ACC100 Introduction to Accounting

Week 5 Adjusting Entries and the Trial Balance Chapter 4 Adjusting entries Study Group Australia Pty Limited, SGA1286-F2/10/12 2

Learning Outcomes On completion of this week s study, you should be able to: ability to explain accrual versus cash accounting. ability to prepare adjustments for prepayments, unearned revenue, payables, receivables, and depreciation. 3

Accounting Principles This week we look specifically at end of period accounting adjustments including depreciation These end of period adjustments are performed as accountants believe they lead to more accurate and therefore more useful and relevant financial information

Adjusting Entries: Today s Main Concepts 1. Explain why accountants perform adjusting entries at period end accrual vs cash accounting 2. Calculate amounts, and record some common adjustments prepayments, unearned revenue, payables, receivables and depreciation 3. Post adjustments both to worksheet and general ledger accounts to produce an Adjusted Trial Balance 4. Prepare financial statements (more in workshop and tutorial on 3 & 4)

Measurement Of Profit Cash basis Income recorded when cash received Expenses recorded when cash paid Accrual basis Income recognised when the anticipated inflow of economic benefit can be reliably measured (i.e. you have done the work or sold the goods, etc) Expenses recognised when the consumption of benefits can be reliably measured (i.e. you have used the resource or received the benefit)

Income (Including Revenue) Income represents increases in economic benefits during the period in the form of inflows or enhancements of assets or decreases in liabilities Income = Revenue + Gains Recognised at the fair value of assets received 7

Expenses Expenses are the costs of services and assets consumed in the current period. Expenses are recognised in the period in which the consumption of costs can be measured. 8

The Need For Adjusting Entries In some cases the period in which cash is paid or received does not coincide with period in which expense and income should be recognised Therefore, some accounts must be adjusted on the last day of the accounting period to recognise income and expenses not reflected in cash receipts or payments In adjusting the income or expense amount, an asset or liability account will also be affected (Debits = Credits) and therefore not only is profit more reliable but so is the balance sheet

Classification Of Adjusting Entries Deferrals (Prepayments) Accruals (Unrecorded) Prepaid Expense Costs/expenses paid before they are consumed (e.g. office supplies, depreciation) Accrued Expense Expenses incurred but not yet paid (payables) (e.g. salary expense) Unearned Revenue Revenues that are collected or received but not yet earned (e.g. subscriptions) Accrued Revenue Revenue earned but not yet received (receivables) (e.g. market services) 10

Rules For Adjusting Entries At least 2 accounts are always affected (double-entry accounting) One side of the adjusting entry is an income or expense account (Income Statement) and the other side is an asset or liability account (Balance Sheet) Debits = Credits N.B. Cash at bank account is never part of an adjusting entry. It may be necessary to correct a previous entry involving cash, but this is not an adjusting entry

Deferrals: Prepaid Expenses Cash paid before benefits are consumed Initially recorded as assets when paid At the end of the period the amount consumed is expensed. ASSET ACCOUNT Prepaid Expense EXPENSE ACCOUNT Initial Cost Debit Adjusting Entry Credit Adjusting Entry Debit Costs consumed or expired 12

Example (1): Office Supplies On 5 June the following entry was made to record a tax invoice covering the purchase of office supplies: General Journal Jun 5 Office Supplies 1 240 GST Outlays 124 Accounts Payable 1 400 (Office supplies purchased on credit) 13

Example: Office Supplies On 30 June it is determined that $1080 remain on hand ($1240 - $1080 = $160 consumed) General Journal Jun 30 Office Supplies Expense 160 Office Supplies 160 (Adjusting entry for office supplies) Initial Entry 1 240 Office Supplies Adjusting Entry 160 Office Supplies Expense Adjusting Entry 160 Costs consumed or expired 14

Example (2): Depreciation Non-Current Asset Initial Cost Debit Contra-Asset Account Accumulated Depreciation Adjusting Entry Credit Depreciation Expense Adjusting Entry Debit Costs consumed and allocated to current period 15

Notes On Depreciation Of Assets Depreciation expense can be thought of as a method of allocating the initial cost of an asset over its useful life The most commonly used allocation method is straight-line depreciation. This method assumes that an asset is evenly used over lifetime The formula is: Depreciation = initial cost residual value estimated useful life

Journal Entry To Record Depreciation The initial cost of equipment purchased on 1 July 2012 is $20,000. The residual value ( scrap value) is estimated to be $5,000 and its useful life is estimated to be 5 years. Assume straight-line depreciation. Record depreciation expense for the year ended 30 June 2013 Jun 30 Depreciation expense-equip. 3000 Accumulated depreciation-equip. 3000 Adjusting entry to record 1 years depreciation of equipment Calculation : (20,000 5000) 5

Deferrals: Unearned Revenue Cash received in advance for services that are to be performed in the future Initially recorded as liability when received Recognised as revenue as earned LIABILITY ACCOUNT Unearned Revenue INCOME ACCOUNT Adjusting Entry Debit Cash Receipt Adjusting Entry Credit Revenue earned during the current period 18

Example: Subscriptions On 8 September a monthly magazine publisher received $264 for a 1 year subscription beginning October General Journal Sept 8 Cash at Bank 264 GST Collections 24 Unearned Subscription Revenue (Receipt of subscriptions in advance) 240 Where does the Unearned Subscription Revenue account belong? Balance sheet or Profit and Loss? Discuss. 19

Example: Subscriptions On 31 December 3 months of revenue has been earned (3/12 x $240 = $60) General Journal Dec 31 Unearned Subscriptions Revenue 60 Subscriptions Revenue 60 (Adjusting entry for subscriptions earned) Unearned Subscriptions Revenue Adjusting Entry 60 Cash 240 Subscriptions Revenue Adjusting Entry 60 Revenue earned during the current period 20

Accruals: Accrued Expenses Expenses that have been consumed but payment has not yet been made Expense must be recognised along with a liability for future payment LIABILITY ACCOUNT Expense Payable Adjusting Entry Credit EXPENSE ACCOUNT Adjusting Entry Debit Expenses Incurred 21

Example: Accrued Salaries 22

Example: Salary Expense On 30 June an adjusting entry is required to correctly determine June s expenses General Journal Jun 30 Salaries Expense 1990 Salaries Payable 1990 (Adjusting entry for salaries payable) Salaries Payable Adjusting Entry 1990 Salaries Expense Adjusting Entry 1990 Expenses Incurred 23

Example: Salary Payable (N.B. Next Accounting Period) The liability is eliminated on 6 July when the next payment is made to employees. General Journal Jul 6 Salaries Payable 1 990 Salaries Expense 1 710 Cash at Bank 3 700 (Payment of salaries earned 23 June to 6 July) 24

Accruals: Accrued Revenue Usually recorded when service is performed No adjusting entry would be necessary eg credit sales Any unrecorded revenue earned needs to be recorded ASSET ACCOUNT Accounts Receivable Adjusting Entry Debit INCOME ACCOUNT Revenue Adjusting Entry Credit Revenue earned but not yet received 25

Example: Market Services On 1 June an agreement was signed to provide marketing services for a monthly fee of $800. On 30 June cash is yet to be received and no invoice has been issued (but the service has been supplied) General Journal Jun 30 Accounts Receivable 800 Marketing Services Revenue 800 (Marketing services fee receivable for June) 26

The Adjusted Trial Balance Adjusting entries are posted to the General Ledger GL balances then reflect true end of period amounts An Adjusted Trial Balance can then be prepared Debits must still equal credits! CHECK More on this in tutorials 27

Preparation Of Financial Statements Next lecture we will examine the preparation of the financial statements from the Adjusted Trial Balance. Income Statement Prepared first to determine profit or loss for period Reflects entity s financial performance Statement of Changes in Equity Shows details of movements in equity Profit (loss) must be added to (subtracted from) equity New equity balance is reported in balance sheet Balance Sheet Reflects entities financial position including new equity balance derived in statement of changes in equity Users find further classification of Assets & Liabilities useful 28

GST Goods and services tax 10% tax added on most goods and services Except GST free goods and services Except Input taxed goods and services The business acts as a tax collection agent, but the cost of the tax is borne by the final consumer Business must register for GST if gross taxable supplies (sales of goods) exceed $75 000. Can voluntarily register if sales are below $75 000

GST mechanics Sales transactions On all sales of taxable goods and services, a GST registered business must : charge GST to customers, collect GST from customers, and Remit the collected GST to the ATO issue a tax invoice

Accounting For Sales Transactions Entry for credit sales: Aug 5 Dr. Accounts Receivable 1 980 Cr. Sales 1 800 Entry for Cr. cash GST sales Collections (liability) 180 Sold merchandise on credit to R Stevens Aug 5 Dr. Cash 1 980 Cr. Sales 1 800 GST Collections (liability) 180 Sold merchandise for cash 31

GST mechanics Purchase transactions On all purchases of eligible goods and services, business will: Pay GST as part of the purchase price of the goods/ services They may claim a refund of the GST amounts paid from the ATO ( input credits) Must have a supporting tax invoice in order to claim back the GST

Purchase and GST Recording an expense with GST Dr. Office consumables 3 150 Dr. GST Outlay (asset) 315 Cr. Cash 3 465 33

Tax Invoices Required for all sales in excess of $75. Requirements for tax invoices : Tax invoice displayed prominently ABN of issuing entity Date of issue Name of suppliers Description of items being supplied. Invoices over $1000 have additional requirements. 34

Examples Of Tax Invoices 35