1. Chapter 7 End-of-period Adjustments
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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2. Chapter 7 Overview 7.1 Accrual accounting 7.2 Adjusting entries
7.3 Sale of assets
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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3. Chapter 7 Objectives Understand accrual accounting
Explain the need for adjusting entries
Complete the steps in the accounting cycle to post all transactions to ledgers
Explain the terms ‘prepayment’ and ‘accrual’
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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4. Chapter 7 Objectives Explain the purpose of reversing entries
Describe how to account for bad debts
Explain the nature of depreciation
Calculate depreciation using various methods
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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5. Chapter 7 Objectives Record the sale of non-current assets
Prepare worksheets for report preparation
Prepare financial statements
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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6. Introduction This chapter introduces:
Bookkeeping at the end of the period
Issues that arise because transactions do not fall neatly into various time periods
The effects of recording transactions rather than cash
accrual accounting
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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7. 7.1 Accrual accounting
Accrual accounting is the recording of economic events or transactions which is different to cash accounting (recording cash transfers)
Events are accounted for in blocks of time called accounting periods
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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8. 7.1 Accrual accounting
Some events cross over these periods and create the need for adjustments
WHY is this important?
So that only the relevant portion of revenue and expenses relating to the period are recorded
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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9. 7.1 Accrual accounting Examples Accrual accounting records the event
A product is advertised (expense) on credit but not paid until the next accounting period
A sale is made (revenue) but no cash is received until the next accounting period
Cash for rent is received in advance before revenue has been earned (liability)
Cash for rent is paid in advance (asset)
Accrual accounting records the event
Cash accounting records the cash transfer
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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10. Enhanced recording system
7.1 Accrual accounting
Enhanced recording system
1. Transaction occurs
2. Record in General Journal
3. Post to the Ledger
4. Prepare the Trial Balance
5. End-of-Period Adjustments
6. Prepare Financial Statements
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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11. 7.2 Adjusting entries There are 7 types of adjustment
1. Prepaid expenses (asset)
2. Unpaid expenses (liability)
3. Unearned revenue (liability)
4. Uncollected revenue (revenue)
5. Supplies (asset)
6. Bad and doubtful debts (expense)
7. Depreciation (expense)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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12. 7.2 Adjusting entries 1. PREPAYMENTS
Expenses that have been paid but not incurred
Initial transaction (payment) is recorded as an expense, but at the end of a period not all ‘future benefits’ have been consumed
The consumed part stays as an expense
The unconsumed part (future benefit) must be adjusted and recorded as an asset
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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13. 7.2 Adjusting entries 1. PREPAYMENTS—Examples Rent paid in advance
Insurance paid in advance
Wages paid in advance
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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14. 7.2 Adjusting entries 1. PREPAYMENTS
Record this transaction as an expense
What happens at 30/6/X4?
EXAMPLE 7.1
1/1/X4 Pay $1200 rent for next 12 months
Copyright  2004 McGraw-Hill Australia Pty Ltd.
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15. 7.2 Adjusting entries 1. PREPAYMENTS EXAMPLE 7.1
Consumed = 6 months of rent = $600
Unconsumed = 6 months of rent = $600
So: $600 should be an expense
$600 should be an asset
Need to adjust the Rent Expense account to reflect this
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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16. 7.2 Adjusting entries 1. PREPAYMENTS Date Accounts Debit Credit
1/1/X4 Rent Expense 1200
Cash
(original entry)
30/6/X4 Prepaid Rent 600
Rent expense
(adjusting entry)
1/7/X4 Rent Expense 600
Prepaid Rent
(reversing entry)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
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17. 7.2 Adjusting entries 2. ACCRUED (unpaid) EXPENSES
Expenses incurred but not paid
Two accounts are adjusted to record the accrued (unpaid) component at the end of the period
Add accrued amount to the expense account
Create a liability for the accrued amount
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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18. 7.2 Adjusting entries 2. ACCRUED (unpaid) EXPENSES Required:
Adjust the Wages Expense account to include the $1000
Create an Accrued Wages account (Liability) for $1000
EXAMPLE 7.2
A business has paid wages of $ but it
also owes another $1000 for work done
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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19. 7.2 Adjusting entries 2. ACCRUED (unpaid) EXPENSES
Date Accounts Debit Credit
During Wages Expense
Year Cash
(original entry)
30/6/X4 Wages Expense
Accrued Wages
(adjusting entry)
1/7/X4 Accrued Wages
Wages Expense
(reversing entry)
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20. 7.2 Adjusting entries 3. UNEARNED REVENUE
Revenue received in advance and not earned before the end of the period
This unearned component of the revenue at balance day becomes a liability as there will be some future sacrifice to the firm
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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21. 7.2 Adjusting entries 3. UNEARNED REVENUE Required: EXAMPLE 7.3
adjust the Revenue account from $2000 to $400
create a Liability account for $1600
EXAMPLE 7.3
Receive $2000 on 1/5/X4 in advance for services
At 30/6/X4, 20% of services are performed
Revenue = $ 400
Liability = $1600
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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22. 7.2 Adjusting entries 3. UNEARNED REVENUE Date Accounts Debit Credit
1/5/X4 Cash
Services Revenue
(original entry)
30/6/X4 Services Revenue 1600
Unearned Revenue
(adjusting entry)
1/7/X4 Unearned Revenue 1600
Services Revenue
(reversing entry)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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23. 7.2 Adjusting entries 4. UNCOLLECTED REVENUE
The services or the goods have been provided and the revenue has been earned but payment is still to be received
Similar to ‘accounts receivable’
Copyright  2004 McGraw-Hill Australia Pty Ltd.
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24. 7.2 Adjusting entries 4. UNCOLLECTED REVENUE Required: EXAMPLE 7.4
Increase an asset and revenue by $3000
EXAMPLE 7.4
On 30/6/X4, a business has yet to record $3000 of
services it has provided on credit
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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25. 7.2 Adjusting entries 4. UNCOLLECTED REVENUE EXAMPLE 7.4
Date Accounts Debit Credit
30/6/X4 Revenue Receivable 3000
Service Revenue
(adjusting entry)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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26. 7.2 Adjusting entries 5. SUPPLIES
Usually, the supplies account at the end of a period is different from at the start
An adjusting entry is required to reconcile the difference between the accounting records and physical supplies on hand
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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27. 7.2 Adjusting entries 5. SUPPLIES EXAMPLE 7.5
Supplies opening balance = $800
Purchases during the year = $500
End of year stocktake finds $400
The amount used = ?
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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28. 7.2 Adjusting entries 5. SUPPLIES EXAMPLE 7.5
Date Accounts Debit Credit
30/6/X4 Supplies Expense
Supplies Inventory
(adjusting entry)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
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29. 7.2 Adjusting entries 6. BAD AND DOUBTFUL DEBTS
Revenue is sometimes never received
Accrual accounting recognises revenue when it is earned, and it may be several periods before it becomes apparent that cash will not be received
This will cause profit to be overstated
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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30. 7.2 Adjusting entries 6. BAD AND DOUBTFUL DEBTS
To avoid overstating profit we need to recognise bad and doubtful debts
How do we know which debts will be bad?
Use a percentage of Accounts Receivable
Look at the previous year(s) bad debt levels
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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31. 7.2 Adjusting entries 6. BAD AND DOUBTFUL DEBTS EXAMPLE 7.6
Accounts Receivable is $2000
Estimate that collection of 5% of this is doubtful
Need $100 as doubtful in an expense account and
reduce the accounts receivable by same
However, as they are doubtful, do not credit the
accounts receivable account. Introduce a contra
account known as Allowance for doubtful debts
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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32. 7.2 Adjusting entries 6. BAD AND DOUBTFUL DEBTS EXAMPLE 7.6
Date Accounts Debit Credit
30/6/X4 Bad and doubtful debts
Allowance for doubtful debts
(adjusting entry)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
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33. 7.2 Adjusting entries 6. BAD AND DOUBTFUL DEBTS
The Allowance for doubtful debts account is deducted from Accounts receivable to show the amount expected to be realised
Note: there is no reversing entry
Balance sheet extract
Accounts receivable
Less allowance for doubtful debts
1900
Copyright  2004 McGraw-Hill Australia Pty Ltd.
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34. 7.2 Adjusting entries 6. BAD AND DOUBTFUL DEBTS
When the doubtful debt does become bad:
Accounts Debit Credit
Allowance for doubtful debts
Accounts Receivable
(Writing off bad debts)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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35. 7.2 Adjusting entries 7. DEPRECIATION
The process of allocation of the cost of an asset over its estimated useful life
(IAS 4—para4)
Similar and opposite concept to prepayments as here we have an asset that is partly consumed, and so a portion of it must be expensed
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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36. 7.2 Adjusting entries 7. DEPRECIATION
3 main methods of depreciation are
1. Straight-line method
2. Reducing-balance method
3. Units-of-use method
Copyright  2004 McGraw-Hill Australia Pty Ltd.
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37. 7.2 Adjusting entries Straight-line method
7. DEPRECIATION
Assumes asset derives equal benefits each year
Amount depreciated is the same each year
Straight-line method
Annual depreciation = cost – residual value
estimated life
Copyright  2004 McGraw-Hill Australia Pty Ltd.
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38. 7.2 Adjusting entries 7. DEPRECIATION EXAMPLE 7.7 Asset cost = $50 000
Residual value after 5 years = $10 000
Depreciation = – = $8000 p.a.
5 years
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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39. 7.2 Adjusting entries Reducing-balance method
7. DEPRECIATION
Assumes asset derives more benefits earlier in its life
Amount depreciated is greater at the start
Reducing-balance method
Depreciation = x % of written-down value
Copyright  2004 McGraw-Hill Australia Pty Ltd.
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40. 7.2 Adjusting entries 7. DEPRECIATION EXAMPLE 7.8 Asset cost = $50 000
Rate of reduction = 30%
Depreciation: Year 1 = × 30% = $15 000
Year 2 = × 30% = $10 500
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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41. 7.2 Adjusting entries Units-of-use method
7. DEPRECIATION
Assumes asset use indicates benefits consumed
Amount expensed is based on amount used
Units-of-use method
Depreciation = (cost – residual) × units used
total units
Copyright  2004 McGraw-Hill Australia Pty Ltd.
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42. 7.2 Adjusting entries 7. DEPRECIATION EXAMPLE 7.9
Asset cost (motor vehicle) = $50 000
Residual value after km = $10 000
Year 1 = 2300 km
Depreciation:
( – ) × km = $9200 km
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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43. 7.2 Adjusting entries
To record depreciation we must have an expense account called ‘Depreciation’
Instead of reducing the asset account directly with a credit, we use a contra account ‘Accumulated depreciation’
This is similar to how we treat Accounts Receivable and the Allowance for Doubtful Debts
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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44. 7.2 Adjusting entries 7. DEPRECIATION Date Accounts Debit Credit
30/6/X4 Depreciation Expense
Accumulated Depreciation
(adjusting entry)
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45. 7.2 Adjusting entries
7. DEPRECIATION
Subtract the contra account from the asset account to obtain the ‘written-down value’ or ‘book value’
Balance sheet extract
Asset
Less accumulated depreciation
Written-down value (book value)
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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46. 7.3 Sale of assets
When a non-current asset is sold, the asset and its accumulated depreciation are removed from the ledger
The following steps are required:
1. Close the proceeds of sale to a sale of asset account
2. Close asset account to the same account
3. Close accumulated depreciation to the same account
4. Close balancing figure to profit or loss account
Copyright  2004 McGraw-Hill Australia Pty Ltd.
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47. 7.3 Sale of assets EXAMPLE 7.10 Sold an asset for $4700
Original cost was $36 000
Accumulated Depreciation was $30 000
Therefore, loss on the sale was $1300
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
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48. 7.3 Sale of assets EXAMPLE 7.10 Accounts Debit Credit
1 Cash at Bank
Sale of Asset
2 Sale of Asset
Asset
3 Accumulated Depreciation
Sale of Asset
4 Loss on Sale
Sale of Equipment
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PPTs t/a Accounting by Jackling et al
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49. Summary
Accrual accounting means adjustments are needed at end of a period
Adjustments relate to apportioning the appropriate amount of assets and expenses, revenues and liabilities
Copyright  2004 McGraw-Hill Australia Pty Ltd.
PPTs t/a Accounting by Jackling et al
Prepared by Courtney Clowes