ACCT1501 Week 5 Lecture Notes (4 Slides)
Content
Business School
ACCT1501 Accounting and Financial Management 1A
Session 1 2015
Week 5
Accrual Accounting Adjustments
Student Handout
Lecturer:
Jeffrey Knapp
School of Accounting
UNSW
QUAD 3103
[email protected]
Moodle: https://moodle.telt.unsw.edu.au/login/index.php
ACCT 1501 Session 1, 2015
WEEK 5: Accrual Accounting Adjustments
1.
Lecturer comments
Accrual accounting exists to provide timely information about the financial affairs of
organisations to users or stakeholders for their economic decision-making. In financial
accounting, the focus is on providing useful information to external stakeholders such as
shareholders and creditors.
The financial affairs of organisations involve financial position, financial performance,
changes in equity and cash flows. The balance sheet addresses financial position by showing
the economic resources under the organisations control (assets) and its financial and other
obligations (liabilities). The balance sheet captures the fundamental equation (A – L = OE)
and it is the driving force in accrual accounting. The need at regular intervals – at the end of
each accounting period – to determine the assets and liabilities of the enterprise is at the heart
of accrual accounting and accrual adjustments. In the business world, analysts and investors
tend to focus on financial performance for the accounting period, that is, profit or earnings.
The profit is the income less expenses for the period. Income equals revenue plus gains. The
income statement shows the revenues for the period less the expenses incurred in generating
those revenues – this is referred to as the matching principle.
Accrual accounting is superior to cash flow information to assess the financial position and
financial performance of an enterprise. Cash flow information only records the financial
effects of transactions and events on the cash balance. In contrast, accrual accounting records
the financial effects of all transactions and events that affect economic resources or
obligations of the enterprise. Consider this simple example. Assume a company sold land
that had cost $1m in return for new land valued at $5m. This transaction would not be
recorded in cash accounting. In accrual accounting we would recognise the new land as an
asset in the balance sheet $5m and we would recognise a gain of $4m in the income statement.
Keeping track of cash flow is important for business success, but it is not enough. We have to
go beyond cash flow to assess economic performance more broadly and to assess non-cash
resources and obligations. In accrual accounting, we make estimates, judgements and other
accounting choices that make the financial information more subjective than transactionbased cash flow figures. Accrual accounting information therefore tends to be more relevant
to users economic decision-making than cash-based information but less reliable.
This week, adjusting entries are the key concept. Adjusting entries are the steps required to
ensure the accounts represent the assets, liabilities, revenues and expenses once we get to the
end of the accounting period. For reasons of convenience, we don’t record a wages expense
for every hour (or minute, or second, or millisecond). But at the end of the accounting
period, we must ensure that any wages owing (liability) is recorded together with the related
wages expense for the period. When preparing the financial statements for the accounting
period, we want to ensure that all assets, liabilities, revenues and expenses are recognised and
measured. To make sure this happen, we have to adjust the accounts.
This week we also consider closing entries. Only the account balances for assets, liabilities
and equity carry forward from one accounting period to the next. The accounts for revenues
and expenses must be closed at the end of the accounting period to determine the profit for
the period. An income summary account is used to facilitate this process. The profit for the
period is then transferred to the equity account of retained profits.
ACCT 1501 Session 1, 2015
2
Learning objectives
At the end of this topic you should be able to:
Explain how the timing of revenue and expense recognition differs from cash inflows
and outflows.
Prepare journal entries for accrual accounting adjustments.
Understand contra accounts and the impact on the financial statements.
Understand and perform the closing process.
Required Reading
Trotman, Gibbins & Carson
Chapter 4:pages 174-177
Trotman, Gibbins & Carson
Chapter 5:pages 201-242
(Note from lecturer. Please read all the learning objectives for chapter 5 on page 201 of
the textbook. These learning objectives are covered during my 4 week lecturing period.)
2.
Tutorial Questions – Due in Week 6
Preparation Questions:
Students should review the following preparation questions using the solutions available from
Moodle.
Discussion Questions DQ 5.2, DQ 5.4, DQ 5.13
Problems P5.4, P5.6, P5.18, P5.20, P5.23
Case 5A
Tutorial Questions:
Students should attempt the following tutorial questions before class.
Discussion Questions DQ 5.10, DQ5.19
Problems P5.7, P5.9, P5.13
ACCT 1501 Session 1, 2015
3
27/03/2015
Topic 5: Learning Objectives (LO)
ACCT1501
Semester 1, 2015
At the end of Topic 5, you should be able to:
LO1: Explain how the timing of revenue and expense recognition
differs from cash inflows and outflows (the accrual concept)
LO2: Prepare journal entries for accrual accounting adjustments (the
adjusting entries)
LO3: Understand contra accounts and the impact on the financial
statements
LO4: Understand and perform the closing process
Week 5
Accrual Accounting Adjustments
Essential reading for Week 5
Jeffrey Knapp
Quad 3103
Trotman, Gibbins & Carson Chapter 4 pp. 174-177
Trotman, Gibbins & Carson Chapter 5 pp. 201-242
2
Recap: Cash and accrual accounting
Accrual accounting records:
Revenues when they are earned, not received.
Expenses when they are incurred, not paid.
E.g.
Remember, cash accounting records revenues and
expenses when…
3
E.g.
E.g.
LO1
Often a timing difference between the significant
economic event (earning revenue/incurring expense) and
related cash flow
Some items that have no cash flow effect.
Accrual accounting
LO1
provide a more complete picture of economic performance,
particularly in the short term
Does not imply that the payment or receipt of cash are
unimportant events
the lifeblood of business
cash is received or paid.
4
1
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Revenue expense and recognition
Revenue recognition
LO1
Let’s review the differences in how revenue and expense
are recognised under an accrual versus cash system.
LO1
1. Recognition of revenue (resource inflow) at the same time
as cash inflow.
E.g. Sale to customer for cash.
Cash entry:
Dr Cash (+A)
Cr Sales (+R)
Accrual entry:
Dr Cash (+A)
Cr Sales (+R)
Note: both entries are the same.
5
6
Revenue recognition
Revenue recognition
LO1
2. Recognition of revenue (resource inflow) prior to cash
inflow
3. Recognition of revenue (resource inflow) after cash inflow.
E.g. Sale to customer on credit.
Cash entry:
Nothing
Accrual entry:
Dr Accounts receivable (+A)
Cr Sales (+R)
LO1
E.g. Receipt of subscription fees in advance.
Cash entry:
Dr Cash (+A)
Cr Sales (+R)
Accrual entry:
Dr Cash (+A)
Cr Unearned revenue (+L)
Note : the cash entry overstates sales.
Note : the cash entry understates sales.
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Expense recognition
1. Recognition of expense (resource outflow) at the same
time as cash outflow.
Expense recognition
LO1
2. Recognition of expense (resource outflow) prior to cash
outflow
E.g. Payment of wages.
Cash entry:
Dr Wages expense (+E)
Cr Cash (-A)
Accrual entry:
Dr Wages expense (+E)
Cr Cash (-A)
Note: both entries are the same.
LO1
E.g. wages owing at year end
Cash entry:
Nothing
Accrual entry:
Dr Wages expense (+E)
Cr Wages payable (+L)
Note: the cash entry understates expenses.
9
10
Expense recognition
3. Recognition of expense (resource outflow) after cash
outflow
Summary: Cash versus accrual profit
LO1
E.g. Payment of insurance for the next 24-month period.
Cash entry:
Dr Insurance Expense (+E)
Cr Cash (-A)
Accrual entry:
Dr Prepaid insurance (+A)
Cr Cash (-A)
LO1
The earning of a revenue is not necessarily accompanied
by an inflow of cash in the same period.
The incurrence of an expense is not necessarily
accompanied by an outflow of cash in the same period.
Accrual profit is not the same as cash profit.
Note : the cash entry overstates expenses.
11
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Accrual accounting adjustments
LO2
Accrual accounting adjustments
Adjusting entries are entries necessary at the end of the
accounting period to measure all revenues and expenses
of that period.
Types:
1.Deferrals-related
1.1 Revenue adjustment: Unearned revenue
Year End
Deferrals
1.1.Unearned revenue
Cash received
before earned Revenue earned over time
...
t-1
t
#1
#2
Expense incurred over time
Cash paid
before incurred
1.2.Prepayment
1.2. Expense adjustment: Prepayment
2. Accruals-related
2.1. Revenue adjustment: Accrued revenues
2.2. Expense adjustment: Accrued expenses
3. Valuation-related: Book value adjustments: Contra accounts
LO2
Accruals
2.1.Accrued revenue
Cash received
after earned
t+1
#1
Cash paid
after incurred
2.2. Accrued expense
Each involves two entries:
#1 One for the cash receipt or payment
#2 One for recording the revenue or expense in the proper period (Adjusting entries)
13
14
1.1. Unearned revenue
Cash received in advance of earning revenue.
1.1. Unearned revenue – An example
LO2
LO2
On 31 May, a company received $1200 for the service to be provided in the future
Liability – goods or services are owing to others
31 May Dr Cash (A)
31 May 1 Jun
Period end
30 Jun
$1,200
Cr Unearned revenue (L)
$1,200
Examples:
insurance premiums
magazine subscriptions
rent received in advance
Qantas, Telstra
$100 of services provided
...
30 Jun Dr Unearned revenue (L)
Cr Revenue (R)
15
$100
$100
16
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1.2. Prepayments
Cash paid in advance of incurring expense
1.2 Prepayments – Example 1
LO2
On 31 May, a company purchased office supplies of $1000.
Assets – future economic benefit
current or non-current asset?
31 May Dr Office supplies (A) $1,000
Cr Cash (A)
31 May 1 Jun
Examples:
LO2
Period end
30 Jun
$1,000
...
At 30 June, $300 of the office supplies remained
i.e. $700 had been consumed.
prepaid insurance
prepaid rent
office supplies
30 Jun Dr Office supplies expense (E)
$700
Cr Office supplies (A)
17
$700
18
1.2 Prepayments – Example 2
1.2 Prepayments – Example 2
LO2
On 1 May 2012, a company pays $1200 for a one-year
1 May Dr Prepaid rent (A)
rent. Financial year ended date is 30 June 2012.
$1,200
Cr Cash (A)
What journal entries will the company make on 1 May
LO2
$1,200
Period end
30 Jun
1 May
...
2012 and 30 June 2012?
2-month rent has been used up
=$1,200/12 ×2 = $200
30 Jun Dr Rent expense (E)
Cr Prepaid rent (A)
19
$200
$200
20
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1.2 Prepayments – Example 3
2.1. Accrued revenue
LO2
Opening balance prepaid rent $3000
Revenue has been earned but cash will not be received
until the following period.
Closing balance prepaid rent: $4000
Rent expense:
c/d
Cash
Receivables, assets
$5000
Examples:
What was the cash paid for rent during the year?
Dr. Prepaid rent
Cr. Cash
LO2
Prepaid rent
(A)
$3000 Rent exp.
$6000 c/d
Dr. Rent exp.
Cr. Prepaid rent
$5000
$4000
commissions earned but not received
interest earned but not received.
Telstra, Sydney water
$3,000+X-5,000=$4,000
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2.1 Accrued revenue – An example
2.1 Accrued revenue – An example
LO2
Orange company deposited $300 000 with a bank at 10
per cent per annum and interest is paid on 1 March
every year and the next payment of interest will be
received on 1 March 2013.
30 Jun
1 Mar, 2012
Financial year ended date is 30 June 2012.
Dr Interest receivable (A)
Cr Interest revenue (R)
...
$10 000
$10 000
Period end 30 June, 2012
...
$10 000 interest
has been earned
What journal entries will the company make on 30 June
2012 and 1 March 2013?
LO2
1 Mar, 2013
$20 000 interest
has been earned
(=$300,000×10%×4/12)
(=$300,000×10%×8/12)
1 Mar
Dr Cash (A)
$30 000
Cr Interest receivable (A)
Cr Interest revenue (R)
23
$10 000
$20 000
24
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2.2. Accrued expense
Expense has been incurred but cash will not be paid until
the following period
Payables, liability
Examples:
2.2 Accrued expense – An example
LO2
A firm pays weekly wages of $50 000 each Friday (25 June,
2 July).
Financial year ended date is 30 June, 2012 (Wednesday).
What journal entries will the firm make on 30 June 2012
and 2 July 2012?
wages earned by employees but not paid after end of
financial period
interest payable on outstanding loan.
25
26
2.2 Accrued expense – An example
25 June Dr Wages expense (E)
Cr Cash (A)
25 June, 2012
Friday
...
30 Jun
3. Contra accounts
LO2
$50 000
Period end 30 June, 2012
Wednesday
...
2 July, 2012
Friday
$30 000
$30 000
2 July
Dr Wages expense (E)
Dr Wages payable (L)
Cr Cash (A)
is paired with and follows its related account
Its normal balance (debit or credit) is the opposite of the
balance of the related account
Examples:
2 days’ wages
incurred
Dr Wages expense (E)
Cr Wages payable (L)
LO3
A contra account
$50 000
3 days’ wages
incurred but not paid
27
LO2
Accounts receivable → Allowance for doubtful debts (ADD)
Property, plant and equipment → Accumulated depreciation
Intangibles → Accumulated amortisation
Inventory → Provision for obsolescence.
$20 000
$30 000
$50 000
28
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3. Contra accounts – Why are they useful?
Allow users to ascertain:
Accounts receivable → Allowance for doubtful debts (ADD)
level of doubtful debts (and changes therein), collection policies and
problems
Property, plant and equipment → Accumulated depreciation
Intangibles → Accumulated amortisation
Inventory → Provision for obsolescence.
Accumulated depreciation (a contra asset account, B/S)
shows all depreciation charged against an asset to date.
likely life of intangibles
Depreciation expense (I/S) shows only this year’s
depreciation allocation.
levels of slow-moving, out-of-date stock, efficiency of stock
management.
29
30
3. Contra account – An example
Comprehensive class example
LO3
Asset costs $100 000 with a life of 5 years and no estimated
salvage value. Straight line depreciation each year:
Dr Depreciation expense
Cr Accumulated depreciation
After 3 years, book value is:
Asset
Accumulated depreciation
Book value
31
LO3
Allocation of the cost of a noncurrent asset to expense
over the life of an asset
To recognise the consumption of the asset’s economic
value.
likely ages of assets and future cash outflows for purchases of new
assets
3. Contra account – Depreciation
LO3
LO2,
3&4
The following information relating to adjusting
entries is available at the end of June 2013
$20 000
$20 000
Transactions 9-13.
$100 000
($60 000)
$40 000
32
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Comprehensive class example
Comprehensive class example
LO2
Transaction 9:
A physical count showed supplies costing $180 on hand
at 30 June 2013.
Opening Balance
Accounts Payable
Opening Balance
Transaction 10:
Accrued interest on the bank loan is $240.
Supplies
A4
210 Supplies expense ?
340
$550
Closing Balance
Interest Expense
Interest Payable
180
$550
180
Supplies Expense
Supplies
Dr
370
E3
A4
LO2
E6
L2
Dr
240
Cr
240
Cr
370
33
34
Comprehensive class example
Transaction 11:
Insurance costing $820 expired during the year.
Insurance Expense
Prepaid Insurance
E4
A3
Comprehensive class example
LO2
Dr
820
Transaction 12:
Depreciation on the vehicle is $5 350.
Cr
820
LO2
&3
Depreciation Expense – MV
Accumulated Depreciation – MV
Dr
Cr
E2
5,350
A5.1
5,350
Remember, in Transaction 6. insurance on vehicle, paid in
advance was $840
35
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Comprehensive class example
LO2
Comprehensive class example –
Closing entries for revenue accounts
Dr
Transaction 13:
The June telephone account for $180 has not been paid or
recorded.
Dr
Cr
Telephone Expense
E5
180
Telephone Expense Payable
L4
180
Piano Tuning Fees (-R)
28,600
Piano Repair Fees (-R)
P&L Summary
24,380
52,980
Piano tuning fees
R1
Piano repair fees
R2
$23 940
Cash
$16 800
A/R
$4 660
A/R
$7 580
Bal.
$28 660
Bal.
$24 380
38
Comprehensive class example –
Closing entries for expense accounts
Comprehensive class example –
Closing entries for P&L summary account
LO4
Dr
P&L Summary
Petrol and Oil (-E)
Depreciation Expense (-E)
Supplies Expense (-E)
Insurance Expense (-E)
Telephone Expense (-E)
Interest Expense (-E)
Cr
LO4
Profit & Loss Summary
12,300
Closing ent (2) 12,300 Closing ent (1) 52,980
2,680
5,350
370
820
2,420
660
Retained Profits 40,680
$2 680
Bal.
$2 680
Cr
40,680
Retained Profits
Petrol and oil expense E1
Cash
Dr
40,680
P&L Summary
Retained Profits (+SE)
Before closing,
39
Cr
Before closing,
Cash
37
LO4
c/d
41,234
b/d
554
P&L Summary 40,680
40
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Revision Question 1
Revision Question 2
Which of the following would be recorded as an asset?
On 15 September 2012, a surveyor received an advance
of $7000 from a client for future services. The work was
completed to the client’s satisfaction on 10 October
2012. The surveyor uses accrual accounting.
What is the journal entry made by the surveyor on 15
September 2012?
A.
B.
C.
D.
prepayments
accrued expenses
unearned revenue
all would be recorded as assets
41
A.
B.
C.
D.
Dr Cash 7000 Cr Unearned Revenue 7000
Dr Unearned Revenue 7000 Cr Cash 7000
Dr Cash 7000 Cr Surveying Revenue 7000
Dr Customer Deposits 7000 Cr Unearned Revenue 7000
42
Revision Question 3
Next Lecture…
On 15 September 2012, a surveyor received an advance
of $7000 from a client for future services. The work was
completed to the client’s satisfaction on 10 October
2012. The surveyor uses accrual accounting.
What is the journal entry made by the surveyor on 10
October 2012?
A.
B.
C.
D.
43
Dr Cash 7000
Cr Unearned Revenue 7000
Dr Accrued Revenue 7000
Cr Surveying Revenue 7000
Dr Unearned Revenue 7000 Cr Surveying Revenue 7000
Dr Surveying Revenue 7000 Cr Unearned Revenue 7000
• Accrual adjustments continued (bad debts)
• Internal control and cash
44
11
ACCT1501 Accounting and Financial Management 1A
Session 1 2015
Week 5
Accrual Accounting Adjustments
Student Handout
Lecturer:
Jeffrey Knapp
School of Accounting
UNSW
QUAD 3103
[email protected]
Moodle: https://moodle.telt.unsw.edu.au/login/index.php
ACCT 1501 Session 1, 2015
WEEK 5: Accrual Accounting Adjustments
1.
Lecturer comments
Accrual accounting exists to provide timely information about the financial affairs of
organisations to users or stakeholders for their economic decision-making. In financial
accounting, the focus is on providing useful information to external stakeholders such as
shareholders and creditors.
The financial affairs of organisations involve financial position, financial performance,
changes in equity and cash flows. The balance sheet addresses financial position by showing
the economic resources under the organisations control (assets) and its financial and other
obligations (liabilities). The balance sheet captures the fundamental equation (A – L = OE)
and it is the driving force in accrual accounting. The need at regular intervals – at the end of
each accounting period – to determine the assets and liabilities of the enterprise is at the heart
of accrual accounting and accrual adjustments. In the business world, analysts and investors
tend to focus on financial performance for the accounting period, that is, profit or earnings.
The profit is the income less expenses for the period. Income equals revenue plus gains. The
income statement shows the revenues for the period less the expenses incurred in generating
those revenues – this is referred to as the matching principle.
Accrual accounting is superior to cash flow information to assess the financial position and
financial performance of an enterprise. Cash flow information only records the financial
effects of transactions and events on the cash balance. In contrast, accrual accounting records
the financial effects of all transactions and events that affect economic resources or
obligations of the enterprise. Consider this simple example. Assume a company sold land
that had cost $1m in return for new land valued at $5m. This transaction would not be
recorded in cash accounting. In accrual accounting we would recognise the new land as an
asset in the balance sheet $5m and we would recognise a gain of $4m in the income statement.
Keeping track of cash flow is important for business success, but it is not enough. We have to
go beyond cash flow to assess economic performance more broadly and to assess non-cash
resources and obligations. In accrual accounting, we make estimates, judgements and other
accounting choices that make the financial information more subjective than transactionbased cash flow figures. Accrual accounting information therefore tends to be more relevant
to users economic decision-making than cash-based information but less reliable.
This week, adjusting entries are the key concept. Adjusting entries are the steps required to
ensure the accounts represent the assets, liabilities, revenues and expenses once we get to the
end of the accounting period. For reasons of convenience, we don’t record a wages expense
for every hour (or minute, or second, or millisecond). But at the end of the accounting
period, we must ensure that any wages owing (liability) is recorded together with the related
wages expense for the period. When preparing the financial statements for the accounting
period, we want to ensure that all assets, liabilities, revenues and expenses are recognised and
measured. To make sure this happen, we have to adjust the accounts.
This week we also consider closing entries. Only the account balances for assets, liabilities
and equity carry forward from one accounting period to the next. The accounts for revenues
and expenses must be closed at the end of the accounting period to determine the profit for
the period. An income summary account is used to facilitate this process. The profit for the
period is then transferred to the equity account of retained profits.
ACCT 1501 Session 1, 2015
2
Learning objectives
At the end of this topic you should be able to:
Explain how the timing of revenue and expense recognition differs from cash inflows
and outflows.
Prepare journal entries for accrual accounting adjustments.
Understand contra accounts and the impact on the financial statements.
Understand and perform the closing process.
Required Reading
Trotman, Gibbins & Carson
Chapter 4:pages 174-177
Trotman, Gibbins & Carson
Chapter 5:pages 201-242
(Note from lecturer. Please read all the learning objectives for chapter 5 on page 201 of
the textbook. These learning objectives are covered during my 4 week lecturing period.)
2.
Tutorial Questions – Due in Week 6
Preparation Questions:
Students should review the following preparation questions using the solutions available from
Moodle.
Discussion Questions DQ 5.2, DQ 5.4, DQ 5.13
Problems P5.4, P5.6, P5.18, P5.20, P5.23
Case 5A
Tutorial Questions:
Students should attempt the following tutorial questions before class.
Discussion Questions DQ 5.10, DQ5.19
Problems P5.7, P5.9, P5.13
ACCT 1501 Session 1, 2015
3
27/03/2015
Topic 5: Learning Objectives (LO)
ACCT1501
Semester 1, 2015
At the end of Topic 5, you should be able to:
LO1: Explain how the timing of revenue and expense recognition
differs from cash inflows and outflows (the accrual concept)
LO2: Prepare journal entries for accrual accounting adjustments (the
adjusting entries)
LO3: Understand contra accounts and the impact on the financial
statements
LO4: Understand and perform the closing process
Week 5
Accrual Accounting Adjustments
Essential reading for Week 5
Jeffrey Knapp
Quad 3103
Trotman, Gibbins & Carson Chapter 4 pp. 174-177
Trotman, Gibbins & Carson Chapter 5 pp. 201-242
2
Recap: Cash and accrual accounting
Accrual accounting records:
Revenues when they are earned, not received.
Expenses when they are incurred, not paid.
E.g.
Remember, cash accounting records revenues and
expenses when…
3
E.g.
E.g.
LO1
Often a timing difference between the significant
economic event (earning revenue/incurring expense) and
related cash flow
Some items that have no cash flow effect.
Accrual accounting
LO1
provide a more complete picture of economic performance,
particularly in the short term
Does not imply that the payment or receipt of cash are
unimportant events
the lifeblood of business
cash is received or paid.
4
1
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Revenue expense and recognition
Revenue recognition
LO1
Let’s review the differences in how revenue and expense
are recognised under an accrual versus cash system.
LO1
1. Recognition of revenue (resource inflow) at the same time
as cash inflow.
E.g. Sale to customer for cash.
Cash entry:
Dr Cash (+A)
Cr Sales (+R)
Accrual entry:
Dr Cash (+A)
Cr Sales (+R)
Note: both entries are the same.
5
6
Revenue recognition
Revenue recognition
LO1
2. Recognition of revenue (resource inflow) prior to cash
inflow
3. Recognition of revenue (resource inflow) after cash inflow.
E.g. Sale to customer on credit.
Cash entry:
Nothing
Accrual entry:
Dr Accounts receivable (+A)
Cr Sales (+R)
LO1
E.g. Receipt of subscription fees in advance.
Cash entry:
Dr Cash (+A)
Cr Sales (+R)
Accrual entry:
Dr Cash (+A)
Cr Unearned revenue (+L)
Note : the cash entry overstates sales.
Note : the cash entry understates sales.
7
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Expense recognition
1. Recognition of expense (resource outflow) at the same
time as cash outflow.
Expense recognition
LO1
2. Recognition of expense (resource outflow) prior to cash
outflow
E.g. Payment of wages.
Cash entry:
Dr Wages expense (+E)
Cr Cash (-A)
Accrual entry:
Dr Wages expense (+E)
Cr Cash (-A)
Note: both entries are the same.
LO1
E.g. wages owing at year end
Cash entry:
Nothing
Accrual entry:
Dr Wages expense (+E)
Cr Wages payable (+L)
Note: the cash entry understates expenses.
9
10
Expense recognition
3. Recognition of expense (resource outflow) after cash
outflow
Summary: Cash versus accrual profit
LO1
E.g. Payment of insurance for the next 24-month period.
Cash entry:
Dr Insurance Expense (+E)
Cr Cash (-A)
Accrual entry:
Dr Prepaid insurance (+A)
Cr Cash (-A)
LO1
The earning of a revenue is not necessarily accompanied
by an inflow of cash in the same period.
The incurrence of an expense is not necessarily
accompanied by an outflow of cash in the same period.
Accrual profit is not the same as cash profit.
Note : the cash entry overstates expenses.
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Accrual accounting adjustments
LO2
Accrual accounting adjustments
Adjusting entries are entries necessary at the end of the
accounting period to measure all revenues and expenses
of that period.
Types:
1.Deferrals-related
1.1 Revenue adjustment: Unearned revenue
Year End
Deferrals
1.1.Unearned revenue
Cash received
before earned Revenue earned over time
...
t-1
t
#1
#2
Expense incurred over time
Cash paid
before incurred
1.2.Prepayment
1.2. Expense adjustment: Prepayment
2. Accruals-related
2.1. Revenue adjustment: Accrued revenues
2.2. Expense adjustment: Accrued expenses
3. Valuation-related: Book value adjustments: Contra accounts
LO2
Accruals
2.1.Accrued revenue
Cash received
after earned
t+1
#1
Cash paid
after incurred
2.2. Accrued expense
Each involves two entries:
#1 One for the cash receipt or payment
#2 One for recording the revenue or expense in the proper period (Adjusting entries)
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1.1. Unearned revenue
Cash received in advance of earning revenue.
1.1. Unearned revenue – An example
LO2
LO2
On 31 May, a company received $1200 for the service to be provided in the future
Liability – goods or services are owing to others
31 May Dr Cash (A)
31 May 1 Jun
Period end
30 Jun
$1,200
Cr Unearned revenue (L)
$1,200
Examples:
insurance premiums
magazine subscriptions
rent received in advance
Qantas, Telstra
$100 of services provided
...
30 Jun Dr Unearned revenue (L)
Cr Revenue (R)
15
$100
$100
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1.2. Prepayments
Cash paid in advance of incurring expense
1.2 Prepayments – Example 1
LO2
On 31 May, a company purchased office supplies of $1000.
Assets – future economic benefit
current or non-current asset?
31 May Dr Office supplies (A) $1,000
Cr Cash (A)
31 May 1 Jun
Examples:
LO2
Period end
30 Jun
$1,000
...
At 30 June, $300 of the office supplies remained
i.e. $700 had been consumed.
prepaid insurance
prepaid rent
office supplies
30 Jun Dr Office supplies expense (E)
$700
Cr Office supplies (A)
17
$700
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1.2 Prepayments – Example 2
1.2 Prepayments – Example 2
LO2
On 1 May 2012, a company pays $1200 for a one-year
1 May Dr Prepaid rent (A)
rent. Financial year ended date is 30 June 2012.
$1,200
Cr Cash (A)
What journal entries will the company make on 1 May
LO2
$1,200
Period end
30 Jun
1 May
...
2012 and 30 June 2012?
2-month rent has been used up
=$1,200/12 ×2 = $200
30 Jun Dr Rent expense (E)
Cr Prepaid rent (A)
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$200
$200
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1.2 Prepayments – Example 3
2.1. Accrued revenue
LO2
Opening balance prepaid rent $3000
Revenue has been earned but cash will not be received
until the following period.
Closing balance prepaid rent: $4000
Rent expense:
c/d
Cash
Receivables, assets
$5000
Examples:
What was the cash paid for rent during the year?
Dr. Prepaid rent
Cr. Cash
LO2
Prepaid rent
(A)
$3000 Rent exp.
$6000 c/d
Dr. Rent exp.
Cr. Prepaid rent
$5000
$4000
commissions earned but not received
interest earned but not received.
Telstra, Sydney water
$3,000+X-5,000=$4,000
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2.1 Accrued revenue – An example
2.1 Accrued revenue – An example
LO2
Orange company deposited $300 000 with a bank at 10
per cent per annum and interest is paid on 1 March
every year and the next payment of interest will be
received on 1 March 2013.
30 Jun
1 Mar, 2012
Financial year ended date is 30 June 2012.
Dr Interest receivable (A)
Cr Interest revenue (R)
...
$10 000
$10 000
Period end 30 June, 2012
...
$10 000 interest
has been earned
What journal entries will the company make on 30 June
2012 and 1 March 2013?
LO2
1 Mar, 2013
$20 000 interest
has been earned
(=$300,000×10%×4/12)
(=$300,000×10%×8/12)
1 Mar
Dr Cash (A)
$30 000
Cr Interest receivable (A)
Cr Interest revenue (R)
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$10 000
$20 000
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2.2. Accrued expense
Expense has been incurred but cash will not be paid until
the following period
Payables, liability
Examples:
2.2 Accrued expense – An example
LO2
A firm pays weekly wages of $50 000 each Friday (25 June,
2 July).
Financial year ended date is 30 June, 2012 (Wednesday).
What journal entries will the firm make on 30 June 2012
and 2 July 2012?
wages earned by employees but not paid after end of
financial period
interest payable on outstanding loan.
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2.2 Accrued expense – An example
25 June Dr Wages expense (E)
Cr Cash (A)
25 June, 2012
Friday
...
30 Jun
3. Contra accounts
LO2
$50 000
Period end 30 June, 2012
Wednesday
...
2 July, 2012
Friday
$30 000
$30 000
2 July
Dr Wages expense (E)
Dr Wages payable (L)
Cr Cash (A)
is paired with and follows its related account
Its normal balance (debit or credit) is the opposite of the
balance of the related account
Examples:
2 days’ wages
incurred
Dr Wages expense (E)
Cr Wages payable (L)
LO3
A contra account
$50 000
3 days’ wages
incurred but not paid
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LO2
Accounts receivable → Allowance for doubtful debts (ADD)
Property, plant and equipment → Accumulated depreciation
Intangibles → Accumulated amortisation
Inventory → Provision for obsolescence.
$20 000
$30 000
$50 000
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3. Contra accounts – Why are they useful?
Allow users to ascertain:
Accounts receivable → Allowance for doubtful debts (ADD)
level of doubtful debts (and changes therein), collection policies and
problems
Property, plant and equipment → Accumulated depreciation
Intangibles → Accumulated amortisation
Inventory → Provision for obsolescence.
Accumulated depreciation (a contra asset account, B/S)
shows all depreciation charged against an asset to date.
likely life of intangibles
Depreciation expense (I/S) shows only this year’s
depreciation allocation.
levels of slow-moving, out-of-date stock, efficiency of stock
management.
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3. Contra account – An example
Comprehensive class example
LO3
Asset costs $100 000 with a life of 5 years and no estimated
salvage value. Straight line depreciation each year:
Dr Depreciation expense
Cr Accumulated depreciation
After 3 years, book value is:
Asset
Accumulated depreciation
Book value
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LO3
Allocation of the cost of a noncurrent asset to expense
over the life of an asset
To recognise the consumption of the asset’s economic
value.
likely ages of assets and future cash outflows for purchases of new
assets
3. Contra account – Depreciation
LO3
LO2,
3&4
The following information relating to adjusting
entries is available at the end of June 2013
$20 000
$20 000
Transactions 9-13.
$100 000
($60 000)
$40 000
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Comprehensive class example
Comprehensive class example
LO2
Transaction 9:
A physical count showed supplies costing $180 on hand
at 30 June 2013.
Opening Balance
Accounts Payable
Opening Balance
Transaction 10:
Accrued interest on the bank loan is $240.
Supplies
A4
210 Supplies expense ?
340
$550
Closing Balance
Interest Expense
Interest Payable
180
$550
180
Supplies Expense
Supplies
Dr
370
E3
A4
LO2
E6
L2
Dr
240
Cr
240
Cr
370
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Comprehensive class example
Transaction 11:
Insurance costing $820 expired during the year.
Insurance Expense
Prepaid Insurance
E4
A3
Comprehensive class example
LO2
Dr
820
Transaction 12:
Depreciation on the vehicle is $5 350.
Cr
820
LO2
&3
Depreciation Expense – MV
Accumulated Depreciation – MV
Dr
Cr
E2
5,350
A5.1
5,350
Remember, in Transaction 6. insurance on vehicle, paid in
advance was $840
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Comprehensive class example
LO2
Comprehensive class example –
Closing entries for revenue accounts
Dr
Transaction 13:
The June telephone account for $180 has not been paid or
recorded.
Dr
Cr
Telephone Expense
E5
180
Telephone Expense Payable
L4
180
Piano Tuning Fees (-R)
28,600
Piano Repair Fees (-R)
P&L Summary
24,380
52,980
Piano tuning fees
R1
Piano repair fees
R2
$23 940
Cash
$16 800
A/R
$4 660
A/R
$7 580
Bal.
$28 660
Bal.
$24 380
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Comprehensive class example –
Closing entries for expense accounts
Comprehensive class example –
Closing entries for P&L summary account
LO4
Dr
P&L Summary
Petrol and Oil (-E)
Depreciation Expense (-E)
Supplies Expense (-E)
Insurance Expense (-E)
Telephone Expense (-E)
Interest Expense (-E)
Cr
LO4
Profit & Loss Summary
12,300
Closing ent (2) 12,300 Closing ent (1) 52,980
2,680
5,350
370
820
2,420
660
Retained Profits 40,680
$2 680
Bal.
$2 680
Cr
40,680
Retained Profits
Petrol and oil expense E1
Cash
Dr
40,680
P&L Summary
Retained Profits (+SE)
Before closing,
39
Cr
Before closing,
Cash
37
LO4
c/d
41,234
b/d
554
P&L Summary 40,680
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Revision Question 1
Revision Question 2
Which of the following would be recorded as an asset?
On 15 September 2012, a surveyor received an advance
of $7000 from a client for future services. The work was
completed to the client’s satisfaction on 10 October
2012. The surveyor uses accrual accounting.
What is the journal entry made by the surveyor on 15
September 2012?
A.
B.
C.
D.
prepayments
accrued expenses
unearned revenue
all would be recorded as assets
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A.
B.
C.
D.
Dr Cash 7000 Cr Unearned Revenue 7000
Dr Unearned Revenue 7000 Cr Cash 7000
Dr Cash 7000 Cr Surveying Revenue 7000
Dr Customer Deposits 7000 Cr Unearned Revenue 7000
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Revision Question 3
Next Lecture…
On 15 September 2012, a surveyor received an advance
of $7000 from a client for future services. The work was
completed to the client’s satisfaction on 10 October
2012. The surveyor uses accrual accounting.
What is the journal entry made by the surveyor on 10
October 2012?
A.
B.
C.
D.
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Dr Cash 7000
Cr Unearned Revenue 7000
Dr Accrued Revenue 7000
Cr Surveying Revenue 7000
Dr Unearned Revenue 7000 Cr Surveying Revenue 7000
Dr Surveying Revenue 7000 Cr Unearned Revenue 7000
• Accrual adjustments continued (bad debts)
• Internal control and cash
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