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Balance Day Adjustments. Objectives – Balance Day Adjustments. Distinguish between the cash basis of and accrual basis of accounting Distinguish the followings Accrued Expenses Prepaid Expenses Accrued revenues Prepaid revenues
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Objectives – BalanceDayAdjustments Distinguish between the cash basis of and accrual basis of accounting Distinguish the followings • Accrued Expenses • Prepaid Expenses • Accrued revenues • Prepaid revenues And able to prepare the necessary adjustments for the above followings. Understand the effects of the adjustments on: • The Profit and Loss Account • The Balance Sheet
Balance Day Adjustments • Basis of accounting for profits • Cash basis • Accrual Basis Cash Basis: Cash receipts – Cashpayments = Profits Accrual Basis: Revenue earned – Expenses incurred = Profits
Which is a more accurate calculation? Balance Day Adjustments JanFebMarch Revenue 1000 1000 1000 Rent (cash) 300 - - Rent (Accrual) 100 100 100 • Rationale for using the accrual basis • Businesses MOSTLY conducted on credit terms
The scenario:- Mr Phua rents a building from Mr Tan and incurs a monthly rent expense of $1 000. Scenario 1 Mr Phua forgets to pay his rent expenses of $12 000 in full to Mr Tan by the end of the accounting year of 2000. Instead he pays $5 000. Phua Chu Kang Pte Ltd The very best in Singapore & JB & some say Batam! Tan Ah Teck Pte Ltd The very best in Bishan & some say Sentosa! Scenario 2 Mr Phua pays his rent expenses of $18 000, which is MORE THAN the actual amount, to Mr Tan by the end of the accounting year of 2001.
Balance Day Adjustments Accrued Expenses
Your mobile phone bill shows that you have not settled last month’s amount. This month mobile phone bill shows an outstanding amount of $100 and the current amount of $80. Hence this outstanding amount of $100 is also known as accrued expense.
Balance Day Adjustments - Accrued Expenses Phua CK is pretending to be calm but actually is very confused. He should have paid $12 000 for the rent for the period from January to December 2000. Scenario 1 However, at the end of the period, he only paid $5 000 to Tan Ah Teck Pte Ltd due to negligence. He still owes the company $7 000. He does not know the correct entries to reflect this!
Let us help him. End of accounting period – December 2000 Should have paid : $ 12 000 Paid only : $ 5 000 Owed : $ 7 000 This owing amount of $7 000 is also known as Accrued Rent Expense. Mr. Phua CK still owes Tan Ah Teck Ltd $7 000 that was not paid for the year of 2000.
Balance Day Adjustments - Accrued Expenses Definition: • Are expense that have been incurred for the accounting period BUT amount not yet paid for by the business.
Balance Day Adjustments - Accrued Expenses What is the nature of accrued expense? Debit or Credit entry? Yes…. Credit entry because it is a liability (still owe people $)
Using Phua CK as an example. If Mr. Phua remembered to pay the rent amount in full, then the entries will be:- JOURNAL Date Particulars Debit Credit Year 2000 Dec 31 $12 000 $12 000 Rent Expense Profit and Loss a/c However, this is not the case. An additional ledger needs to be created – Accrued Rent Expense
JOURNAL Date Particulars Debit Credit Year 2000 $7 000 Dec 31 $7 000 Rent Expense Accrued Rent Expense RENT EXPENSES a/c Year 2000 Dec 31 Bank$5 000 Year 2000 Dec 31 Profit & Loss$12 000 Accrued rent $7 000 Expense $12 000 $12 000 ACCRUED RENT EXPENSES a/c Year 2000 Dec 31 Bal c/d$7 000 Year 2000 Dec 31 Rent Expense$7 000 $7 000 $7 000 Year 2001 Jan 1 Bal b/d$7 000
JOURNAL Date Particulars Debit Credit 2000 Dec 31 Profit & Loss a/c $12 000 Rent Expense $12 000 (Being rent expense closing off to P&L a/c) Profit & Loss Account 2000 Dec 31 Expenses $12 000 Balance Sheet as at Dec 2000 Liability Accrued Rent Expense $7 000
Balance Day Adjustments - Accrued Expenses Summary • Definition • Credit/Debit nature? • Is there a need to open another ledger for accrued expense? • Post this ledger to P/L or Balance Sheet?
Balance day Adjustments Prepaid Expenses
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Assuming that the monthly subscription is $20. You like the promotion and paid $1 200 (6x$20) immediately in order to get the new mobile phone. Hence you are paying in advance for the expense. The payment in advance of subscription fees ($1 200) is also known as Prepaid Expense.
Prepaid Expense/Payment in Advance Are expenses that have been paid in advance but NOT yet incurred for the current accounting period. Definition
Since expense is a debit entry. If the expense had been prepaid, what will be the nature of the entry? Prepaid expense is like an asset to the firm as it is similar to people owing services to the firm. Hence a DEBIT ENTRY.
Prepaid Expense/Payment in Advance Phua CK learnt his lesson last time of not paying on time last year, so he decides to pay in advance to “save his face” this year. The rent expense for the accounting year of 2001 is $12 000, but he pays $18 000. Hence he prepaid $6 000 for expenses that has not been incurred in 2001. Scenario 2
Prepaid Expense/Payment in Advance Recall that the monthly rent expense is $1 000. Hence from January to December 2001, the total rent is $12 000. Phua CK prepaid rent expense of $6 000 for January to June 2002. 1 Jan 2001 31 Dec 2001 30 June 2002 $ 12 000 incurred $6 000 prepaid $18 000 paid
JOURNAL Date Particulars Debit Credit Year 2001 $6 000 Dec 31 $6 000 Prepaid Rent Expense Rent Expense RENT EXPENSES a/c Year 2001 Dec 31 Bank$18 000 Year 2001 Dec 31 Prepaid Rent $ 6 000 Profit & Loss$12 000 $18 000 $18 000 PREPAID RENT EXPENSES a/c Year 2001 Dec 31 Rent Expense $6 000 Year 2001 Dec 31 Bal c/d $6 000 $6 000 $6 000 Year 2002 Jan 1 Bal b/d$6 000
Profit & Loss Account 2001 Dec 31 Expenses $12 000 Balance Sheet as at Dec 2001 Current Assets Prepaid Rent Expense $6 000 Summary • Definition • Credit/Debit nature? • What are the differences in adjustments between the accrued and prepaid expenses?
Practice! Accrued & Prepaid Expenses
Practice - Accrued and Prepaid Expenses • During the year of 2001, the cash book shows: • maintenance Expense $ 900 • Selling Expense $1 200 • On 31 May 2001, the Balance Sheet also shows • Prepaid Maintenance Expense $ 400 • Accrued Selling expense $ 300 • Find the actualamount of the expenses incurred for the year of 2001.
1 Prepaid Maintenance Expense Maintenance Expense $ $ Cash at Bank 900 Profit & Loss 500 Prepaid Maint Exp 400 900 900 2 Accrued Selling Expense Selling Expense $ $ Cash at Bank 1 200 Profit & Loss 1 500 Accrued Selling Exp 300 1 500 1 500