Accounting Adjustments Dr. Clive Vlieland-Boddy FCA FCCA MBA
The Trial Balance • The trial balance is a summary of the balances from the “T” accounts. • It represents the totals to date. • Normally these are divided between items that will appear in the Balance Sheet and those that will appear in the Income Statement.
Balance Sheet Vs Income Statement • The Balance Sheet Shows what is not consumed. • The income statement shows what has been consumed.
Revisiting Double Entry Book-keeping • Remember…. For every Credit there has to be a Debit and for every Debit there has to be a Credit.
The Trial Balance So Far • This will show the transactions of the enterprise up to the date of the Balance Sheet. The day the picture is taken. • But there will be adjustments to get this picture into correct focus.
Trial Balance of ABC at 31st Dec 2010 Debit Credit Accounts Receivable 226,000 Inventories 1st Jan 2010 235,000 Bank 50,500 Accounts Payable 100,700 Machinery 500,000 Depreciation to 1st Jan 2010 100,000 Loan 125,000 Shares 100,000 Retained Earnings 1st Jan 2010 201,600 Sales 2,500,400 Purchases 1,456,000 Overheads 669,200 TOTAL 3,136,700 3,136,700
Adjustments • Closing Inventories • Bad Debts • Depreciation for the period/year • Tax for the period/year • Dividends • Sundry Accruals • Sundry Prepayments • Part of Long Term loan repayable in 12 months
Closing Inventories • The Trial Balance will have a balance representing the opening Inventories. • This has to be taken out and replaced with the closing inventories.
Firstly to Reverse out Opening Inventory • We will have to Credit the existing account with the balance and take to Cost of Goods Sold in the Income Statement • Credit The existing Inventory account with 235,000 and Debit Cost of Goods Sold in the Income Statement. • What we are saying is the opening inventories have been consumed.
The “T” Accounts Balance Sheet Income Statement 235,000 235,000
Now introduce the ending inventory • Debit The Inventory Account in the Balance Sheet • Credit Cost of Goods Sold in the Income Statement as these items have not been consumed. • So if closing inventories were say €275,000 then…..
The “T” Accounts Balance Sheet Income Statement 275,000 275,000
Bad Debts • Some Accounts Receivable may not be good. Remember an asset is only one that will bring future economic value. • An accounts receivable that is bad needs to be adjusted for. • If say €5,000 of the Accounts Receivable were uncollectable then………….
The “T” Accounts Balance Sheet Income Statement 5,000 5,000 Note: That Bad Debts are actually deducted from the accounts receivable They appear in the income statement as an overhead
The Balance Sheet Current Assets Current Liabilities Accounts Payable Less: Bad Debts Non Current Assets Non Current Liabilities Equity
Depreciation • Non Current Assets need to be depreciated. They lose value all the time and an adjustment has to be made. • Normally accounting policies will dictate the rate and method to be used. • The adjustment will represent a charge in the income statement as an overhead and an increase in the accumulated depreciation which is a deduction from NCA in the Balance Sheet. • It the charge for the year has been assessed at €85,000 then………..
The “T” Accounts Balance Sheet Income Statement 85,000 85,000 Note: Depreciation is shown as a deduction from the total of Non Current Assets in the Balance Sheet. It is an overhead in the income statement
The Balance Sheet Current Assets Current Liabilities Non Current Assets Non Current Liabilities Plant & Equipment Cost Less: Accumulated Depreciation Equity
Tax • All companies have to pay tax normally based on a % of the profits. • This can only be calculated when the profit is established. • Then a provision has to be created. • This will appear in the Income Statement below EBIT and as a Current Liability in the Balance Sheet. (Note if part is Deferred) • So if the tax bill has been assessed at €85,000 then……………..
The “T” Accounts Balance Sheet Income Statement 85,000 85,000 Note: if some of this tax is to be deferred then it will be split between Current Liabilities and Non Current Liabilities in the Balance Sheet. In the Income Statement it comes after EBIT.
Dividends • Only when the profit and tax is established can the company propose a dividend to the shareholders. Sadly they are always last… • A charge will appear after EBIT in the Income Statement and a Current Liability will be created for the dividend to be paid. • So if a dividend is to be paid of €70,000 then…..
The “T” Accounts Balance Sheet Income Statement 70,000 70,000 Note: Dividends payable will normally be a Current Liability in the Balance Sheet. In the Income Statement they are the last item before Net Profit Retained for the year/period.
Sundry Accruals • There may well be small additional liabilities that were not there when the “picture was taken”. A phone bill arriving a day or so after but for calls made in the closed period. • A current liability is created and a charge in the income statement under overheads is made. • So if there was an invoice arrived a few days into the new year for €6,000 for telephone calls all made in the closed year. Then……
The “T” Accounts Balance Sheet Income Statement 6,000 6,000 Note: These will appear under Current Liabilities in the Balance Sheet. In the Income Statement as an overhead adding to the existing costs to date for telephone.
Sundry Prepayments • Some expenditures may not have been totally consumed. • Insurance is paid a year in advance. It is therefore totally unconsumed on the day it is paid. • An adjustment has to be made by creating a current asset, prepayments and reducing the charge in the income statement. • So if we had prepaid insurance of €3,000. Then…..
The “T” Accounts Balance Sheet Income Statement 3,000 3,000
Long Term Loans • Normally these will all be shown as Non Current Liabilities as they are repayable in more than 12 months. • However, often a proportion is to be repaid within 12 months. This represents a Current Liability. • So of €15,000 of the loan is repayable within 12 months then………
The “T” Accounts Balance Sheet Income Statement 15,000 -15,000 Note: Here the adjustment is to reduce Non Current Liabilities and place the amount payable within 12 months in Current Liabilities.
The Balance Sheet Current Assets Current Liabilities Current Portion of Long Term Debt Non Current Assets Non Current Liabilities Long Term Debt Equity
The Net Income for the Year • Once the income statement has been added up, there will be a profit or loss for the accounting period at the bottom. • This figure represents the retained earnings for the period. • This has to be taken to the Balance Sheet and added to the existing retained earnings.
The Balance Sheet Current Assets Current Liabilities Non Current Assets Non Current Liabilities Equity Retained Earnings Add Profits Retained for Year