching principal to be followed
 Inclusion in the Income Statement allows for the
matching of revenue for the period with the expense
incurred in the same period

 Inclusion in the Balance Sheet reflects the true value of

accounts receivable likely to be received
 ADJUSTING PROVISION FOR
DOUBTFUL DEBT

 Generally, there will be a different estimation/value

for each year.

 Because this account is a negative asset it is never

“closed” and stays open. We need to adjust its
balance to reflect each new years estimation
 ADJUSTING PROVISION FOR
DOUBTFUL DEBT

For example, if the balance of the “Provision for DD”

a/c is $10,000 on 30 June 08, but it should be
$12,000... we need to record a GJ entry to make this
balance $12,000.

In this case, we would:

June 30 Doubtful Debt 2,000
Provision for Doubtful debt 2,000
(Adjustment to the provision account)
Why create and use the Provision
for doubtful debts?

 Matching Principle (Matches expenses with revenues (i.e.

the bad debts and the sales)
 Enables the true value of Accounts Receivable (and
therefore Assets) to be reflected
Accounts Receivable 1 000 000
Less Provision for Doubtful debts 50000 950000
 Steps to adjust the provision
Steps Journal entry
1. Create the provision for doubtful Doubtful debts DR
debts (if applicable, i.e if one doesn’t Prov for doubtful debts CR
exist (appear in the Trial Balance)

2. Write off any additional bad debts Bad debts DR

(not those already recorded in the TB) GST Clearing DR
A/C Rec control CR

3. Transfer the bad debts to the Prov for doubtful debts DR

provision for DD (only up to the Bad debts CR
amount of the provision)

4. Adjust the provision for the new Doubtful debts DR

provision amount Prov for doubful debts CR
(difference between whats left in the (same as step 1)
prov and the new desired balance)
Other Balance Day Adjustments

The provision for doubtful debts is simply an estimation of

those debts that will not pay us back. In reality, we have
the problem of chasing these debts.

Businesses have two options to account for unpaid debts:

-Charge interest (and be charged interest when the
business doesn’t pay its own creditors)
-Write off the A/C Rec as a Bad debt.
Other Balance Day Adjustments

Interest
A business might have a credit policy where they charge
interest to customers who do not pay their accounts
according to terms and conditions (interest revenue)
 If interest is charged, the business must give appropriate
notice to the accounts receivable before adding interest to
the outstanding balance

Likewise, if the business has an accounts payable that

they do not pay in time, the creditor may charge the
business interest (expense)
 Other Balance Day Adjustments

Interest Revenue
 When the business charges the debtor interest for an
overdue account, the accounts receivable a/c is
debited because it is increasing. We record this in the
GJ.

A/c Rec – D.Oke $10

Interest Revenue $10
(Interest charged on overdue account)
 Other Balance Day Adjustments

Interest Expense
 Interest charged by a creditor always has the effect of
increasing the amount owed ie. the a/c payable
account. This is recorded in the GJ.

Interest expense $120

A/c Payable – J.Sali $120
(Interest charged on overdue account)
Other Balance Day Adjustments

BAD DEBTS
 Despite trying to get debtors to pay, sometimes not all debts are
received by a business.
 Bad Debt = “is an accounts receivable’s outstanding balance,
which is deemed will not be received”
 The ATO has specific criteria to meet before declaring an a/c
receivable as ‘bad debt’
1. Debtor has died without leaving assets
2. Debtor and his/her assets cant be traced
3. Debtor in liquidation(if it is a company) / bankruptcy
4. Little or no likelihood of debt being recovered
 Other Balance Day Adjustments

BAD DEBT – written off

 Bad debts are an expense to the business. When a bad debt occurs it
increases expenses, so the expense a/c is debited.

 The accounts receivable a/c is an asset that is decreasing because it no

longer has the potential to be converted to cash / recovered (credited)

 Because GST was initially recorded as being received (therefore owed to

the ATO) we need to reverse this entry because we have not actually
received this GST money (remember, the debtor didn’t pay). Therefore,
we need to debit this liability a/c (GST Clearing)
 Other Balance Day Adjustments

BAD

DEBT EXAMPLE
On 28 July, Ashmore Computers received notification that
R.Walden has been declared bankrupt. He had an amount
owing of $220 (incl GST).

July 28 Bad Debt expense $200

GST Clearing $ 20
A/c Rec – R.Walden $220
(Bad debts written off & GST reversed)
 Other Balance Day Adjustments

Bad Debt – written off with part payment

Lets assume that R.Walden can pay 40c in the dollar
of his debt

We need to do 2 things:

◦ Record the portion of cash we do receive from the
debtor (CRJ ENTRY – or in the general journal)
◦ Write off the remainder of the debt and reverse it’s
portion of GST (GJ ENTRY)
 Other Balance Day Adjustments
 Remember, R.Walden owed $220. He can pay $0.40 in the dollar:
 $220 x $0.40 = $88 (cash received)
 $220 x $0.60 = $132 (not received / bad debt)
 1/11th of $132 = $12 (GST no longer due to the ATO)

Entries:
1. Cash at Bank 88
A/C Rec- R Walden 88
(40 cents in the dollar owing received)

2. Bad debts expense 120

GST Clearing 12
A/C Rec- R Walden 132
(remainder of account owing written off)
 Other Balance Day Adjustments

Recovery of Bad Debt

Sometimes, a business will write off a bad debt after
receiving notification that the customer can’t or won’t
pay....BUT... there may be times when the customer ends
up paying their debt in the future after it has been written
off.

Maybe the customer wants to:

 Restore their credit rating
 Rebuild their reputation and relationship with the business
 Practise ethical principals
 Other Balance Day Adjustments

Recovery of Bad Debt

 When a written off bad debt is received, we need to
do two things:
1. Reverse the original debt written off
2. Record the money received

The “Bads debt recovered” account is a revenue account.

 Other Balance Day Adjustments

 Let’s assume on 31 Dec R.Walden pays the $220 debt that we had written off

1. Reverse the written off debt in the GJ

31 Dec A/c Rec- R.Walden 220

GST Clearing 20
Bad Debts recovered 200
(Bad debt recovered)

2. Record the payment received

31 Dec Cash at bank 220
A/C Rec – R.Walden 220
(receipt of payment)

After posting these two journal entries, it will have the effect of:
 R.Walden will have a nil balance
 recognise the GST owing to the ATO
 recognise the revenue from the bad debt recovered
 Amortisation

 Amortisation is like depreciation, except it is on intangible assets or

natural resources.
 It is treated the same as a depreciation entry.

 For example:
 Balance of Copyright = $4000
 Copyright is to be ‘written down’ to $3500
 Journal entry:
DR Amortisation Expense 500
CR Accumulated Amortisation – Copyright 500
(Amortisation of Copyrights)
 Completing the exam
1. General Journal
Prepare the journal entries for the BDA’s from the additional information
2. Worksheet
1. Add new accounts to the bottom of the trial balance from journal entries
2. Add the values from the journal entries into the BDA’s column
3. Classify each account by Type (REALOE) and Category (Cat) (e.g SD)
4. Using the ‘Sort and Filter’ function do a custom sort. First level – Type
(REALO) and second level – Category
(R,OR,SD,GA,FE,CA,CL,FA,PPE, IN, NCL,O)
5. Complete the Adjusted Trial Balance Column based on the nature of each
account:
Debits = + Debits – Credits
Credits= - Debits + Credits
6. Complete the Income Statement and Balance Sheet columns by cell
referencing the data into these columns
1. Income Statement – cell reference (=cellENTER) everything you can from the
Worksheet – this will speed up the process!
2. Balance Sheet – as above