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Accruals and Prepayments

Accruals and Prepayments. Accruals in the balance sheet are (current) liabilities, prepayments are (current) assets. They arise because of the accruals (or ‘matching’) concept - profit is not the same as cash and cash is not the same as profit!

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Accruals and Prepayments

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  1. Accruals and Prepayments • Accruals in the balance sheet are (current) liabilities, prepayments are (current) assets. • They arise because of the accruals (or ‘matching’) concept - profit is not the same as cash and cash is not the same as profit! • Expenses in the profit and loss account are recorded in the periods to which they relate - the balance sheet records the amounts over or under paid in cash

  2. Accruals and Prepayments Example Annual buildings insurance £4,000 paid in advance 1 July 2001. The insurance premium for the year to 30 June 2001 was £3,600. On 5th October 2001, received electricity bill for £560 for the quarter ended 30 September 2001. Other electricity costs for the year ended 30 September 2001 were £1,200. A/cing y/end is 30 September. • P&L: • B/Sheet:

  3. Depreciation • Annual depreciation is charged to the profit and loss account. It is an application of the accruals (‘matching’) concept, designed to spread the cost of fixed assets over their useful economic lives. • Accumulated depreciation is deducted from the fixed asset cost in the balance sheet (to give net book value - NBV). This is the total depreciation charged to date. • Depreciation is NOT a cash flow.

  4. Main Methods • Straight-Line • annual depreciation = (cost - scrap value)/UEL • Reducing Balance • depreciation in year 1 = cost  dep’n. rate • depreciation in year 2 = b/f NBV  dep’n. rate • etc.

  5. Example - straight-line • Annual depreciation = • NBV =

  6. Example - reducing balance • Depreciation in yr 1 = • yr 2 = • yr 3 = • yr 4 =

  7. Profit/Loss on Disposal • When a fixed asset is sold, its NBV is no longer included in the balance sheet BUT the business may have made a profit or loss on disposal, which should be included in the P&L a/c for the year of disposal. • Profit on disposal = sales proceeds - NBV

  8. Example • NBV after 2 years: • Profit if sold for £50,000: • Profit if sold for £80,000:

  9. Fixed Assets and the Cash Flow Statement • The purchase of a fixed asset is capital expenditure - the cash outflow is recorded under this heading in the CFS for the year in which it occurs. • Remember that this initial outflow does NOT go into the profit and loss account. • Depreciation is a non cash item and must be added back in the reconciliation of op. profit to net cash flow from op. activities.

  10. Disposals of fixed assets are a bit more complicated. • Profits and losses on disposals of fixed assets must be adjusted in the reconciliation of op. profit to net cash flow from op. activities. • Cash proceeds from the sale (an inflow) are shown in the body of the CFS for the year in which they are received.

  11. Bad and Doubtful Debts • If you know you will never recover a specific amount from a specific debtor, WRITE-OFF • expense in P&L a/c • deduct from debtors in B/S • If you are unsure whether you will recover some of your debtors balance, PROVIDE • charge increase/credit decrease in provision to P&L a/c • deduct total provision from debtors on face of B/S

  12. Example • Debtors currently £120,000. • Bad debt £20,000 (customer in liquidation) • Doubtful debts estimated at 2%. Brought forward provision for doubtful debts is £1,600. • What will the B/S and P&L show? • What if the b/f provision was £2,200 ?

  13. Debtors and Creditors:Missing Numbers • You will often be asked questions where there is a piece of information missing. You will have to find the missing number from the other numbers that you have. • To do this, it is important that you understand how sales, cash receipts and debtors are related, and how purchases, cash payments and creditors are related.

  14. Credit Sales/Debtors

  15. Example • Debtors in last year’s balance sheet £90,000. • Cash received from debtors this year £240,000. • Debtors in this year’s balance sheet £100,000. • What are credit sales for this year?

  16. Credit Purchases/Creditors

  17. Cost of Sales

  18. Cost of Sales: Missing Numbers • Sometimes we need to use information about gross profit margins or mark-ups to work out the sales or purchases figure. • Remember, gross profit = sales - cost of sales • A ‘mark-up’ is a gross profit percentage calculated on cost of sales. • A ‘margin’ is a gross profit percentage calculated on sales.

  19. Examples • Sales £1,000 made at mark-up of 25%. What is cost of sales? • Cost of sales £500, profit margin on sales 20%. What is sales?

  20. The Trial Balance • The trial balance is a list of balance sheet items, separated into two columns. One column shows ‘debit’ balances, the other ‘credit’ balances. • Debit balances are assets (or expenses), credit balances are liabilities (or income). • If everything has been recorded correctly, it should balance (just like the balance sheet). • Unfortunately, there could be a mistake and the TB could still balance - e.g. if you forget to record a transaction altogether

  21. Example Trial Balance

  22. Double-Entry Book-keeping • Every transaction has two effects • One effect is a ‘debit’ (DR) and one effect is a ‘credit’ (CR) • Create ‘T’ accounts for each category in the balance sheet (and P&L) • ‘Debit’ and ‘credit’ these as appropriate - must ‘debit’ one ‘T’ account and ‘credit’ another each time. Record as ‘journals’. • At end, ‘close off’ all B/S ‘T’ accounts, and put c/f balances into the ‘trial balance’.

  23. What do you debit or credit?

  24. Simple Example - Joe Smith Revisited

  25. Joe Smith Trial Balance

  26. Check that you could produce the balance sheet and P&L for the simple Joe Smith example. • Lecture examples 5 and 6 are more complex. • We will do example 5 in the lecture. You can work through example 6 yourselves (it is rather long and quite hard - contact me if you need extra help) as you have the completed ledger in the notes.

  27. Example 5: The Ashton Company Revisited • Journal entries:

  28. The Ashton Company Trial Balance

  29. Control Accounts • Missing numbers questions involving debtors/sales/cash receipts or creditors/purchases/cash payments can be answered using ‘control accounts’. • Control accounts are ‘T’ accounts for either debtors/receivables, or creditors/payables. • The idea is the same as we saw before (incomplete records) - you can use either method for answering questions

  30. Incomplete Records - Example

  31. Cost of Sales for quarter: £ % Sales Less: COS Gross Profit

  32. Purchases for quarter: £ Opening Stock Purchases Less: Closing Stock Cost of Sales

  33. Go through as much of Chippendale as there is time for

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