In this module we look at how financial records are balanced and how financial reports are produced, incorporating Balance Day adjustments.

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1 Introduction In this module we look at how financial records are balanced and how financial reports are produced, incorporating Balance Day adjustments. At the end of each accounting period an organisation produces a set of financial reports. Before this can be done, it must ensure that all financial transactions and financial events that impact upon the organisation are accounted for. Before you begin If you already have some knowledge of Balance Day adjustments and the production of financial reports incorporating such adjustments, you might choose to begin with the Quick quiz on page 22 and then the Review tasks on page 24. When you have answered as many of the quiz and review questions as you can, come back to the beginning of the module and begin to work through it, to: confirm or revise your answers find the answers you did not know. When you have completed the module, you should revise the quiz and the review tasks. If you have little or no knowledge of Balance Day adjustments, read on. Key learning outcomes The learning outcomes for this module are divided into two categories learning which involves improving your knowledge or understanding, and learning which develops skills and strategies. After successfully completing all the exercises in this module you will: understand how Balance Day adjustments are made be able to interpret the effect of Balance Day adjustments on the accounts. 001

2 Book-keeping: Balance Day and producing financial reports Balance Day adjustments If transactions in an accounting period are simply entered and then presented as they are, they might not reflect the true financial position of an organisation, for example: the organisation might earn income before it is actually paid the organisation might make purchases or incur expenses on credit, with payment to be made at some time in the future the assets that the organisation uses in its operations will usually decrease in value during the course of their use. As a result, when the accounts for a period are closed, adjustments sometimes need to be made so that the reports balance. The day on which the adjustments are made and the reports are balanced is called Balance Day. Personal scenario Consider the following scenario: An amount of $500 was paid in the current accounting period for the repair of furniture. The expense was actually incurred in a previous accounting period. If no adjustment was made to reflect the fact that the cost was shown in the incorrect accounting period, the following untrue picture of the organisation's financial situation would result: the liability would not be recorded at the last balance date (end of the accounting period) the expenditure of the last accounting period would be understated the expenditure of this accounting period would be overstated. Not all period-end adjustments (Balance Day) relate to actual receipts and payments, eg: the financial effect of the depreciation or wear and tear of fixed assets is shown by reducing the value of the asset and showing the cost as an expense employees accrue leave pay. At the end of an accounting period this cost to the organisation is recognised and a liability is set up for this purpose. The corresponding cost is shown as an expense. 002

3 The General Journal The General Journal is a journal for recording financial transactions or events which are general in nature. These transactions may occur on a frequent or ongoing basis but they are only recognised, quantified and brought to account on a periodic basis, usually at the end of an accounting period. The General Journal is different from other journals such as the Cash Receipts Journal and the Cash Payments Journal. Those journals record only specific types of transactions (eg cash receipts or cash payments) and they are recorded in detail as they occur. The General Journal shows: the date of the journal entry the name of the accounts affected the account numbers of those accounts the debit amount the credit amount. The General Journal is usually set out as a simple multi-column journal. Types of Balance Day adjustments In considering the sorts of Balance Day adjustments that may be required for your organisation, work through the following checklist: q Is all income earned during the period included in the Income and Expenditure Statement? Fees for services provided during the accounting period must be included as income, even if the organisation is still awaiting payment of those fees. Conversely, fees received in the accounting period, for services which were provided in an earlier accounting period or which are to be provided in a future accounting period, must be excluded. Make sure that fees for service are actually earned rather than merely promised before they are entered. q Are all expenses incurred in earning income included, whether they have been paid for or not? If the organisation has made purchases of goods or utilised services (eg telephone or electricity) during the accounting period but has not yet paid for those goods or services, their value must be brought to account as an expense. q Are expenses that do not require payment of cash included? Depreciation represents the reduction in the value of fixed assets as a result of their use and the passage of time. It is not a cash transaction, but it does represent a cost to the organisation. The cost to the organisation must be reflected as an expense in the Income and Expenditure Statement. q Is everything owned or owed included? All assets of the organisation, including all debts owing to the organisation, should be reflected in the Balance Sheet. 003

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5 q Are all debts owing, monetary or otherwise, included? Liabilities must be included in the Balance Sheet, including the value of services the organisation is committed to providing in return for fees received. q Have payments for expenses relating to future periods been included as assets? Where amounts paid have been for goods or services to be received in future periods, those amounts must be shown as an asset called prepayments. q Have expenses which have been incurred but not yet been paid for been included as liabilities? Expenses incurred by, and invoiced to, the organisation must be included as a liability accounts payable. The value of expenses incurred by the organisation but not yet invoiced should be estimated and included as a liability, called accruals or accrued expenses. Make sure liabilities recorded include: credit card transactions purchases made on the Internet grants in advance. q Has income earned but for which payments have not yet been received been included as assets? Amounts owing to the organisation for services it has provided must be shown as an asset accounts receivable. q Have payments received in respect of services to be provided in future periods been included as liabilities? Payments already received in respect of future services to be provided by the organisation must be included as a liability unearned income. q Do assets such as property, buildings or equipment reflect their real value to the organisation? If fixed assets are worth less to the organisation than the written recorded value, further adjustment must be made to reflect their lower value. The amount of depreciation must be offset against the cost of fixed assets to reflect their real value. Balance Day adjustments are recorded in the General Journal. 005

6 Book-keeping: Balance Day and producing financial reports Common adjustments The following Balance Day adjustments are common. Study the examples to explore the way these adjustments are dealt with. 1. Prepaid expenses Insurance is paid annually on 1 March. At Balance Day, there is $600 in the Insurance Expense account that relates to next year. The expense account is credited to reduce it by this amount and an asset account, Prepaid Insurance is set up to account for the prepayment. Journal Entry Debit Prepaid Insurance $600 Credit Insurance Expense $600 Stationery on hand at the end of the period can be treated in the same way. Create an asset account called Stationery Stock, eg stationery on hand on Balance Day is $500. Journal Entry Debit Stationery Stock $500 Credit Stationery Expense $ Depreciation to be provided for the period All non-current assets (those expected to last beyond one accounting period) reduce or depreciate in value over time - with the exception of land. Including depreciation in the accounting process spreads the cost of the asset over its useful life and is charged as an expense. Each time depreciation is charged against the asset, the asset is reduced in nett value. The reduced value of the asset is called its Written Down Value or WDV. The WDV of an asset at any time is its original cost less the total of accumulated depreciation. The following example illustrates how the WDV is calculated and shown as a Balance Day adjustment. Example The cost of furniture is $12,000. The balance in the accumulated depreciation account is $3,200 which represents depreciation to date, ie a little over three and a half years. Depreciation to be charged against furniture in this period is $1,200. Calculating Depreciation Charge When charging depreciation evenly over the life of the asset (fixed instalment method), the annual depreciation charge is calculated using the following equation: Annual Depreciation Charge = Input Cost - Residual Value Expected Life 006

7 For example, furniture costs $ At the end of its useful life of 5 years it is expected to have a value of $7600. Annual Depreciation Charge = 12, = $880 5 Depreciation involves a debit to the expense account Depreciation and a credit to the contra (negative asset) account Accumulated Depreciation. Balance Day adjustments for depreciation are recorded in the General Journal, examples of which are shown below: Journal Entry Debit Depreciation Expense $880 Credit Accumulated Depreciation, Furniture $880 After the depreciation is charged the Accumulated Depreciation Furniture account has a balance of $3,200 + $880 = $4,080. In the Balance Sheet the asset will appear like this: Furniture 12,000 Less Accumulated Depreciation (4,080) 7,920 OR Furniture (WDV) 7,920 This represents depreciation for a little over 4.5 years. The remaining depreciation, (to arrive at the projected figure of $7,600) will be brought to account during the next period. 3. Wages incurred and unpaid at Balance Day Wages are paid fortnightly and are not due to be paid yet but wages amounting to $2,200 have been incurred in the last week and are unpaid at Balance Day. The expense account Salaries and Wages is debited to increase it and a liability, Accrued Wages, is set up to account for wages owing. Journal Entry Debit Salaries and Wages $2,200 Credit Accrued Wages $2, Income received in advance or prepaid at Balance Day Income received in advance, or prepaid at Balance Day is unearned income. When fees are paid in advance for the following term/year, the value is owed to the student. This must then be shown in the Balance Sheet as a liability, Prepaid Course Fees. The income account Course Fees is reduced (debit) to properly reflect income earned this period. Course fees prepaid for next year amount to $600. Journal Entry Debit Course Fees $600 Credit Prepaid Course Fees $

8 Book-keeping: Balance Day and producing financial reports 5. Leave provisions In order to fully account for all liabilities provisions should be made for staff leave entitlements, such as annual leave, long service leave and sick leave. The provision is a liability to be paid at some future date. Entitlements are earned throughout the period and paid at some time in the future (when due or taken). Example You need to make provision for annual leave in the amount of $3,500, long service leave of $1,200 and sick leave of $1,000. The accounting procedure is to charge (debit) the relevant expense account and increase (credit) the relevant provision (liability) account. The journal entries are: Journal Entry Debit Annual Leave Expense $3,500 Credit Provision for Annual Leave $3,500 Debit Long Service Leave Expense $1,200 Credit Provision for Long Service Leave $1,200 Debit Sick Leave Expense $1,000 Credit Provision for Sick Leave $1,000 How the accounting process works In the following example we use financial information from Sunnyway Training Services Inc to show how transactions are recorded and financial reports produced from an adjusted Trial Balance. Steps in the process 1. Cash transactions are recorded in the Cash Payments Journal and the Cash Receipts Journal. Transactions not involving cash (the bank) are recorded in the General Journal. 2. At the end of each month, the ledger accounts are updated and a Trial Balance is prepared. 3. Outstanding transactions and Balance Day adjustments are recorded in the General Journal. 4. A post-adjustment Trial Balance is prepared and financial reports generated, ie an Income and Expenditure Statement and a Balance Sheet. To prepare an Income and Expenditure Statement and Balance Sheet for Sunnyway, as at April 30, the following financial information was used: Sunnyway Trial Balance as at March 31 list of Sunnyway s April transactions from the Cash Receipts and Cash Payments Journals Balance Day adjustments made as at 30 April. 008

9 The balances in the accounts of Sunnyway Training Services Inc on 31 March 2006 were: Sunnyway Training Services Inc Trial Balance as at 31 March 2006 Account Debit Credit Cash at bank 7,800 Accounts receivable 7,300 Prepaid expenses 800 Stationery stock 200 Investments 1,200 Land and buildings 85,000 Furniture 29,300 Accumulated Depreciation Furniture & fittings 22,800 Creditors and accrued expenses 8,100 Accrued wages 0 Course fees prepaid 0 Accumulated funds 1 January 91,100 Funding allocation 18,000 Student fees 49,400 Interest, dividends, other income 1,800 Salaries and wages 35,000 Course costs 5,100 Depreciation 1,600 Rent 7,000 Other operating expenses Accountancy and audit 700 Bad debts 0 Bank charges 90 Insurance 2,400 Leave entitlements 900 Light and power 850 Postage 250 Printing and stationery 1,200 Repairs and maintenance 1,060 Superannuation 3,150 Travel expenses , ,

10 Book-keeping: Balance Day and producing financial reports During the month of April, cash transactions were processed through the Cash Receipts and Cash Payments journals. (The processing of cash transactions in the Cash Receipts and Cash Payments Journals is covered in Module Seven.) At the end of the month the totals of those journals were as follows: Cash Receipts Journal of Sunnyway Training Services Inc Interest Date Receipt Number Particulars Bank (Debit) Funding Allocation Student fees dividends, other 23,700 6,000 17, Cash Payments Journal of Sunnyway Training Services Inc Date Cheque Number Particulars Bank A/cs Payable Salaries and Wages Course Costs Rent Bank Charges Prin Stat 20,530 3,700 12,000 2,000 2, Balance Day adjustments that need to be made to the accounts on 30 April are: depreciation of furniture for the month - $540 wages incurred and unpaid - $2,000 the value of stationery stock on hand at the end of the month - $300 fees paid in advance for next term - $4,500. Insurance for the months of March and April was paid at the beginning of March. The amount paid was $1,600 and, of this, $800 was accounted for as a prepaid expense at the end of March. For an Income and Expenditure Statement and Balance Sheet to be prepared for Sunnyway a five-step process is followed: 1. April transactions are entered in the Cash Journal 2. Journal totals are entered in the ledger accounts (update accounts) 3. Balance Day adjustments are determined and are entered in the General Journal and updated accounts are prepared 4. A post-adjustment Trial Balance is prepared 5. An Income and Expenditure Statement and a Balance Sheet are prepared. 010

11 Step 1: Enter April cash transactions into the Cash Journal In the example on page nine only the totals of the cash journals are shown. If you are unsure of the process for recording cash transactions return to Module Seven now. Step 2: Update general ledger accounts from journal totals After the bookkeeping cycle has been completed, the transactions must be recorded in a ledger account as well. A ledger account is kept for each different account type. Keeping separate records provides totals of similar categories of accounts. This is important for the presentation and analysis of financial information. Step 3: Prepare Balance Day adjustments and update accounts Balance Day adjustments may be necessary to ensure the financial situation of an organisation is accurately reflected. Balance Day adjustments are recorded in the General Journal as shown below: General Journal of Sunnyway Training Services Inc Date Particulars Debit Credit June 30 Depreciation expense 540 Accumulated depreciation furniture month depreciation provided. Wages expense 2,000 Creditors and accruals 2,000 Wages incurred and unpaid at Balance Day. Stationery stock 100 Stationery expense 100 Increase in stationery stock remaining at Balance Day from $200 to $300. Course fees 4,500 Course fees prepaid 4,500 Fees prepaid at Balance Day. Insurance expense 800 Prepaid expenses 800 April s insurance, prepaid in March, now expensed. 011

12 Book-keeping: Balance Day and producing financial reports The totals from the cash journals, together with the entries recorded in the General Journal, are now posted to the general ledger accounts, and the balances in those accounts are updated. Step 4: Prepare a post-adjustment Trial Balance A Trial Balance is a list of values of the debit and credit accounts in the General Ledger. The system of double entry bookkeeping requires that for every debit there is an equal and opposite credit, so the totals of the debits and the credits will always be equal. The post-adjustment Trial Balance is prepared on Balance Day, after the general ledger has been balanced at the end of an accounting period. Remember, if necessary adjustments are not made on Balance Day the profit or loss for the period and the amount of assets and liabilities would be inaccurate. Consider the Sunnyway Trial Balance on the following page 012

13 Sunnyway Training Services Inc. Trial Balance as at 30 April 2006 Account Debit Credit Cash at bank 10,970 Accounts receivable 7,300 Prepaid expenses Stationery stock 300 Investments 1,200 Land and buildings 85,000 Furniture 29,300 Accumulated Depreciation Furniture & fittings 23,340 Creditors and accrued expenses 4,400 Accrued wages 2,000 Course fees prepaid 4,500 Accumulated funds 1 January 91,100 Funding allocation 24,000 Student fees 61,900 Interest, dividends, other income 2,500 Salaries and wages 49,000 Course costs 7,100 Depreciation 2,140 Rent 9,300 Other operating expenses Accountancy and audit 700 Bad debts 0 Bank charges 120 Insurance 3,200 Leave entitlements 900 Light and power 850 Postage 250 Printing and stationery 1,600 Repairs and maintenance 1,060 Superannuation 3,150 Travel expenses , ,

14 Book-keeping: Balance Day and producing financial reports Step 5: Prepare an Income and Expenditure Statement and a Balance Sheet The Income and Expenditure Statement and the Balance Sheet are the two reports prepared from the financial data recorded in the Trial Balance. The Income and Expenditure Statement The Income and Expenditure Statement records the financial result of the accounting period (ie the amounts of income and expenditure in that period). The nett total (income less expense items) is the profit or loss for the period. All income and expenditure accounts are closed off on Balance Day and the balances transferred to the accumulated funds account (the nett figure being the profit or loss for the period). When a new accounting period commences, all the income and expenditure accounts are clear. After recording entries for an accounting period the balances shown on these accounts will represent the profit or the loss for that period. The Income and Expenditure Statement is the most likely document to be seen at management meetings as it provides the committee with an indication of the organisation's trading position. Consider the Sunnyway Income and Expenditure Statement on the following page. 014

15 Sunnyway Training Services Inc Income and Expenditure Statement for the four months ended 30 April 2006 Revenues Funding allocation 24,000 Student fees 61,900 Interest, dividends, other income 2,500 Total Revenues 88,400 Less Expenses Salaries and wages 49,000 Course costs 7,100 Depreciation 2,140 Rent 9,300 Other operating expenses Accountancy and audit 700 Bad debts 0 Bank charges 120 Insurance 3,200 Leave entitlements 900 Light and power 850 Postage 250 Printing and stationery 1,600 Repairs and maintenance 1,060 Superannuation 3,150 Travel expenses 300 Total Expenses 79,670 Surplus to Accumulated Funds 8,

16 Book-keeping: Balance Day and producing financial reports The Balance Sheet The Balance Sheet records the financial situation of an organisation at any one time. The asset and liability account balances are used to prepare the Balance Sheet, which gives a snapshot picture of the financial position of the business at a specific point in time, usually the end of an accounting period. The Balance Sheet is used to record the balances of all the assets and liabilities as either current or non-current. Those in each category are grouped together from the most fluid (changeable) to the most permanent. Assets are set up showing their cost or nett realisable value. Liabilities are the amounts owing to third parties. The difference between the totals of the assets and the totals of the liabilities is referred to as the nett worth or equity (funds plus profits) in the organisation. Consider the Sunnyway Balance Sheet on the following page. 016

17 Sunnyway Training Services Inc Balance Sheet as at 30 April 2006 Current assets Cash at bank 10,970 Accounts receivable 7,300 Prepaid expenses Stationery stock 300 Total current assets 18,570 Non-current assets Investments 1,200 Land and buildings 85,000 Furniture 29,300 Less accumulated depreciation (23,340) 5,960 Total non-current assets 92,160 Total assets 110,730 Current Liabilities Creditors and accrued expenses 4,400 Accrued wages 2,000 Course fees prepaid 4,500 Total current liabilities 10,900 Total liabilities 10,900 Nett Assets $ 99,830 Represented by: Accumulated Funds 1 January 2006 Surplus for the 4 months to April 30 91,100 8,730 $ 99,

18 Book-keeping: Balance Day and producing financial reports Assessment of accounting information Checklist of financial statements The following checklist can be used as a ready-reckoner when finalising the financial statements. Checklist Tick Yes or No Is the Surplus/Deficit shown in the Income and Expenditure Statement the same as that shown in the Balance Sheet? Yes No Is the closing Equity balance equal to nett assets (Assets Liabilities)? Is the closing cash balance shown in a Cash Flow Statement the same as the cash account(s) in the Balance Sheet? 018

19 Q Exercise 8.1: Indicate how you would expect adjustments for the following items to be reported in both the Income and Expenditure Statement and the Balance Sheet for an ACE organisation at 31 December: 1. The unpaid telephone bill shows that $1,000 is outstanding, including $300 for rental from 1 November to 31 January and $700 in calls and charges to 31 October. 2. Annual rates of $1,200 were paid on 1 April. 3. In this year $2,500 has been earned by staff in long service leave accruals, $17,000 in annual leave and leave loading, and $3,000 in sick leave. 4. Interest of $1000 will be received on a 12-month term deposit when the deposit matures on 2 January. 5. Ten computers, which the organisation purchased on 1 April at $3,500 each, need to be depreciated. The organisation plans to keep them for three years, and expects to sell them at the end of that time for $500 each. 6. A funding allocation of $50,000 for next year was deposited in the organisation s bank account on 29 December. Item Unpaid phone bill $1,000 Income and Expenditure Balance Sheet Annual rates paid on 1 April $1,200 Leave accruals Interest to be received on 2 January Depreciation on computers Funding allocation received in advance 019

20 Book-keeping: Balance Day and producing financial reports A Answers Exercise 8.1 You were asked to indicate how you would expect adjustments for the items listed to be reported in the Income and Expenditure Statement and in the Balance Sheet at 31 December. Item Income and Expenditure Balance Sheet Unpaid phone bill $1,000 Annual rates paid on 1 April $1,200 Leave accruals Interest to be received on 2 January Depreciation on computers Funding allocation received in advance Increase Telephone Expense by $900. ($700 for phone calls and $200 for outstanding rent. The other $100 relates to next year) Reduce Rates Expense by prepaid amount $300 Expense accounts for the year: Long Service Leave $2,500 Annual Leave $17,000 Sick Leave $3,000 Interest Income account to be credited (increased) by $1,000 Cost: 10 $3,500 = $35,000 Residual value: 10 $ 500 = $ 5,000 Expected life: 36 months Age at 31 December: 9 months Monthly depreciation charge: 35,000 5,000 = $ Charge for 9 months: $ x 9 = $7,500 Debit Depreciation Expense $7,500. Reduce funding allocation account by $50,000 if credited already Liability for unpaid account $100. Accrued Telephone Expense $900. Asset for amount relating to next year $300 Provisions to be increased Long Service Leave $2,500 Annual Leave $17,000 Sick Leave $3,000 Create asset, Accrued Interest Income $1,000 Credit Accumulated Depreciation Equipment $7,500. Create liability: Income received in advance $50,

21 Q Exercise 8.2: In which reports would you expect to see the following items, and what information would they provide? Item Telephone and fax expenses Which report and what information Printing Prepaid funding allocations Accumulated funds Depreciation of equipment Accumulated depreciation Sale of workbooks Creditors Interest earned Classroom furniture Stock of stationery (asset) Course fees Salaries (expense) Rent owing Accrued long service leave Commonwealth Bank term deposit Insurance (expense) Car registration (expense) 021

22 Book-keeping: Balance Day and producing financial reports A Answers Exercise 8.2 You were asked to indicate in which reports would you expect to see the following items, and what information they would they provide. Item Telephone and fax expenses Printing Pre-paid funding allocations Accumulated funds Depreciation of equipment Accumulated depreciation Sale of workbooks Creditors Interest earned Classroom furniture Stock of stationery (asset) Course fees Salaries (expense) Rent owing Accrued long service leave Commonwealth Bank term deposit Insurance (expense) Car registration (expense) Which report and what information I & E Total amount incurred in period (expense) I & E Total amount incurred in period (expense) B/S Liability for amount of unearned income B/S Balance of equity I & E Total amount charged as expense in period B/S Total amount of depreciation charged to date I & E Amount earned during period (income) B/S Amount owing (liability) I & E Amount of interest earned during period (income) B/S Original cost of furniture (asset) B/S Amount of stationery remaining on Balance Day I & E Amount earned during period (income) I & E Amount of salaries earned by employees for period B/S Liability for rent unpaid at Balance Day (liability) B/S Provision for amount accrued (liability) B/S Amount invested (asset) I & E Amount of insurance expense incurred for period I & E Amount expense incurred for period 022

23 Quick quiz Use the questions below to check your understanding of the material covered in this module. If you are unable to complete the quiz, review the appropriate section of the module. The quiz contains questions where you write short answers in the spaces provided, eg Question 2. In other questions, eg Question 1, you are given more than one possible answer and you tick the box or boxes that you think are correct. In Question 6 you are required to write numbers, 1 to 5, in the boxes. 1 Balance Day adjustments are recorded in th e... General Journal Cash Payments Journal Cash Receipts Journal 2 List three common Balance Day adjustments Balance Day adjustments... always relate to actual payments are made at the end of the accounting period are made so that different financial reports will balance 4 Balance Day adjustments could include... all assets outstanding fees good/services not yet paid for all liabilities outstanding expenses fees for services in a future accounting period 5 A Trial Balance... is the most likely document to be seen at management meetings is a list of values of the debit and credit accounts in the general ledger always shows debits and credits as equal 023

24 Book-keeping: Balance Day and producing financial reports 6 There are five steps in the process of preparing an Income and Expenditure Statements and a Balance Sheet. Number them in order, 1 to5. Prepare Balance Day adjustments and update accounts Prepare a post-adjustment Trial Balance Enter the journal totals in the ledger accounts (update general ledger accounts) Prepare an Income and Expenditure Statement and a Balance Sheet Enter cash transactions into the Cash Journal 7 What factors, besides cash transactions, impact on an organisation s financial situation and results? 1 purchases or expenses incurred on credit List two benefits of making Balance Day adjustments

25 Review tasks 1. Balance Day adjustments Complete these sentences. 1. As well as relating to actual receipts and payments, Balance Day adjustments can relate to 2. If adjustments were not made on Balance Day. 025