Acc week 7

transcript

TOPIC 7

PRINCIPLES OF INTERNAL CHECKS

In Your Textbook...

Roshayani Arshad, et al. (2007), Financial Accounting An Introduction, 2nd Edition, Malaysia, McGraw Hill.

• Chapter 7: Adjusting Entries and the Preparation of Financial Statements (pp. 100 – 114)

• Chapter 12: Receivables (pp. 217 – 230)

Learning Objectives

• At the end of the topic, you should able to:- Distinguish between cash basis and accrual basis.- Explain why adjusting entries are needed.- Identify the major type of adjusting entry.- Prepare a worksheet incorporating the adjusting entries.

Accounting Period

Matching Principle

Accrual Concept

The need to prepare periodic financial

reports.

Expense & revenue have to be assigned

and matched to periods of time.

Underlying Concepts

Revenue reported when earnedRevenue reported when earnedExpense reported when Expense reported when

incurred (used)incurred (used)Cash receipts/payment Cash receipts/payment

irrelevantirrelevant

1 2 3 4

Annual

Monthly

Quarterly

Semiannual

The Accounting Period

1 2 3 4 5 6 7 8 9 10 11 12

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Matching Principle

• Sunny Company bought RM24,000 yearly motor vehicle insurance from August 2007 to July 2008. What should the company expense into the income statement from 1st January to 31st December 2007 ?

1 2 3 4 5 6 7 8 9 10 11 12

5 months

7 months

According Matching Principle:

Expenses incurred must match with the accounting period. Since the accounting year ended for Sunny Company was on 31 December, it should record the insurance expenses for only 5 months :

RM 24,000 x 5/12 = RM 10,000

Accrual Basis vs. Cash Basis

Accrual Basis

Revenues are recognized when

earned and expenses are recognized when

incurred.

Cash Basis

Revenues are recognized when

cash is received and expenses recorded when cash is paid.

Not GAAPNot GAAPNot GAAPNot GAAP

Accrual Basis vs. Cash Basis

On the cash basis the entire RM2,400 would be recognized as insurance expense in 2006. No insurance expense from this policy would be recognized in 2007 or

2008, periods covered by the policy.

On the cash basis the entire RM2,400 would be recognized as insurance expense in 2006. No insurance expense from this policy would be recognized in 2007 or

2008, periods covered by the policy.

RM 2,400

Jan Feb Mar Apr May Jun Jul Sep Oct Nov DecAug

RM 100

2008RM 100

RM 100

On the accrual basis RM100 of insurance expense is recognized in

2006, RM1,200 in 2007, and RM1,100 in 2008. The expense is

matched with the periods benefited by the insurance

coverage.

On the accrual basis RM100 of insurance expense is recognized in

2006, RM1,200 in 2007, and RM1,100 in 2008. The expense is

matched with the periods benefited by the insurance

coverage.

AdjustmentsAdjustments

An adjusting entry is recorded to bring an asset or liability account balance to its proper amount.

Adjusting Accounts

Paid (or received) cash before expense (or revenue) recognizedPaid (or received) cash before

expense (or revenue) recognizedPaid (or received) cash after

expense (or revenue) recognized

Prepaid (Deferred) expenses*

Unearned (Deferred) revenues

AccruedexpenseAccruedexpense

AccruedrevenuesAccruedrevenues

Framework for Adjustments

This is the checkfor my first

6 months’ insurance.

This is the checkfor my first

6 months’ insurance.

Adjusting Prepaid (Deferred) Expenses

Resources paid for prior to receiving the actual benefits.

A current asset item.

Resources paid for prior to receiving the actual benefits.

A current asset item.

Suria Sdn. Bhd.TRIAL BALANCE

as at 31 DECEMBER 2006

Prepaid Insurance

Suria Sdn. Bhd. practiced to close the accounts on 31 December for every year. On 1 December 2006, Suria Company paid RM12,000 to cover insurance for December 2006 through May 2007. The accountant recorded the expenditure as Prepaid Insurance on 1 December. What adjustment is required?

128Jan Feb Mar Apr May Jun Jul Sep Oct Nov DecAug

RM 12,000

Insurance expired for 1 month

31/12(year end )

Example

Insurance Expense

31/12 2,000

Prepaid Insurance

31/12 2,000

Adjusting for Prepaid

Dec. 31 Insurance Expense 2,000 Prepaid Insurance 2,000

To record first month's expired insurance

1/12 12,000

12,000 12,000

31/12 Bal 10,000

31/12 P&L 2,000

Insurance expired for 1 month = Recognized insurance expense for 1 month

1 month = RM12,000 / 6

= RM 2,000

Adjusting Unearned (Deferred) Revenues

-Cash received in advance of providing products or services.

-A current liability item.

-Cash received in advance of providing products or services.

-A current liability item.

On 1 October 2006, Suria Sdn. Bhd. received cheque RM 20,000 for services to be provide in next five months.

Oct. 1 Bank 20,000 Unearned Revenue 20,000

Revenue received in advance

Example

Adjusting Unearned (Deferred) Revenues

1/10/06 31/12/06Year end

28/02/07

5 months

Services already performed for 3 months

Service performed for 3 months = Recognized service revenue for 3 months

3 month = RM20,000 x 3/ 5

= RM 12,000

Service revenue

31/12 12,000

Unearned revenue

1/10 20,00031/10 12,000

20,000 20,000

31/12 Bal 8,000

31/10 P&L 12,000

Oct. 31 Unearned revenue 12,000 Service revenue 12,000

To record service performed

- Costs incurred in a period that are both unpaid and unrecorded.- A current liability item.

Adjusting for Accrued Expenses

The telephone bill for December 2006 haven’t pay. When should I record it?

On 3 January 2007, Suria Sdn. Bhd. paid RM 300 for its December telephone bill.

1/12/06 31/12/06Year end

3/01/07

December Bill : RM300 Paid

Example

Dec. 31 Telephone Expense 300 Telephone Payable 300

To accrue telephone bill

Telephone Expense

31/12 300

Telephone payable31/12 300

Adjusting Accrued Revenues

- Revenues earned in a period that are both unrecorded and not yet received.- A current asset item.

Suria Sdn. Bhd. had RM31,200 of services completed but not yet billed to clients. Let’s make the adjusting entry necessary on 31 December 2006.

Example

Adjusting for Accrued Revenues

Dec. 31 Accounts Receivable 31,200 Service Revenue 31,200

To accrue revenue earned

Accounts receivable

31/12 31,200

Service revenue

31/12 31,200

Straight-LineDepreciationExpense

= Asset Cost - Salvage Value

Useful Life

Adjusting for Depreciation

Depreciation is the process of computing expense from allocating the cost of plant and equipment over their expected useful lives.

Adjusting for DepreciationOn 1 January 2006, Suria Sdn. Bhd. purchased equipment for RM60,000 cash. The equipment

has an estimated useful life of 5 years. Salvage value for the equipment is RM2,000.

Let’s record depreciation expense for the year ended 31 December 2006.

2006Depreciation

Expense= RM60,000 - RM2,000

5= RM11,600

Depreciation Expense

31/12 11,600

Accumulated Depreciation31/12 11,600

Adjusting for DepreciationDec. 31 Depreciation Expense 11,600

Accumulated Depreciation - Equipment 11,600 To record equipment depreciation

Adjusting for Depreciation

Equipment is shown net of accumulated depreciation.

SourceDocuments

Journal

LedgerTrial BalanceAdjustments

AdjustedTrial Balance

Financial Statements

Closing Entries

The Accounting CycleThe Accounting Cycle

First, the initial

unadjusted amounts are added to the worksheet.

First, the initial

unadjusted amounts are added to the worksheet.

Next, Suria’s adjustments are added.

31 DECEMBER 2006

SYKT MAJUTRIAL BALANCE

31 DECEMBER 2006

Finally, the totals are determined.

Lecture Exercise

Adjustments:• Telephone expense owing was RM30.• Commissions revenue received in advance amounted to

RM200.• RM600 of the insurance not yet expired.• Electricity expense owing amounted to RM100.• Interest of RM400 was earned but not yet received.• RM500 of the rent revenue was not yet earned.

Dr (RM) Cr (RM)

Telephone expense 480

Commissions revenue 4,000

Insurance expense 3,000

Electricity expense 2,000

Interest revenue 3,800

Rent revenue 6,500

Show the above adjustments in the journal and ledger.

ReceivablesBad & Doubtful Debts

Classification of ReceivablesClassification of Receivables

Accounts Receivable—used for selling merchandise or services on credit, and normally expected to be collected in a relatively short period.

Notes Receivable—used to grant credit on the basis of a formal instrument of credit, called a promissory note.

Other Receivables—include interest receivable, taxes receivable, and receivables from officers and employees.

Collectability of DebtsCollectability of Debts

Experience shows that not all amounts owing from

debtors are collected. This uncollected portion is knows as bad debts.

Experience shows that not all amounts owing from

debtors are collected. This uncollected portion is knows as bad debts.

Possible reasons may give rise to bad debts:• Debtor experiences financial difficulties• Debtor cannot be traced• Death of a debtor

Collectability of DebtsCollectability of Debts

Writing Off Bad Debts Writing Off Bad Debts Writing Off Bad Debts Writing Off Bad Debts

On May 10, D. Ross’ account was On May 10, D. Ross’ account was determined to be uncollectible. The determined to be uncollectible. The

RM420 balance is written off the books.RM420 balance is written off the books.

On May 10, D. Ross’ account was On May 10, D. Ross’ account was determined to be uncollectible. The determined to be uncollectible. The

RM420 balance is written off the books.RM420 balance is written off the books.

May 10 Bad Debts Expense 420 00

Accounts Receivable—D. Ross 420 00

To write off an uncollectible account.

Writing-off Bad DebtsWriting-off Bad DebtsEffect on Profit & LossEffect on Profit & Loss

Dr Profit & Loss A/C for the year ended 31 Dec 05 Cr

Bad debts RM420

Recovery of Bad DebtsRecovery of Bad Debts

The situation where the debtor (has previously been regarded as bad debts) unexpectedly pays his debt.

Recovery of Bad Debts Recovery of Bad Debts Recovery of Bad Debts Recovery of Bad Debts

Later, on 1 August 2005, D. Ross Later, on 1 August 2005, D. Ross unexpectedly turns up to settle his debt. unexpectedly turns up to settle his debt.

Aug 1 Cash 420 00

Recovery of Bad Debts 420 00

To recover bad debts that were written-off earlier .

Recovery of Bad DebtsRecovery of Bad DebtsEffect on Profit & LossEffect on Profit & Loss

Dr Profit & Loss a/c for the year ended 31 Dec 2005 Cr

Bad debts $500

Recovery of bad debts $500

Provision for Provision for Doubtful DebtsDoubtful Debts

• An ESTIMATE of the amount of the debt that is likely to become bad.

• Reasons for provisions:– To charge as an expense in the profit and

loss account for that year an amount representing debts that may never be paid.

– To show in the balance sheet a debtors figure as close as possible to the true value of debtors.

– The adherence to the Prudence concept.

Creating Provision for Doubtful DebtsCreating Provision for Doubtful Debts Creating Provision for Doubtful DebtsCreating Provision for Doubtful Debts

Dec. 31 Doubtful Debts Expense 4 000 00

Provision for Doubtful Debts 4 000 00

On December 31, Cynthia estimates that a total On December 31, Cynthia estimates that a total of RM4,000 of the RM105,000 balance in her of RM4,000 of the RM105,000 balance in her

company’s company’s Accounts ReceivableAccounts Receivable will eventually be uncollectible.

On December 31, Cynthia estimates that a total On December 31, Cynthia estimates that a total of RM4,000 of the RM105,000 balance in her of RM4,000 of the RM105,000 balance in her

company’s company’s Accounts ReceivableAccounts Receivable will eventually be uncollectible.

Adjusting Entry

Doubtful debts 4,000

Creating Provision for Creating Provision for Doubtful Debts Doubtful Debts

Balance Sheet as at 31 December 2004

Current Assets: $ $

Accounts Receivable 105,000

Less Provision for Doubtful Debts 4,000

101,000

Adjustment to Provision Adjustment to Provision for Doubtful Debtsfor Doubtful Debts

On 31 December 2004, Cynthia’s Trial Balance appears as follows:

Sundry debtors 135,000 (dr)Provision for Doubtful Debts 4,000 (cr)

Cynthia still maintains 4% of sundry debtors as the Provision for Doubtful Debts.

• Calculation of provisionsProvision for Doubtful Debts on 31.12.2005 (4% x $135,000) 5,400

Less: Provision for Doubtful Debts on 1.1.2005 (as per TB) 4,000

Increase in Provision for Doubtful Debts 1,400

Only the NET increase amount is being recorded in

the entries.

Only the NET increase amount is being recorded in

the entries.

Dec. 31Doubtful Debts Expense 1 400 00

Provision for Doubtful Debts 1 400 00

To increase amount of provision for doubtful debts.

Adjustment to Provision for Adjustment to Provision for Doubtful DebtsDoubtful Debts

Doubtful debts $1,400 Balance Sheet as at 31 December 2005

Current Assets: $ $

Sundry debtors 135,000

129,600

On 31 December 2005, Cynthia’s Trial Balance appears as follows:Sundry debtors 102,000 (dr)Provision for Doubtful Debts 5,400 (cr)

The trader still maintains her policy of allowing 4% of sundry debtors as doubtful debts.

• Calculation of provisionProvision for Doubtful Debts on 1.1.2006 (as per Trial Balance) 5,400

Less:Provision for Doubtful Debts on 31.12.2006 (4% x $102,000) 4,080

Decrease in Provision 1,320

Only the NET decrease amount is being recorded in

the entries.

Only the NET decrease amount is being recorded in

the entries.

Dec. 31Provision for Doubtful Debts 1 320 00

Doubtful Debts Expense 1 320 00

To decrease amount of provision for doubtful debts.

Doubtful debts $1,320

Current Assets: $ $

97,920

• Provision for Doubtful Debts are calculated AFTER all bad debts are written-off.

On Balance Day, 31 December 2006. Nathan’s Trial Balance shows the following: $

• Debtors 10,000(dr)• Bad debts 200(dr)• Provision for Doubtful Debts 150(cr)

On further checking, Nathan discovered that:a) a bad debt of RM300 has not yet been recorded in the

books.b) He needs to maintain his Provision for Doubtful Debts

at 2% of debtors as is his policy.

When Provision for Doubtful Debt When Provision for Doubtful Debt and Bad Debts Exists and Bad Debts Exists

SimultaneouslySimultaneously

Procedures to be adopted:1. Calculate the additional bad debts.2. Existing debtors less additional bad

debts = Net debtors.3. Net debtors × % of provision for

doubtful debts = prov. for doubtful debts amount.

4. Record the provision for doubtful debts.

When Provision for Doubtful Debt When Provision for Doubtful Debt and Bad Debts Exists and Bad Debts Exists

SimultaneouslySimultaneously

Example - CalculationsExample - Calculations

Provision for Doubtful Debts on 31.12.2006 (2% @ $9,700)

Less Provision for Doubtful Debts on 1.1.2006

Increase in Provision for Doubtful Debts

Calculation:Net debtors = $10,000 - $300 = $9,700

The additional bad debts, and the net increase in

doubtful debts have to be recorded.

The additional bad debts, and the net increase in

doubtful debts have to be recorded.

Dec. 31Bad Debts Expense 300 00

Debtors 300 00

Dec. 31Doubtful Debts Expense 44 00

Provision for Doubtful Debts 44 00

Effect on P&L and Effect on P&L and Balance SheetBalance Sheet

Bad debts 500

Doubtful debts 44

Current Assets: $ $

Less Provision for Doubtful Debts 194

End of Topic 7End of Topic 7

Acc week 7

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