Financial accounting (3)

transcript

CIMA C02 Fundamental of Financial Accounting

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Adjustments

In order to ascertain the fair and true results of a business for a particular

period, it is essential that all the expenses, revenues related only to that period

or year should be considered

If Financial Statement for 2011 are prepared, then the expenses and revenues

related to 2010 and 2012 should not be considered, the focus will be on 2011

incurred expenses and earned revenues

Every adjusting entry will include one income statement account and one

balance sheet account

Cash is not adjusted at the end of the accounting period, thus should not use

cash in the adjusting process

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Types of Adjustments

Others

Accruals

Before to an accrual adjustment, the expense account (and the

related liability account) or the revenue account (and the related

asset account) are understated

Thus, the adjusting entry for accruals will increase both a balance

sheet and an income statement account

Accruals fall into two categories

o Accrued Expenses

o Accrued Revenues

Accrued Expenses

Accrued Expenses or Outstanding Expenses or Expenses Payable

Expenses incurred but not yet paid or recorded are called accrued

expenses. Interest, taxes, utility bills and salaries are common

examples of accrued expenses

For example, salary for December is generally paid till the 2nd

and 3rd January next

When books of account are closed and Financial Statements are

prepared the amount of staff salary for December is treated as an

“Outstanding Salaries”.

Example # 3.1: At December 31, 2010, Company expects to pay

employees’ salaries of Rs. 8,400 as a result of work performed since

the last pay day

Accrued Revenue

Revenue earned but not yet received in cash in accounting year

Revenues earned but not yet recorded at the statement date are

accrued revenues

Accrued revenues may accumulate (accrue) with the passing of

time, as in the case of interest revenue. These are unrecorded

because the earning of interest does not involve daily transactions.

Companies do not record interest revenue on a daily basis because

it is often impractical to do so

Example # 3.2: Rs. 100,000 fixed deposits amount in bank in July 01,

2007 and contract is to earn 10% per annum at the end of contract year.

So in this case we will receive Rs. 10,000 at June 2008, but we have

earned interest of six months in this period 2007, so pass adjusted entry

Prepayments

Prepayments are also called Deferrals.

Costs or revenues that are recognized at a date later than the point

when cash was originally exchanged

Companies make adjusting entries for prepayments to record the

portion that was incurred as an expense or earned as revenue

during the current accounting period. The two types are:

Prepaid expenses/ Unexpired expenses

Unearned revenues

Prepaid Expenses

Expenses are paid in advance are called prepaid expenses or

unexpired expenses

Expenses paid in cash and recorded as assets until they are used

or consumed

Prepaid expenses are costs that expire with the passage of time (i.

e. rent and insurance) or through use (i. e. supplies)

Examples of common prepayments are insurance, supplies,

advertising, and rent.

Example 3.3: For example, on September 1, 2010 full year insurance paid of Rs. 24,000. We will utilize this expense for 12 months and we have 4 months expense for 2010 and remaining for 2011. Prepaid expenses has two case on the basis of journal entry and trial balance presentation

Case 1: Expense Method

The effect of above regular entry in end of year trial balance is presented below

So adjusting entry at December 2010 in order to adjust the balance

Case 2: Asset Method

Unearned Revenue

Income received in advance but has not been earned in accounting period is

called unearned revenue

Example # 6.8: For example, rent received for four year in January 01, 2010 of Rs.

80,000. At the end of 2010 accounting period only one year rent is recognized as

revenue and remaining liability for next accounting year

There are some items of income statement such as interest, rent, discount etc.

which might have been received in advance for which the services in full has not

been given so for

Case 1: Revenue Method

Case 2: Liability Method

Accrued …. Expenses…….. Liability…… Unrecorded expenses (expenses incurred,

but cash not yet been paid

Accrued ……… Revenue ………. Assets ….. Unrecorded revenues (revenues earned,

but cash not yet received

Prepaid………….... Expenses…………….. Assets ……………..…. Unexpired

costs or deferred

Deferred…..…………Revenue ……………..Liability ………………. Unearned

or Cash received in advance of performing services or selling goods

Irrecoverable Debts

For achieving the maximum sales, goods are often sold to known customers

on credit

Since of these customers fails to pay their debts due to insolvency or any

other factor

It should be noted here that no adjustment is required for any bad debt which

is appearing already in the Trial Balance. The bad debt appearing in the trial

balance shows as expense in the income statement only

Three procedures used in this context methods are Write-off Method,

Allowance and Recovery

Direct Write-Off

When a specific account is determined to be uncollectible, the loss is charged to

bad debts expense or Irrecoverable debt expense account

Bad debts expense will show only actual losses from uncollectible

Using the direct write-off method, entries to record write-offs are often made in

a period following sales rather than in the period in which the sales were made.

Therefore, there is no matching of expenses with the revenue Use of the direct write-off method can reduce the usefulness of both the income

statement and balance sheet

Unless bad debt losses are insignificant, the direct write-off method is not

acceptable for financial reporting purposes

Example # 3.4: Based on an analysis the bad debts expense adjustment

for the year 2008 is Rs. 1,000 for Ali and Sons

Write-Off

When a specific account is determined to be uncollectible, the loss of bed debts

is charged to allowance

This is the case where allowance already maintained and reflected in balance

Write-off against allowance is acceptable for financial reporting purposes

Under this, every bad debt write-off is debited to the allowance account (not to

Bad Debt Expense) and credited to the appropriate Account Receivable

Allowance

Allowance or Provision is liability of uncertain timing or amount

The accounting for allowance involves estimating uncollectible accounts at the

end of each period

It provides better matching of expenses and revenues on the income statement

and ensures that receivables are stated at their cash (net) realizable value on the

balance sheet

The allowance method is required for financial reporting purposes when bad

debts are material

The credit balance in the allowance account will absorb the specific write-offs

when they occur

Example # 3.5: Assume Abbottabad Furniture has credit sales of Rs. 1,200,000 in 2011, of which Rs. 200,000 remains uncollected at December 31st. The credit manager estimates that Rs. 12,000 of these sales will prove uncollectible. Pass the adjusting entry to record the allowance

Assume that the vice-president of finance on March 1, 2012, authorizes a write-off of Rs. 500 balance owed by R. A. Sons. Pass the adjusting entry to record the write-off

Recovery

When a customer pays after the account has been written off, two entries are :1. The entry made in writing off the account is reversed to reinstate the

customer’s account2. The collection is journalized in the usual manner

The recovery of a bad debt, like the write-off of a bad debt, affects only balance sheet accounts

When R. A. Sons pays Rs. 500, two journal entries are required to record the collection:

MCQ 1Rent paid on 1 October 2002 for the year to September 2003 was

£600 and rent paid on 1 October 2003 for the year to 30 September

2004 was £800. Rent payable, as shown in the profit and loss account

for the year ended 31 December 2003, would be?

(a) £600

(b) £800

(c) £650

(d) £750

(c) £650

$ 12,000

MCQ 3A decrease in the provision for doubtful debts would result in?

(a) An increase in liabilities

(b) A decrease in working capital

(c) A decrease in net profit

(d) An increase in net profit

MCQ 4Which of the following transactions would result in an increase in

capital employed?

(a) Selling inventories at a profit

(b) Writing off a bad debt

(c) Paying a payable in cash

(d) Increasing the bank overdraft to purchase a non-current asset

(a) Selling inventories at a profit

Carriage

Discount

MCQ 5 What is cash discount?

(a) When payment is made in cash

(b) When payment is made by cheque

(c) When payment is made before due date

(d) When purchases are made in bulk

(c) When payment is made before due date

MCQ 6What is the double entry for discount allowed?

(a) Dr Debtors Cr Discount allowed

(b) Dr Debtors Cr Discount received

(c) Dr Discount allowed Cr Debtors

(d) Dr Discount allowed Cr Supplier

(c) Dr Discount allowed Cr Debtors

MCQ 7Where is discount allowed disclosed?

(a) Trading account

(b) Profit and loss account

(c) Trial balance

(d) Balance sheet

MCQ 8What is the double entry for discount received?

(a) Dr Supplier Cr Discount received

(b) Dr Discount received Cr Supplier

(c) Dr Discount received Cr Customer

(d) Dr Customer Cr Discount received

(a) Dr Supplier Cr Discount received

MCQ 9Where is discount received disclosed?

(a) Profit and loss account

(b) Trading account

(c) Balance sheet

(d) Trial balance

MCQ 10What is trade discount?

(a) Discount as bulk purchases

(b) Discount when paying in cash

(c) Discount as early settlement of invoice

(d) Discount if you trade overseas only

(a) Discount as bulk purchases

MCQ 11What is the double entry for trade discount?

(a) Dr Sales Cr Trade discount

(b) Dr Trade discount Cr Sales

(c) Dr Purchases Cr Trade discount

(d) No double entry

MCQ 12Where is carriage inwards disclosed?

(b) Balance sheet

(c) Trading account

(d) Trial balance

(c) Trading account

MCQ 13What does carriage inwards effect?

(a) Sales

(b) Purchases

(c) Drawing

(d) Capital

(b) Purchases

MCQ 14Carriage outwards is disclosed in

(a) Balance sheet

(c) Trading account

(d) Trial balance

MCQ 15

MCQ 16

(b) $ 114,000

Gross Pay or Employer’s Payment a. Basic pay b. Allowancesc. Bonuses and commissiond. Other pay

Net Pay or Take Home Pay Net pay is equal to Gross pay minus Total Deductions Deductions are two type i.e. Statutory and Non-Statutory Deductions Statutory deductions are deductions from pay that are made by state or law

o Income tax o Social security tax (SS)

Non-statutory deductions are voluntary deductions from pay that the employee chooses to make

Contributions by the employee to a pension scheme Any advance taken by employee Insurance etc.

An employee has a gross monthly salary of $1,000. In September the

tax deducted was $200, the employee‘s social security tax was $60,

and the employer‘s social security tax was $100. What was the

charge for salaries in the income statement? $.........................

MCQ 17

$ 1,100

MCQ 18

7081,008

Accounting for Sales Tax

In the UK this is ‘VAT’ and in France ‘TVA’. In this session we shall use the generic name ‘sales tax’

As a consequence the amount that they charge their customers for goods and services supplied will increase by the addition of sales tax

The rate of sales tax varies between countries and will also vary between the nature of the goods and services supplied

The sales tax collected does not belong to the organisation that charges and collects it and the tax must therefore be remitted to the tax authorities on a regular basis (liability for organization)

Sales tax received can be referred to as ‘output’ sales tax, and sales tax paid can be referred to as ‘input’ sales tax

The sales tax paid to suppliers is therefore an asset (receivable) and the amount received from customers is a liability (payable)

The double-entry bookkeeping records need to show the goods and sales tax values separately so that the purchases and sales are posted net (i.e. without the addition of sales tax) and the sales tax amounts are posted to a separate sales tax account

Example 6.3: During October, W had the following credit transactions:

October

1 Purchased goods from H $360 subject to 20 per cent trade discount

3 Sold goods to HG for $80

5 Sold goods to PL for $15

8 Bought goods from KJ for $4,000 subject to 10 per cent trade discount

12 Received a credit note from KJ for goods returned valued at $1,200 list price

15 Sold goods to RW for $2,000

18 Issued credit note for $500 to RW for goods returned

All of these transactions are subject to sales tax at the rate of 17.5 per cent

MCQ 19Calculate the VAT on £100 at standard rate?

(a) £17.50

(b) £14.89

(c) £117.50

(d) Nil

(a) £17.50

MCQ 20How much is the VAT amount, if gross sales were £100?

(a) £17.50

(b) £14.89

(c) £117.50

(d) Nil

(b) £14.89

MCQ 21X purchased goods costing £500 from Z Ltd (before VAT). Z gave X

a trade discount of 20%, calculate the net amount after discount.

(a) £470.00

(b) £400.00

(c) £587.50

(d) £340.43

(b) £400.00

MCQ 22As per Mcq 21 above, calculate VAT on purchases after trade

discount.

(a) £87.50

(b) £70.00

(c) £17.50

(d) £82.25

(b) £70.00

MCQ 23As per Mcq 22 above, what would be the final double entry after

calculation of trade discount and VAT?

MCQ 24The sales account is

(a) Credited with the total of sales made, including VAT

(b) Credited with the total of sales made, excluding VAT

(c) Debited with the total of s ales made, including VAT

(d) Debited with the total of sales made, excluding VAT

(b) Credited with the total of sales made, excluding VAT

Financial accounting (3)

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