Adjustments for Final Accounts

1. Adjustments for Final Accounts

2. Prepayments and Accruals • Expenses and revenues are not always paid or received on time. • Cash paid and received in a year should not be entered directly into the profit and loss account of that year. • Adjustment should be made.

3. Prepaid expenses • those to be used in the following period but have been paid for in advance. • Accrued expenses • those which have been used up in the current year, but have not yet been paid for. • Prepaid income • those to be earned in the following period but have been received in advance. • Accrued income • those which have been earned in the current period but have not yet been received.

4. Example • 2 firms who pay rent for buildings in Hong Kong. The rent for each building is $1,200 a year. • Firm A paid $1,00 in the year. Own $200 for rent. • Firm B paid $1,300 in the year. $100 in advance for the following year.

5. P & L accounts for 12 months needs 12 months rent as an expense = $1,200. • Firm A, $200 accrued expenses be adjusted. • Firm B, $100 prepaid expenses be adjusted

6. Accrued Expenses

7. Accrued expenses • Assume that rent of $1,000 per year is payable at the end of every 3 months. • The rent was not always paid on time

8. Rent 2005 $ 2005 $ Dec 31 Profit and loss 1,000 Mar 31 Bank 250 Jul 2 Bank 250 Oct 4 Bank 250 Dec 31 Accrued c/d 250 1,000 1,000 2006 Jan 1 Accrued b/d 250

9. Prepaid Expenses

10. Prepaid expenses • Insurance for a firm is at the rate $840 a year, starting from 11 January 2005. • The firm has agreed to pay this at the rate of $210 every 3 months.

11. Insurance 2005 $ 2005 $ Feb 28 Bank 210 Dec 31 Profit and loss 840 Aug 31 Bank 420 Dec 31 Prepaid c/d 210 Nov 18 Bank 420 1,050 1,050 2006 Jan 1 Prepaid b/d 210

12. Prepayment will also happen when items other than purchases are bought for use in the business, and they are not fully used up in the period. • For instance, stationery is normally not entirely used up over the period in which it is bought.

13. Example • Year ended 31 December 2005 • Stationery bought in the year $2,200 • Stock of stationery in hand as at 31 December 2005 $400

14. Stationery 2005 $ 2005 $ Dec 31 Bank 2,200 Dec 31 Profit and loss 1,800 Dec 31 Stock c/d 400 2,200 2,200 2006 Jan 1 Stock b/d 400 The stock of stationery is not added to the stock of unsold goods in hand in the balance sheet, but is added to the other prepayments of expense.

15. Accrued Income

16. Accrued income • Assumed our warehouse is larger than we need. We rent part of it to another firm for $800 per annum.

17. Rent receivable 2005 $ 2005 $ Dec 31 Profit and Loss 800 Apr 5 Bank 200 Jul 6 Bank 200 Oct 9 Bank 200 Dec 31 Accrued c/d 200 800 800 2006 Jan 1 Accrued b/d 210

18. Expenses and revenue accounts covering more than one period Example: • On 31 Dec. 2004 3 months rent of $3,000 was owing. • The rent chargeable per year was $12,000. • The following payments were made in the year 2005: 6 Jan. $3,000; 4 April $3,000; 7 July $3,000; 18 Oct $3,000 • The final 3 months rent for 2005 is still owing.

19. Rent 2005 $ 2005 $ Jan 6 Bank 3,000 Jan 1 Owing b/d 3,000 Apr 4 Bank 3,000 Dec 31 Profit and loss 12,000 Jul 7 Bank 3,000 Oct 18 Bank 3,000 Dec 31 Owing c/d 3,000 15,000 15,000 2006 Jan 1 Owning b/d 3000

20. Example Rent and rates are joined together. • Rent is payable of 6000 per annum • Rates of $4,000 per annum are payable by instalments. • At 1 Jan 20x5 rent $1,000 had been prepaid in 20x4. • On 1 Jan 20x5 rates were owned of $400. • During 20x5 rent was paid $4,500.

21. During 20x5 rates were paid $5,000. • On 31 Dec 20x5 rent $500 was owing. • On 31 Dec 20x5 rates of $600 had been prepaid.

22. Rent and Rates 2005 $ 2005 $ Jan 1 Rent prepaid b/d 1,000 Jan 1 Rates owing b/d 400 Dec 31 Bank: rent 4,500 Dec 31 Profit and loss 10,000 Dec 31 Bank: rates 5,000 Dec 31 Rates prepaid c/d 600 Dec 31 Owing c/d 500 11,000 11,000 2006 2006 Jan 1 Prepaid b/d 600 Jan 1 Owing b/d 500

23. Expenses for the period = Cash paid – Accruals in last year + Accruals in this year + Prepayments in last year – Prepayment in this year

24. Income for the period = Receipt – Accruals in last year + Accruals in this year + Prepayments in last year – Prepayments in this year

25. Trading and Profit and Loss Account • Gross profit / loss = Net sales – Cost of goods sold • Net sale = Sales – Returns Inwards • Cost of goods sold = Opening stock + [Purchase + Carriage inwards – Returns outwards + other purchase costs] – Closing stock

26. Net Profit = Gross profit + Other income – Total expenses

27. Name of the Company Trading and Profit and Loss Account for the year ended 31 Dec 19xx $ $ $ Sales x Less Returns Inwards x x Less cost of Goods Sold Opening Stock x Purchases x Add Carriage Inwards x Less Returns Outwards (x) Less Closing Stock (x) x Gross Profit x Add Discount received x Rent Received x Profit on Disposal on M.V. x Decrease in provision for bad debt x x Less Expenses Rent and Rates x Insurance x Carriage Outwards x Discount Allowed x Bad debts x Increase in provision for bad debts x Depreciation x Loss on Disposal of Furniture x x Net Profit x

28. Name of the Company Trading and Profit and Loss Account for the year ended 31 Dec 19xx $ $ $ Fixed Assets Cost Dep. Net Machinery x x x Motors x x x x x x Investment ($x at market value) x x Current Assets Stock x Debtors x Less provision for bad debt (x) x Prepaid expenses x Accrued income x Bank x Cash x x Less: Current Liabilities Creditors x Accrued expenses x Prepaid income x Bank overdrafts x Working Capital x x

29. $ $ $ Financed by: Capital Bal as at 1 Jan 19xx x Add: Net profit / Less Net loss x x Less: Drawings x x Long-term Liabilities Debentures x Bank Loans x x

30. Working capital • Working capital is the amount by which current assets exceed current liabilities.

31. Drawings • They refer to the using up of business resources by the owner(s) of the business.

32. Accounting entries

33. Losses of goods • Losses of raw materials and trading stock can be classified • normal losses • abnormal losses

34. Normal Loss • Normal Losses caused by wastage, obsolescence and other reasons which are expected within the ordinary activities of the business. • No entry is needed for normal losses.

35. Abnormal Loss . • Losses caused by reasons which are unexpected within the ordinary activities of the business such as fire or accidents. • These should be recorded in the books as below.

37. Example (Normal loss) $ Purchases (100 units) 100 Sales (70 units) 210 Closing stock (20 units) 20 Expenses 50 10 units of goods were obsolete.

38. Abnormal loss without insurance claim Trading and Profit and Loss Account $ $ Purchase ($1 * 100) 100 Less Closing Stock($1*20) 20 80 Less Fire loss 10 Cost of goods sold 70 Gross profit 140 210 Expenses 50 Fire Loss 10 Net Profit 80 140 Sales ($3 * 70) 210 ____ 210 Gross Profit 140 ___ 140

39. Abnormal loss with insurance claim ($6) Trading and Profit and Loss Account $ $ Purchase ($1 * 100) 100 Less Closing Stock 20 80 Less Fire loss 10 Cost of goods sold 70 Gross profit 140 210 Expenses 50 Fire Loss ($10 - $6) 4 Net Profit 86 140 Sales ($3 * 70) 210 ____ 210 Gross Profit 140 ___ 140