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

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:

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.

Main Methods
Straight-Line
annual depreciation = (cost - scrap value)/UEL

Reducing Balance
depreciation in year 1 = cost depn. rate depreciation in year 2 = b/f NBV depn. rate etc.

Example - straight-line
Annual depreciation =

NBV =

Example - reducing balance

Depreciation in yr 1 =
yr 2 = yr 3 = yr 4 =

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

Example
NBV after 2 years:

Profit if sold for 50,000:

Profit if sold for 80,000:

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.

 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.

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

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 ?

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.

Credit Sales/Debtors
What number is missing? Opening debtors ("already owed") + Credit sales in period ("extra sales") Total owed x

x ___ "T" ___

Amounts received in the period x in respect of credit sales (from debtors) + Amounts written off + Still owed (closing debtors) Total owed x x ___ "T" ___

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

Credit Purchases/Creditors
Opening creditors ("already owed") + Credit purchases in period ("extra purchases") Total owed x x ___ "T" ___ Amounts paid in the period in respect of credit purchases + Still owed (closing creditors) Total owed x

x ___ "T" ___

Cost of Sales
Opening stock x from last year's balance sheet (current assets) or cost of sales (P&L) often needs to be calculated if credit purchases are involved from this year's balance sheet (current assets)

Add: Purchases

x
______

Less: Closing stock COST OF SALES

x (x)
______

x
______

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.

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?

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

Example Trial Balance

Land and Buildings cost Buildings accumulated depreciation Machinery cost Machinery accumulated depreciation Stock Trade debtors Provision for doubtful debts Cash in hand Bank overdraft Trade creditors Mortgage Capital Reserves (incl. retained profit) DR 50,000 12,000 3,000 3,500 5,000 500 45 2,000 3,600 30,000 10,000 17,445 70,545 CR 4,000

70,545

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.

What do you debit or credit?

Asset Liability Balance Sheet Accounts DR CR + Liability (Claim) Asset +

Expenses Income

Profit & Loss Accounts DR CR + Income Expenses

Simple Example - Joe Smith Revisited

Journal Entries:
Start business invest 1,000 cash Dr cash Cr capital Purchase stock for cash Dr purchases Cr cash Sell stock for cash Dr cash Cr sales Purchase stock on credit Dr purchases Cr trade creditors 50 50 150 150 100 100 1,000 1,000

Cash at Bank

Capital

Bal c/f
_________________ _________________ ______________ _________________ _________________ _________________ ______________ _________________

Balance b/f Trade Creditors Stock

Bal c/f
_________________ ________________ ______________ _________________ ________________ ______________

Bal c/f
_________________ _________________

Balance b/f

Balance b/f

Sales

Purchases

Trading Account

Profit and Loss Account (Reserves)

Bal c/f
______________ _________________ ______________ _________________

Balance b/f

Joe Smith Trial Balance

DR 1,050 50 CR

Cash Stocks Creditors Capital Profit and Loss Account

50 1,000 50
_________________ _________________

1,100
_________________

1,100
_________________

 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.

Example 5: The Ashton Company Revisited

Journal entries:

Cash at Bank Bal b/f

350

Trade Creditors Bal b/f

18,000

Bal c/f
______________ _________________ ______________ _________________

Balance b/f | | Stock - Raw Materials Bal b/f 17,500

Bal c/f
_________________ _________________ ______________ _________________ _________________ _________________ ______________ _________________

Balance b/f

Bal b/f

Trade Debtors 30,000

Stock - Finished Goods Bal b/f 10,000

Bal c/f
_________________ _________________ ______________ _________________ _________________ ______________

Bal c/f
_________________ _________________

Balance b/f Sales

Balance b/f Purchases

Manufacturing Expenses

Non-Manufacturing Expenses

Trading Account

Profit and Loss Account (Reserves) Bal b/f 34,200

Bal c/f
______________ _________________ ______________ _________________

Balance b/f

The Ashton Company Trial Balance

Land (NBV) Buildings (NBV) Plant and machinery (NBV) Investments Stock - raw material Stock - finished goods Debtors Cash in hand Trade creditors Bank overdraft Mortgage Proprietors capital Retained profit (reserves) DR 20,000 35,000 50,000 2,500 CR

50

12,500 100,000

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

Receivables/Sales/Debtors
Balance b/f (opening balance) last year's Balance Sheet Credit sales for year (may be a missing figure!) X Cash received from debtors during the year bank a/c Bad debts written off in year Returns inwards Closing debtors (receivables) current asset in this year's Balance Sheet
__________

x x x

__________

X
__________

x
__________

Payables/Creditors
Payments made during the year (Bank a/c) X Opening balance b/f at start of year last year's Balance Sheet Credit purchases during the year (may be 'missing figure') x

Returns outwards Closing creditors current liability is this year's Balance Sheet

X X
__________

__________

X
__________

x
__________

Incomplete Records - Example

Receivables/Sales/Debtors
Balance b/f Cash received from debtors during the quarter Bad debts written off in quarter Returns inwards in quarter Closing debtors (receivables)
__________ __________ __________ __________

Credit sales for quarter

 Cost of Sales for quarter: Sales Less: COS Gross Profit

 Purchases for quarter:

Opening Stock Purchases Less: Closing Stock Cost of Sales

Payables/Creditors
Payments made during the quarter Returns outwards in quarter Closing creditors
__________ __________ __________ __________

Balance b/f Credit purchases during the quarter

 Go through as much of Chippendale as there is time for