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Completing the Accounting Cycle Lecture Four Prepare and use an accounting work sheet to complete the accounting cycle Close the revenue, expense and drawings accounts Correct typical accounting errors Reversing Entries Classify Assets & Liabilities

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Completing the accounting cycle l.jpg

Completing the Accounting Cycle

Lecture Four

CRICOS Provider Code 00301J


Learning objectives l.jpg

Prepare and use an accounting work sheet to complete the accounting cycle

Close the revenue, expense and drawings accounts

Correct typical accounting errors

Reversing Entries

Classify Assets & Liabilities

Use the current and debt ratios to evaluate a business

Other Issues

Profit Recognition

Measurement

Disclosure

Learning Objectives

CRICOS Provider Code 00301J


Objective 1 accounting work sheet l.jpg

The accounting cycleaccounting cycle is the process by which accountants produce the financial statements for a specific period of time

Work is performed at two different times:

During the period

journalising transactions and posting to the ledger

End of the period

Adjusting entries

Closing entries

Preparing financial statements

Objective 1: Accounting Work Sheet

CRICOS Provider Code 00301J


Work sheet l.jpg

A multi-column document, a accounting cyclework sheet, summarizes the effects of all the period’s activity

Facilitates the calculation of periodic profit/loss

Convenient device for completing the accounting cycle

It is NOT a journal or ledger

Actual adjustments of the accounts MUST be journalised and posted to the accounts

It is an internal document only – it is NOT an auditable legal document

Closing entries can also be prepared at this time

Work Sheet

CRICOS Provider Code 00301J


Worksheet l.jpg
Worksheet accounting cycle

CRICOS Provider Code 00301J


Work sheet entering adjusting entries l.jpg
Work Sheet – Entering Adjusting Entries accounting cycle

  • Enter the following adjusting entries

    • Sales earned for the period is $10,000

      Dr Sales 5,000

      Cr Unearned Revenue 5,000

    • Wages owing but not paid $2,500

      Dr Wages Expense 2,500

      Cr Accrued Wages 2,500

    • Doubtful debts are estimated to be $750

      Dr Doubtful Debts Expense 750

      Cr Allowance for Doubtful Debts 750

CRICOS Provider Code 00301J


Worksheet7 l.jpg
Worksheet accounting cycle

CRICOS Provider Code 00301J


Worksheet8 l.jpg
Worksheet accounting cycle

CRICOS Provider Code 00301J


Objective 2 closing entries l.jpg

Closing the accounts is the end of period process that prepares the accounts for recording transactions during the next period. Revenues, expenses, drawings and increments to capital represent increases and decreases in owner’s equity during a specific period

At the end of an accounting period nominal (temporary) accounts are closed out – returned to a zero balance :

.

.

.

Only permanent accounts remain open and their balances carried forward to the next period :

.

.

Follows the going concern, time period and matching principles

Objective 2: Closing Entries

CRICOS Provider Code 00301J


Closing entries l.jpg
Closing Entries prepares the accounts for recording transactions during the next period. Revenues, expenses, drawings and increments to capital represent increases and decreases in owner’s equity during a specific period

  • Close ALL revenue and expense accounts to the Income Summary Account (Profit and Loss Summary Account)

  • Close Income Summary Account (net profit/loss) to Owners Equity

  • Close drawings to Owners Equity

CRICOS Provider Code 00301J


Closing entries11 l.jpg
Closing Entries prepares the accounts for recording transactions during the next period. Revenues, expenses, drawings and increments to capital represent increases and decreases in owner’s equity during a specific period

  • Refer Worksheet Example (Slide 8)

  • Sales revenue 10,000

    Income Summary 10,000

  • Income Summary 3,495

    Telephone exp. 245

    Wages exp. 2,500

    Doubtful debts exp. 750

    3. Income Summary 6,505

    Capital 6,505

CRICOS Provider Code 00301J


Post closing trial balance l.jpg
Post-closing Trial Balance prepares the accounts for recording transactions during the next period. Revenues, expenses, drawings and increments to capital represent increases and decreases in owner’s equity during a specific period

  • The accounting cycle ends with the post-closing trial balance.

  • The post-closing trial balance is dated as of the end of the period for which the statements have been prepared.

  • What accounts will a post-closing trial balance show?

CRICOS Provider Code 00301J


Objective 3 correct typical accounting errors l.jpg

Accountants correct errors by making correcting journal entries

Errors can arise at any stage of processing:

Journal stage - it is necessary only to rewrite the entries to reflect the correction

After posting to the general ledger - a correcting general journal entry is required

.

Objective 3: Correct Typical Accounting Errors

CRICOS Provider Code 00301J


Example 1 correct accounting error l.jpg

Transaction was for $500 not $5,000 entries

At journal stage – error detected prior to posting

Cross out entry and initial

Example 1 – Correct Accounting Error

CRICOS Provider Code 00301J


Example 2 correct accounting error l.jpg

Transaction was for $500 not $5,000 entries

Error detected after posting

Correcting entry required

Example 2 – Correct Accounting Error

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Objective 4 reversing entries l.jpg

Are special types of entries that facilitate the accounting process for the new accounting period

Relate to accrued revenue and expenses

Reverses a previous adjusting entry

Not required but they save accountants having to remember that part of a payment or receipt in the next period relates to the previous period.

Objective 4: Reversing Entries

CRICOS Provider Code 00301J


Reversing entry example l.jpg
Reversing Entry Example process for the new accounting period

Assume wages of $15,000 have been paid during the period. An additional $10,000 needs to be accrued at the end of the period (30/6/07) i.e. earned but not paid

1. Adjusting Entry

Cash

Wages Expense

Wages Payable

15,000

15,000

10,000

10,000

$25,000

$10,000

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Reversing entry example18 l.jpg
Reversing Entry Example process for the new accounting period

2. Closing Entry

Cash

Wages Expense

Wages Payable

15,000

15,000

10,000

10,000

25,000

0

$10,000

CRICOS Provider Code 00301J


Reversing entry example19 l.jpg
Reversing Entry Example process for the new accounting period

3. Wages Paid Next Period (example 1 without reversing entry but correct allocation)

Cash

Wages Expense

Wages Payable

15,000

10,000

14,000

4,000

10,000

4,000

CRICOS Provider Code 00301J


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Reversing Entry Example process for the new accounting period

3. Wages Paid Next Period (example 2 without reversing entry and incorrect allocation)

Cash

Wages Expense

Wages Payable

15,000

10,000

14,000

14,000

$14,000

$10,000

CRICOS Provider Code 00301J


Reversing entry example21 l.jpg
Reversing Entry Example process for the new accounting period

3. Wages Paid Next Period (with reversing journal entry)

Wages Payable 10,000 dr

Wages Expense 10,000 cr

Cash

Wages Expense

Wages Payable

15,000

10,000

10,000

10,000

14,000

14,000

$4,000

$0

CRICOS Provider Code 00301J


Objective 5 classify assets liabilities l.jpg
Objective 5: Classify Assets & Liabilities process for the new accounting period

  • On the balance sheet, assets and liabilities are classified as either current or non-current to indicate their relative liquidity.

  • Current assets are cash or can be converted to cash within 1 year (or normal business cycle)

  • Non current assets are all other assets

  • Current liabilities are debts or obligations due within 1 year

  • Non current liabilities are all other liabilities

CRICOS Provider Code 00301J


Classify assets liabilities l.jpg
Classify Assets & Liabilities process for the new accounting period

  • Balance Sheet Classification

    • Current assets are listed in order of decreasing liquidity

    • Current liabilities are listed in order of how soon they must be paid

CRICOS Provider Code 00301J


Different formats of the balance sheet l.jpg
Different Formats of the process for the new accounting periodBalance Sheet

Report Format

Account Format

Assets

=

Liabilities

+

Owner’s Equity

Assets = Liabilities

+

Owner’s Equity

CRICOS Provider Code 00301J


Objective 6 use the current debt ratio to evaluate a business l.jpg
Objective 6: Use the current & debt ratio to evaluate a business

  • Current and Debt ratios are two common ratios that measure liquidity

  • Current Ratio measures the ability of a business to pay its current liabilities with its current assets

    • Current ratio = current assets/current liabilities

  • Debt Ratio indicates the proportion of a business’s assets that are financed with debt

    • Measures the ability to pay both short and long-term debt

    • Debt ratio = total liabilities/total assets

CRICOS Provider Code 00301J


Use the current debt ratio to evaluate a business examples l.jpg
Use the current & debt ratio to evaluate a business (examples)

  • Extract from Balance Sheet

CRICOS Provider Code 00301J


Use the current debt ratio to evaluate a business l.jpg
Use the current & debt ratio to evaluate a business (examples)

  • Current ratio – current assets/current liabilities

    • 20X4 6304/3932 = 1.6

    • 20X5 6805/4261 = 1.6

    • 20X6 7098/5348 = 1.3

  • Debt ratio - total liabilities/total assets

    • 20X4 5151/8268 = .62

    • 20X5 5252/8868 = .59

    • 20X6 5968/9695 = .62

CRICOS Provider Code 00301J


Objective 7 1 profit recognition l.jpg
Objective 7(1): Profit Recognition (examples)

  • The profit recognition principle provides guidance on the timing and amount of profit to record - or more precisely revenue and expense recognition.

  • Profits should be recorded when earned and not before.

    • Interest and rent accrue with the passage of time.

    • Most sales and many services revenue is recognised at a point in time.

CRICOS Provider Code 00301J


Profit recognition l.jpg
Profit Recognition (examples)

  • In some businesses there are many phases in the earning of profits;

    • from customers ordering to the end of warranty period.

  • Three conditions for revenue to be recorded (AASB 118):

    • Control of the goods has passed to the purchaser

    • Collectibility of the revenue is probable

    • Amount can be easily measured

CRICOS Provider Code 00301J


Profit recognition30 l.jpg
Profit Recognition (examples)

  • Four Methods

    • Sales method; sales for cash and on credit.

    • Collection method; if receipt of cash is uncertain.

    • Instalment method; for instalment sales - provides same overall gross profit as the sales method - difference is the period/s in which it is recognised.

    • Percentage-of-completion method.

CRICOS Provider Code 00301J


Installment method l.jpg
Installment Method (examples)

  • Real estate developer sells land;

    • Down payment $200,000 (year 1)

    • Annual payments $250,000 (year 2)

      $260,000 (year 3)

      $290,000 (year 4)

    • If land cost $660,000

      Gross Profit = $1,000,000 – 660,000 =$340,000

      GP% = 340,000/1,000,000 = 34%

CRICOS Provider Code 00301J


Slide32 l.jpg

Installment Method (examples)

Year Collection x G.P.% = G.P.

1 $200,000 x 34% = $68,000

2 $250,000 x 34% = $85,000

3 $260,000 x 34% = $88,400

4 $290,000 x 34% = $98,600

Total $1,000,000 $340,000

CRICOS Provider Code 00301J


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Percentage-of-Completion Method (examples)

  • Especially for construction projects that extend over several periods.

  • Profit is recognised as the work is performed.

  • To use this method businesses need to be able to reliably estimate both

    • The outcome of the contract (profit) and percentage of project completed

      Steps:

      1.Calculate % of project (divide costs incurred this period by total estimated project costs)

      2. Multiply total project revenue by % of completion

      3. Revenue less expenses = period profit

CRICOS Provider Code 00301J


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Percentage of Completion Method (examples)

Example:

  • Energy Corp is building a desalination plant

    • Total costs over 3 year project = $660,000 (y1=$100,000; y2=260,000; y3=300,000)

    • Clients are billed as follows: Y1 $330,000; Y2 $270,000; Y3 $400,000 (Total $1m)

  • Calculations

    • Costs: y1 = 100,000/660,000 = .15

      y2 = 260,000/660,000 = .40

      y3 = 300,000/660,000 = .45

    • Revenue y1 = 1,000,000 * .15 = 150,000

      y2 = 1,000,000 * .40 = 400,000

      y3 = 1,000,000 * .45 = 450,000

    • Profit y1 = 150,000 - 100,000 = $50,000

      y2 = 400,000 - 260,000 = $140,000

      y3 = 450,000 – 300,000 = $150,000

      Total Profit = $340,000 (1,000,000 – 660,000)

CRICOS Provider Code 00301J


Instalment method vs of completion method l.jpg
Instalment method vs. % of Completion Method (examples)

Instalment % of Compl.

`Year G.P. GP

1 $68,000 $ 50,000

2 $85,000 $140,000

3 $88,400 $150,000

4 $98,600

Total $340,000 $340,000

Instalment – based on collections * GP%

% of Completion – based on expected revenues * yearly costs/total costs

CRICOS Provider Code 00301J


Percentage of completion method36 l.jpg
Percentage-of-Completion Method (examples)

  • Where estimates are not possible AASB 111 Construction Contracts requires;

    • costs incurred to be recognised as an expense

    • Where it is probable cost will be covered by revenue

      • revenue equal to costs is recognised and nil profits reported

      • all profits are reported upon completion.

    • If a loss is likely on the contract the full amount of the expected loss should be taken up immediately - even if the construction has not commenced.

      • An example of conservatism - do not anticipate any profits but anticipate all losses.

CRICOS Provider Code 00301J


Objective 7 2 measurement issues l.jpg
Objective 7(2): Measurement Issues (examples)

  • Transactions are recorded at historical cost - what was paid for assets or expenses.

  • The information is:

    • reliable

    • relatively easy to identify

    • objective

    • usually recorded for commercial reasons.

CRICOS Provider Code 00301J


Measurement issues l.jpg
Measurement Issues (examples)

  • Historical cost not always used

    • AASB 102 allows the ‘write down’ of inventory if their net realisable value falls below purchase price.

    • AASB 116 allows assets to be revalued to market value (up or down)

CRICOS Provider Code 00301J


Measurement issues39 l.jpg
Measurement Issues (examples)

  • Market Value

    • Less reliable than historic cost but may be more relevant.

      • Could increase profits and increase assets, (but only if the asset was sold).

      • Could increase assets and increase owners’ equity

      • Could disclose market values in the notes and not alter the figures in the balance sheet.

CRICOS Provider Code 00301J


Objective 7 3 disclosure policies l.jpg
Objective 7(3): Disclosure Policies (examples)

  • AASB 101 Presentation of Financial Statements, requires a summary of accounting policies be given in the initial section of the notes.

    • The specific accounting principles, bases or rules adopted.

    • Describe the measurement basic e.g. H.C.

    • Give the method of accounting when there is choice e.g. method of depreciation.

CRICOS Provider Code 00301J


Disclosure policies l.jpg
Disclosure Policies (examples)

  • AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors

    • Consistency is important for comparability.

    • If a change is made the company should reveal:

      • nature of the change

      • reason for the change

      • effect of the change on net profits.

    • Change in accounting policy

      • Eg. FIFO to LIFO

    • Change in accounting estimate

      • Eg. life of an asset is extended

CRICOS Provider Code 00301J


Disclosure policies42 l.jpg
Disclosure Policies (examples)

  • AASB 110 Events After the Balance Sheet Date

    • There is a period of time between the reporting date (end of the financial year) and the publishing of the financial statements (authorised for issue).

    • 2 Types of Events:

    • Those that provide evidence of conditions that existed at the reporting date – requires adjustment

    • Those that are indicative of conditions that arose after the reporting date – no adjustment but requires disclosure if material

CRICOS Provider Code 00301J


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Disclosure Policies (examples)

  • AASB 110 Events After the Balance Sheet Date

    • Adjusting Events

      • Settlement of court case

      • Asset impairment

      • Existing customer declared bankrupt

    • Non-adjusting Events

      • Decline in market value of investments

      • Dividend declaration

    • Non-adjusting Events that are material and require disclosure

      • The nature of the event

      • An estimate of the financial effect or statement that it cannot be estimated.

        • Change in business combination

        • Discontinuance of an operation

        • Major purchases of assets; change in classification of assets (for use or for sale)

        • Destruction of a major plant/operation

CRICOS Provider Code 00301J


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