Chapter 6 Accounting Adjustments and Working papers

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1 Chapter 6 Accounting Adjustments and Working papers Topics 1. Cash basis vs. Accrual Basis 2. Accrued Income 3. Accrued Expenses 4. Prepaid Expenses 5. Unearned Income 6. Depreciation 7. Supply Expenses 8. Doubtful Account 9. Working papers 1

2 1. Cash basis vs. Accrual basis Accrual Basis Cash Basis 2

3 Adjustments under Accrual Basis 1. Accrued Income Revenues for services performed but not yet received in cash or recorded. 2. Accrued Expenses Expenses incurred but not yet paid in cash or recorded. 3. Prepaid Expenses Expenses paid in cash before they are used or consumed. 4. Unearned Incomes Cash received before services are performed. 3

4 Adjustments under Accrual Basis 4

5 2. Accrued Income (= Asset) Revenues for services performed but not yet received in cash or recorded. Revenue Recorded BEFORE Cash Receipt Accrued revenues often occur in regard to: Interest Rent Services performed Contract starts Contract ended Close account ( xxx) Dr. Accrued Income (Asset code 1XX) Cr. Income (Revenue code 4XX) Cash received 5

6 2. Accrued Income (= Asset) 6 Example 2.1 As of December 1 st, 20X1, the company deposits cash to Bank 1,000,000 Baht. The interest rate is 1.2% per year. Th bank pays interest once a year. The company closes account on December 31 st, 20X1 Dec 1 st, 20X1 Nov 30 th, 20X2 Close account ( X1) Cash received 20X1 Dec 31 Dr. Accrued interest income 1XX 1,000 - Cr. Interest income 4XX 1,000 - Pay for 3-month advertising fee

7 2. Accrued Income (= Asset) 7 Exercise 2.1 The company provides consulting service to Mr. A for 4 months. The consulting fee is 48,000 Baht. The contract starts on Nov 1 st, 20X1 and ends on Feb 28 th, 20X2. Mr. A will pay total 48,000 Baht to the Company at the end of contract.. The company closes account on December 31 st, 20X1

8 2. Accrued Income (= Asset) 8 Exercise 2.2 As of July 1 st, 20X1, the company deposits cash to Bank 5,000,000 Baht. The interest rate is 3% per year. The bank pays interest once a year. The company closes account on December 31 st, 20X1

9 3. Accrued Expense (= Liability) 9 Expenses incurred but not yet paid in cash or recorded. Expense Recorded BEFORE Cash Payment Accrued expenses often occur in regard to: Rent Taxes Interest Salaries Contract starts Contract ended Close account ( xxx) Cash payment Dr. Expense (Expense code 5XX) Cr. Accrued Expense (Liability code 2XX)

10 3. Accrued Expense (= Liability) 10 Example 3.1 The company hasn t paid salary of the month December 20X1 to 5 employees. Each employee monthly salary is 3,000 Baht. The Company will pay December salaries on January 5 th, 20X2. Please adjust this account transaction as at December 31 st, 20X1. Dec 1 st, 20X1 Jan 5 th, 20X2 Close account ( X1) Cash Payment 20X1 Dec 31 Dr. Salary expense 5XX 15,000 - Cr. Accrued salary expense 2XX 15,000 - Pay for 3-month advertising fee

11 3. Accrued Expense (= Liability) 11 Exercise 3.1 The company rents office area from Central Company. Annual rental fee is 60,000 Baht. The rent agreement period is from May 1 st, 20X1 to April 30 th, 20X2. The company will pay rental fee to Central Company at the end of the agreement. Please adjust this account transaction as at December 31 st, 20X1.

12 3. Accrued Expense (= Liability) 12 Exercise 3.2 On August 1 st, 20X1 the company borrows 500,000 Baht from the bank. Interest rate is 5% a year. The company pays interest to bank twice a year at the end of January and at the end of July. Please adjust this transaction when the company closes account on December 31 st, 20X1.

13 4. Prepaid Expenses (= Asset) 13 Payment of cash, that is recorded as an asset because service or benefit will be received in the future. Cash Payment BEFORE Expense Recorded Prepayments often occur in regard to: insurance supplies advertising rent equipment buildings Contract starts Contract ended Cash payment Close account ( xxx)

14 4. Prepaid Expenses (= Asset) 14 There are 2 methods to record prepaid expenses 1. Record all to Expense Account and adjust later On Payment Date On closing date (31 Dec XX) Dr. Expense (5XX) xx Dr. Prepaid Expense (1XX) xx Cr. Cash (1XX) xx Cr. Expense (5XX) xx 2. Record all to Prepaid Expense Account and adjust later On Payment Date On closing date (31 Dec XX) Dr. Prepaid Expense (1XX) xx Dr. Expense (5XX) xx Cr. Cash (1XX) xx Cr. Prepaid Expense (1XX) xx

15 4. Prepaid Expenses (= Asset) 15 1 st Method: Record all to expense account Example 4.1 As of November 1 st, 20X1, the company pays 3-month advertising fee amounting to 12,000 Baht. The advertisement starts on November 1 st, 20X1. The Company closes account as of December 31 st, 20X1 20X1 Nov 1 Dr. Advertising Expense 5XX 12,000 - Cr. Cash ,000 - Pay for 3-month advertising fee Adjusting Entry as of December 31 st, 20X1 20X1 Dec 31 Dr. Prepaid Advertising Expense 5XX 4,000 - Cr. Advertising Expense 101 4,000 - Adjust advertising expense

16 4. Prepaid Expenses (= Asset) 16 1 st Method: Record all to expense account Exercise 4.1 As of March 1 st, 20X1, the company pays 12-month car insurance amounting to 24,000 Baht. The insurance period starts on March 1 st, 20X1. The Company closes account as of December 31 st, 20X1 Adjusting Entry as of December 31 st, 20X1

17 4. Prepaid Expenses (= Asset) 17 2 nd Method: Record all to prepaid expense account Example 4.2 As of November 1 st, 20X1, the company pays 3-month advertising fee amounting to 12,000 Baht. The advertisement starts on November 1 st, 20X1. The Company closes account as of December 31 st, 20X1 20X1 Nov 1 Dr. Prepaid Advertising Expense ,000 - Cr. Cash ,000 - Pay for 3-month advertising fee Adjusting Entry as of December 31 st, 20X1 20X1 Dec 31 Dr. Advertising Expense 5XX 8,000 - Cr. Prepaid Advertising Expense 102 8,000 - Adjust advertising expense

18 4. Prepaid Expenses (= Asset) 18 2 nd Method: Record to prepaid expense account and adjust later Exercise 4.2 As of March 1 st, 20X1, the company pays 12-month car insurance amounting to 24,000 Baht. The insurance period starts on March 1 st, 20X1. The Company closes account as of December 31 st, 20X1 Adjusting Entry as of December 31 st, 20X1

19 5. Unearned Income (= Liability) Receipt of cash that is recorded as a liability because service has not be performed. Cash Receipt BEFORE Revenue Recorded Unearned incomes often occur in regard to: Rent Magazine subscriptions Airline tickets Customer deposits Contract starts Contract ended Cash receipt Close account ( xxx) 19

20 5. Unearned Income (= Liability) 20 There are 2 methods to record unearned income 1. Record all to Income Account and adjust later On Payment Date On closing date (31 Dec XX) Dr. Cash (1XX) xx Dr. Income (4XX) xx Cr. Income (4XX) xx Cr. Unearned Income (2XX) xx 2. Record all to Unearned Income Account and adjust later On Payment Date On closing date (31 Dec XX) Dr. Cash (1XX) xx Dr. Unearned Income (4XX) xx Cr. Unearned Income (2XX) xx Cr. Income (4XX) xx

21 5. Unearned Income (= Liability) 21 1 st Method: Record all to income account Example 5.1 As of November 1 st, 20X1, the company receives 50,000 baht cash from a tenant for the 5 months rental fee from Nov 1, 20X1 to Mar 31, 20X2. 20X1 Nov 1 Dr. Cash ,000 - Cr. Rental Income 4XX 50,000 - Receive 5-month rental fee from a tenant Adjusting Entry as of December 31 st, 20X1 20X1 Dec 31 Dr. Rental Income 4XX 30,000 - Cr. Unearned Rental Income 2XX 30,000 - Adjust rental income

22 5. Unearned Income (= Liability) 22 1 st Method: Record all to income account Exercise 5.1 As of May 1 st, 20X1, the company receives 12-month magazine subscription fee amounting to 6,000 Baht. The subscription period starts on May 1 st, 20X1. The Company closes account as of December 31 st, 20X1 Adjusting Entry as of December 31 st, 20X1

23 5. Unearned Income (= Liability) 23 2 nd Method: Record all to unearned income account Example 5.2 As of November 1 st, 20X1, the company receives 50,000 baht cash from a tenant for the 5 months rental fee from Nov 1, 20X1 to Mar 31, 20X2. 20X1 Nov 1 Dr. Cash ,000 - Cr. Unearned Rental Income 2XX 50,000 - Receive 5-month rental fee from a tenant Adjusting Entry as of December 31 st, 20X1 20X1 Dec 31 Dr. Unearned Rental Income 2XX 20,000 - Cr. Rental Income 4XX 20,000 - Adjust rental income

24 5. Unearned Income (= Liability) 24 2 nd Method: Record to prepaid expense account and adjust later Exercise 5.2 As of May 1 st, 20X1, the company receives 12-month magazine subscription fee amounting to 6,000 Baht. The subscription period starts on May 1 st, 20X1. The Company closes account as of December 31 st, 20X1 Adjusting Entry as of December 31 st, 20X1

25 Adjustments for fixed assets 25

26 6. Depreciation (= Expense) Buildings, equipment, and vehicles (assets with long lives) are recorded as assets, rather than an expense, in the year acquired. Depreciation allocates a portion of the asset s cost as an expense during each period of the asset s useful life. Depreciation does not attempt to report the actual change in the value of the asset. Acquired Date End of useful life Close account ( xxx) 26

27 6. Depreciation (= Expense) Straight-Line Depreciation Method Depreciation = Cost of Assets Residual value Useful Life (Years) Where o Cost of Assets = The initial amount paid to acquire the assets o Residual Value = The fair value of the assets at the end of useful life o Useful Life = Numbers of years that the assets can be used ***Depreciation can also be expressed as percentage per year 27

28 6. Depreciation (= Expense) 28 Example 6.1 On January 1 st, 20X1, the company buys a car 1,200,000 Baht cash. The useful life is 5 years and the estimated residual value is 250,000 Baht 20X1 Jan 1 Dr. Vehicle 1XX 1,200,000 - Cr. Cash 1XX 1,200,000 - Buy a car with cash Depreciation = 1,200, ,000 5 Depreciation = 190,000 Baht/Year 20X1 Dec 31 Dr. Depreciation 5XX 190,000 - Cr. Accumulated Depreciation - Vehicle 1XX 190,000 - Record depreciation for a car

29 6. Depreciation (= Expense) 29 Exercise 6.1 On June 1 st, 20X1, the company buys a machine 425,000 Baht cash. The useful life is 5 years and the estimated residual value is 50,000 Baht 20X1 Jun 1 Buy a machine with cash 20X1 Dec 31 Record depreciation for a machine

30 6. Depreciation (= Expense) 30 Exercise 6.2 On August 1 st, 20X1, the company buys equipment 720,000 Baht cash. The useful life is 3 years. There is no residual value for this equipment.

31 7. Supplies (= Asset) When the company buys supplies (such as pens, A4 papers, printer s ink, etc.), the company usually buys many items at once and gradually use it. Supplies are usually consumed within a short period of time. Accounting entry when the company buys supplies is Dr. Supplies (1XX) Cr. Cash / AP xx xx Accounting entry when the company uses the supplies is Dr. Supply expense (5XX) Cr. Supplies (1XX) xx xx 31

32 7. Supplies (= Asset) Example 7.1 The beginning (B/F) balance of supplies as of January 1, 20X1 is 7,450 Baht. During the year, the company buys supplies 1,250 Baht. At the end of year (C/F), the remaining supplies is 3,650 Baht. Please record supply expense of the year 20X1 Supplies, 1 January 20X1 7,450 Add Purchase Supplies during the year +1,250 Less Supplies, 31 December 20X1-3,650 Supply expense 5,050 20X1 Dec 31 Dr. Supply expense 5XX 5,050 - Cr. Supplies 1XX 5,050 - Adjust supplies and supply expense 32

33 7. Supplies (= Asset) Exercise 7.1 The beginning (B/F) balance of supplies as of Jun 1, 20X1 is 2,500 Baht. During June 20X1, the company buys supplies 1,800 Baht. At the end of month (C/F), the remaining supplies is 1,300 Baht. Please record supply expense of the month June 20X1 33

34 8. Doubtful Account (= Expense) Doubtful account is an expense, estimated from the account receivables that are expected to be bad debt in the future. Allowance for doubtful account is a contra-asset account that reduce the accounts receivable balance to reflect only the accounts receivable expected to be collected. Management is responsible to best-estimate doubtful account and allowance for doubtful account, and disclose the estimation policy in annual financial report. There are 2 methods to calculate doubtful account 1. Calculate from Credit Sales 2. Calculate from Accounts Receivable Balance 34

35 8. Doubtful Account (= Expense) 1 st Method: Calculate from Credit Sales Example 8.1 The company has total credit sales 50,000 Baht. The policy for allowance for doubtful account is 1% of credit sales. Please record the adjusting entry for the doubtful account. Allowance for doubtful account = 50,000 x 1% = 500 Baht 20X1 Dec 31 Dr. Doubtful Account 5XX Cr. Allowance for doubtful account 1XX Adjust allowance for doubtful account 35

36 8. Doubtful Account (= Expense) 2 nd Method: Calculate from Accounts Receivable Balance Example 8.2 The company has A/R balance as of December 31, 20X1 25,000 Baht. The policy for allowance for doubtful account is 2% of A/R balance. Please record the adjusting entry for the doubtful account. Allowance for doubtful account = 25,000 x 2% = 500 Baht 20X1 Dec 31 Dr. Doubtful Account 5XX Cr. Allowance for doubtful account 1XX Adjust allowance for doubtful account 36

37 8. Doubtful Account (= Expense) BAD DEBT will be recorded when the company will not be able to collect cash from accounts receivable in the future. For example, the customer company goes bankruptcy. Example 8.3 The Company sell goods to AA Company for 1,000 Baht on credit. The Company finds out that AA Company is being liquidated and the possibility of debt recovering is none. Therefore, the Company decides to write off this amount of bad debt. 20X1 Dec 31 Dr. Bad Debt 5XX 1,000 - Cr. Accounts Receivable 1XX 1,000 - Adjust AR to bad debt 37

38 8. Doubtful Account (= Expense) 38 Exercise 8.1 The followings are balance of the Company as of 31 Dec 20X1 - Cash 10,000 - Cash Sales 40,000 - Accounts Receivable 12,500 - Credit Sales 60,000 - Accounts Payable 4,800 - Credit Purchase 12,000 The Company has estimation policy for allowance for doubtful account at 5% of credit sales. Moreover, the company finds out that one of customers is bankrupted so the AR balance to be write off as bad debt is 500 Baht. 20X1 Dec 31 Adjust AR and bad debt 20X1 Dec 31 Adjust allowance for doubtful account

39 Adjustments for assets 1. Depreciation of fixed assets Equipment, Cost as of 31 December 20X1 100,000 Less Accumulated Depreciation (20,000) Equipment, net 80, Supplies vs. Supply expenses 3. Doubtful accounts vs. Allowance for doubtful accounts Accounts receivable, as of 31 December 20X1 140,000 Less Allowance for Doubtful Accounts (14,000) Accounts receivable, net 126,000 39

40 9. Working papers 40 A 10-Column worksheet is a template that helps accountants facilitate the reporting process at the end of the fiscal year helps eliminate errors associated with the end-of-period adjustment ensures that all accounting transactions have been properly recorded

(Accrual and Prepayment)

(Accrual and Prepayment) Accrual and Prepayment Longman Question 13 The following balances were extracted from the ledgers of Mr Ko at 31 March 2014: $ Telephone 12,355 Dr Rent and rates 55,000 Dr Loan to Bob 450,000 Dr Rental