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Last Revised: 13th August 2008. kaheiyeh.web.officelive.com
Page 3: The Nature of Accounting Page 5: The Balance Sheet & Transaction Analysis Page 8: The Income Statement & Transaction Analysis Page 13: Financial Reporting Principles Page 18: Adjustment to Accounting Entries Page 23: Completing the Accounting Cycle Page 26: Accounting for Cash Holdings & Receivables Page 30: Accounting for Inventory Page 37: Accounting for Non-Current Assets I Page 42: Accounting for Non-Current Assets II Page 45: Accounting for Liabilities
Week 1 – The Nature of Accounting
What is Accounting? Accounting is the main way in which organisations present the financial performance and financial position of that organisation. Essentially, it is a "language". It is also used to convey economic information to the decision-makers (users). The Rise of Economic Consequences Economic consequences have a very acute relationship with accounting. Take, for example, the collapse of Enron in 2001. This was due to: Misleading accounting Accounting scandals Accounting along took the business down and also the auditing firm and demonstrates this relationship. There is a focus on economic consequence in equity markets. This means that the decision maker is usually the investor/owner and they decide the value and the amount of shares they are willing the buy or sell. Users of Accounting Some users of accounting include: Management: To Monitor and Control Creditors: To decide lending amounts and terms Customers: To buy the product or not? (This generally applies to large buyers, not the end consumer) Tax Office: To see the assessable income Regulators: To check for compliance with legislation and laws Analysts: To provide recommendations to potential and current shareholders Competitors: To gain insight into the business's strategies Managers: To decide on performance incentives (Pay rises, bonuses etc.) Employees: To check their work, pay and conditions Accounting is a dynamic field. It can adapt and is responsive to current events. Double Entry Book-Keeping Double Entry Book-Keeping states that for every transaction, there is a source and a resource. That is: RESOURCES = SOURCES Which turns into: ASSETS = LIABILITIES + OWNER'S EQUITY This is known as the Accounting Equation and always balances.
Assumptions in Accounting There are a few assumptions in accounting: Reporting Entity The enterprise which is being reported should be the same entity (Either the legal entity or the economic entity or both) The Legal Entity is the enterprise itself, such as Woolworths Ltd. The Economic Entity is the consolidated business, such as Woolworths Ltd and all it's subsidiaries. Monetary Assumption The universally accepted medium of exchange, such as cash, and in common denominators, such as the Australian Dollar, is assumed. Going Concern The report is prepared under the presumption that the business will continue to trade for the indefinite future. Period Assumption This assumes that reports are generated at set intervals (per month, year etc.) Historical Cost This assumes that transactions are initially recorded at the price they were bought for. Cash Accounting and Accrual Accounting Cash Accounting is when the transaction is recorded when the actual cash is received. Accrual Accounting records a transaction when it happens, not when the cash is received.
Week 2 – The Balance Sheet & Transaction Analysis The Statement of Financial Position The Statement of Financial Position (aka. shows an organisation's resources and claims on those resources at a particular point in time. Or ASSETS LIABILITIES OWNER'S EQUITY Important elements on the Balance Sheet include: The entity The date at which the statement was prepared The currency and amount Assets. Liabilities and Owner's Equity. The sheet shows an enterprises' assets. The Balance Sheet). the Balance Sheet shows the accounting equation: ASSETS = LIABILITIES + OWNER'S EQUITY The balance sheet is usually laid out in the following: ASSETS LIABILITIES OWNER'S EQUITY This emphasises the equality between Assets. Liabilities and Owner's Equity Australian Accounting Standards Board (AASB) Requirements The AASB101 requires that the following must be shown on the Balance Sheet: Assets Cash and cash equivalents Trade and other receivables Inventories Biological assets Investments Other financial assets ~5~ . liabilities and owner's equity. Owner's Equity can be described in different ways: A Company: Shareholder's equity A Sole Trader: Proprietor's equity A Partnership: Partners' equity Most importantly.
Liabilities A liability is defined by the AASB Framework as: "A present obligation of the entity arising from past events.AASB Framework ~6~ . A past event is usually a transaction such as the purchase of an item or through production. As long as it helps in generating future economic benefit (such as buildings). An item must meet all three requirements to be classed as an asset. the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. It must also be noted that persons cannot be considered assets. An asset should be recognised on the balance sheet if it is probable (more likely than not likely)that any future economic benefit associated with it will flow into the entity and that the asset has a cost or value that can be measured with reliability. it's realisable value (current or market value) (how much you can sell it for now).AASB Framework Control of an asset is not necessarily limited to legal ownership of the asset. plant and equipment Investment property Intangible assets Liabilities Trade and other payables Interest-bearing liabilities Tax liabilities Provisions Owner's Equity Contributed equity/Issued capital Reserves Retained profit Minority interest/Outside equity Assets An asset is defined by the AASB Framework as: "A resource controlled by the entity as a result of past events from which economic benefits are expected to flow to the entity. its present value (value in use) (the amount it can generate). it can be classed as an asset. The value of an asset can be measured through historical cost. or the current cost (the amount you have to pay to replace it today). Future economic benefit is the potential for the asset to generate profits/cash flows in the future." . Tax assets Property." . The asset does not actually need to generate a future economic benefit itself. as you do not control them.
it is considered a Non-Current Liability. Such as the planning of purchasing an asset in two years is NOT considered a liability) and the giving up of resources embodying future economic benefits is the payment of cash or the provision of services as obliged. A liability should be recognised on the balance sheet with the same requirements as that of an asset.A present obligation may be due in the near future (A present obligation is not a future commitment. "Double entry accounting". it is considered a Non-Current Asset. Non-Current An asset is considered current if it is: Expected to be realised within 12 months of the date Unrestricted cash or cash equivalent Held primarily to be traded Expected to be settled in normal business processes If it does not meet these criteria. Equity Equity is defined as: "The residual interest in the assets of the entity after deducting all liabilities" That is: OWNER'S EQUITY = ASSETS .LIABILITIES Current vs. ~7~ . A liability is considered current if it is: Due to be settled in 12 months of the date No right to extend the settlement date past 12 months Held primarily to be traded If it does not meet these criteria. liabilities and owner's equity. except with an outflow of cash and not an inflow. hence. The criteria for a transaction are: Exchange of economic value External to the entity Evidence of the exchange In dollars for quantification purposes Balance is always maintained in transactions. More on transactions is revealed in Week 3. Transactions A Transaction is an impact on the company's assets. There are always two or more things moving.
it presents the difference between revenues and expenses.EXPENSES Differences with the Balance Sheet: The income statement covers a period of time and not a point in time. Basically. The company is there to benefit shareholders but. Owner's equity can be decreased by distributions to owners. For us. it records the change in financial position of a business.The Income Statement & Transaction Analysis Relating Performance and Wealth A company's net assets (ie. we will focus on looking at the company's benefit to its shareholders. That profit can be distributed amongst shareholders as dividends.Week 3 . Retained Profit is when a company earns profit. NET PROFIT . some don't. does it benefit society? The community? The economy? The environment? Some do. dividends and unprofitable transactions and events. That is: PROFIT = REVENUES . ~8~ . The Statement of Changes in Equity Changes to owner's equity can be calculated in this way: Start of Year Balance Add Contributions (new share issues) Add Profit/Loss (Revenue . share capital and profitable transactions and events. Their Owner's Equity) increases in wealth as the company's wealth increases. The Income Statement) uses the accrual accounting principle and measures the financial performance of an enterprise over a period of time. Principally.Expenses) Add Increases in Reserves Less Distributions (dividends) ----------------------------------------------------= End of Year Balance Owner's equity can be increased by contributions by owners.DISTRIBUTIONS = RETAINED PROFITS It must be stressed that DIVIDENDS ARE NOT AN EXPENSE! The Statement of Financial Performance The Statement of Financial Performance (aka.
Both can have extensive explanatory notes which are referred to throughout the statement. They are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or liabilities that result in decreases in equity. Income can be further split into two categories: Revenue Revenue arises in the course of ordinary activity of an entity. They include sales. fees. royalties. Expenses Expenses are the opposite of revenues. however. The Statement of Financial Performance must include: Revenue Finance costs Share of the profit or loss of associates and joint ventures accounted for using the equity method A single amount that combines the post tax profit (loss) of discontinued operations and the post tax gain (loss) on the disposal of the related assets Tax expense Profit or loss The following may be shown on either the statement or the notes for it: Income or expenses items that are material Analysis of expenses Depreciation Amortisation Employee benefits Dividends to equity holders Elements of the Statement of Financial Performance Income Income increases with economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases in liabilities that result in increases in equity. The good or service has been delivered) It should be noted that revenue is any sort of inflow of economic benefits. other than those relating to contributions from equity participants (ie. rents etc. Gains Gains are no different in nature from revenue. gross profit. the inflow of money is still labelled as revenue. Revenue should be recognised if the good or service has been rendered (ie. other than those relating to distributions to equity participants. Even if the activity produces a net loss of equity. they may or may not arise in ordinary activities and are usually displayed separately in decision making. expenses. interest. Different types of data are displayed such as detailed revenue. Those from Owner's Equity). net profit and net profit before tax. dividends. ~9~ .
If a business continually classes the acquiring of an asset as capitalising (so that Owner's Equity is not affected). Cash vs.Capitalising vs. only when cash has been transacted. This can cause discrepancies when analysing statements and transactions. Expensing is when the transactions is seen as a deduction from cash and also a deduction in Owner's Equity. If it does not meet those requirements. Expanding the Accounting Equation Consider the Accounting Equation ASSETS = LIABILITIES + OWNER'S EQUITY We know what comprises of assets and liabilities: CA + NCA = CL + NCL + OE But what comprises Owner's Equity? Owner's equity is comprised of: Contributions by owners Retained Earnings Profit (revenue and expenses) Distributions ~ 10 ~ . the accrual profit is not the same as the cash profit. The incurrence of an expense is not necessarily accompanied by an outflow of cash nor is the earning of revenue necessarily accompanied by an inflow of cash. Under accrual accounting. When should something be recognised? Recognition should occur for revenue when a service has been performed and expenses when you expect to have incurred it. Accrual Profit An enterprise may post an accrual profit but not a cash profit if the cash has not been received after the day the statement was made. consider it under expensing. Recall the definition of an asset from last week. the business may get into serious problems later on. In short. They should be given asymmetric treatment. Expensing Capitalising is when the transaction is seen as a deduction in cash but an increase in asset which evens it out with no net change. You do not need to know when cash will arrive. This can create issues if there are large amounts of money involved but not very much with small amounts. cash flows are not necessary to recognise revenue and expenses.
The general rule of thumb is that Normal or Increases result in a Credit and a decrease results in a Debit. Double Entry Accounting: Transactions This is an extension of transactions we briefly introduced in Week 2.Expenses (E) .Hence. that being: ASSETS = LIABILITIES + OWNER'S EQUITY However. ~ 11 ~ . This provides us with the link between the Balance Sheet and the Income Statement.E . this is only different for Expenses. We already know of one example of double entry accounting. RE + RE + R . there is another example: DEBITS = CREDITS Debits are abbreviated to "Dr" Credits are abbreviated to "Cr" To consider what credits and debits do to each part of the accounting equation. however different parts of Owner's Equity have different effects on where to debit and credit. the final equation is: CA + NCA = CL + NCL + CC + Op.D Therefore. RE) + Revenue (R) .D We see the Revenue and Expenses are part of the Income Statement and the whole equation is part of the Balance Sheet. consult this table: Type of Account Assets Liabilities Share Capital Retained Profits Revenues Expenses Normal Debit Credit Credit Credit Credit Debit Increases result in Debit Credit Credit Credit Credit Debit Decreases result in Credit Debit Debit Debit Debit Credit *Note: The sections in italics are all part of Owner's Equity.Distributions (D) = CC + Op. RE + RE + R .E . Owner's Equity can be described as: Capital Contributions (CC) + Retained Earnings (RE) + Opening Retained Earnings (Op.
there has to be at least two effects. one debit. ~ 12 ~ . there must always be two or more effects. Also take note of the indents. One must be a credit activity and one must be a debit activity. They must also keep the accounting equation balanced. this helps to differentiate debits from credits and show that they balance more easily than if they were accounted for in a straight column. Remember that in every transactions. Journal Entries Journal Entries are small entries that document transactions with credits and debits. An example of a Journal Entry is as follows: ________________________________________________________ Date Debit Account Credit Account Short Statement of transaction PR PR $xxx $xxx ________________________________________________________ *Where PR = Posting Reference. one credit.Remember that in a transaction. This is usually provided for you in the example. such as "A1" or "E3".
"Framework for the Preparation and Presentation of Financial Statements" (Published July 2004 by the AASB) and is available at this link: http://www. Listed here briefly are the assumptions: Accrual Basis This simply means that financial statements should be produced under accrual accounting methods (to record transactions when they occur.au/pronouncements/aasb_standards_2005. The full set of reports (as required by the AASB) includes: The Balance Sheet The Income Statement The Cash Flow Statement (This uses cash accounting) The Statement of Changes in Equity (This is not discussed in ACCT1501. performance and cash flows to help the users of that information make good economic decisions.) Notes to these accounts and also other relevant material.com. not when the cash is received) so that they can meet their objectives. The notes to the accounts and reports are not required in a There is a demand for this information which stems from the need to make appropriate and reliable economic decisions for the firm.Week 4 – Financial Reporting Principles *Note: The entire first section of this week (everything before the accounting cycle) is explained in the document. look at the Week 1 notes. ~ 13 ~ . we will need to look at four areas: Underlying Assumptions Qualitative Characteristics The elements of the financial report Recognition Principles Underlying Assumptions The underlying assumptions are basically the same as those discussed in Week 1. For more details.htm What is Financial Reporting? Financial reporting is used to provide information about a firm's financial position. Going Concern Financial reports should be prepared under the assumption that the business that it is reporting on will continue to operate and function for the foreseeable future. The people demanding this information want to know about the: Performance of the firm Financial position of the firm Financing and investing with the firm Firm's compliance with laws Framework Within the AASB's framework.aasb.
It must be based on current information so that proper predictions can be made.e.This is so that the business has no assumed intention of liquidation or to scale back its operations. agreements may exist that ensure that the entity continues to enjoy the future economic benefits embodied in the asset. Relevance (Materiality) The information presented on the statements must be relevant to the time period that it is describing. then it need not be included. It should be objective).e. Prudence must be exercised in that assets or revenue or gains are not overstated and liabilities or expenses are not understated. The information in financial reports must also be complete within the bounds of materiality and cost. the reporting of a sale would not represent faithfully the transaction entered into (if indeed there was a transaction). may be a small level of bias allowed with small immaterial amounts such as those described above. but less professional users should be advised to seek professional advice.e. Information may be relevant and reliable but it may be immaterial. Relevant information that is complex should still be presented in statements. Reliability There should be a faithful representation of transactions and events (i. The way in which the information is displayed is vital to this (i. "If information is to represent faithfully the transactions and other events that it purports to represent. nevertheless. No material bias or error. however. There. an entity may dispose of an asset to another party in such a way that the documentation purports to pass legal ownership to that party. An omission can cause information to be false or misleading and thus unreliable and deficient in terms of its relevance. Transactions of small amounts). The relevance of information is usually classed by its materiality. In such circumstances. Qualitative Characteristics The accounting statements must fulfil a wide range of qualitative characteristics so that it can be understood by all. For example. it is necessary that they are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. The substance of transactions or other events is not always consistent with that which is apparent from their legal or contrived form. Logical sequence). If the item will not affect the user's decisions (i." @ ~ 14 ~ . These are: Understandability The statements must be able to be understood by a wide variety of people including professional accountants to high school graduates. Including this on statements may do nothing but impair its understandability.
The asset is always relevant to the accounting statements but its measurement is not always reliable. The firm should state which policy that it has used. The appropriate application of and the balance of qualitative characteristics will usually lead to this result. Relevancy Information that may be relevant can also be unreliable in nature. Another issue with this is usually with historical cost of assets. Financial reports should provide a fair and true view of the financial information of an entity. these should be mentioned on the notes of the statements. 3. the costs are not necessarily borne by those who will reap the benefits of that information. Benefits of Information The cost of providing the information to the user should never outweigh the benefits that can be derived from the information that is produced. Comparability The information that is generated by the firm must be able to be compared with those generated from other firms and to its own statements from earlier periods as well. There are some problems with this as evaluation of the information is largely by judgement. Cost vs. The Accounting Cycle The accounting cycle is a never-ending cycle of gathering economic information and presenting that to the users. 4. Information should always be relevant to when the statements were prepared and not for a period before. any changes to that policy and the effects of those changes. The cycle is: 1. Thus. 2. Appropriate balance must be maintained among these characteristics so that it can meet the objective of financial reports. This means that the information should be presented in the standards as set by the AASB. but its cost cannot be measured reliably. In the end. Reliability vs. there must always be a trade-off between the qualitative characteristics and this is often inevitable. The timeliness of the information also matters as the information will lose its relevance if there is a delay in reporting it. 5. Also. Such as a lawsuit against a company would be relevant to the users. Transactions Identifying and measuring (Source Documents) Recording (Journal Entries) Classifying and summarising (Ledgers and Trial Balances) Reporting (The Financial Statements) ~ 15 ~ . or representing it would be useless and/or potentially misleading to the users.
However. Journal entries were discussed in Week 3. Transactions are a vital first step to the accounting cycle and so must not be left out. They are usually identified by a single number and are listed in the accounting manual. As always. Transactions First. the problem with journal entries is that they only show the balance at any one point in time. invoices.1. Writing to a ledger can be in the same way as that of journal entries. revenue and expenses. Writing to the ledger is a very simple process of just transferring the information from journal entries directly to the ledger entry. please see Week 3's notes for more details. Debts and Credits to each of the accounts still follow the same rules as those for journal entries (See Week 3 notes). We need ledger accounts to show a change in balance over time (This is similar to how a balance sheet is to the income statement). Journal Entries From source documents. These are different for each firm and it does not matter how they list them. ~ 16 ~ . 4. A chart of accounts is basically. It shows a list of all accounts in assets. It is normally intended to enhance information. Source Documents Source documents are those that provide evidence that a transaction has taken place. the transactions are transformed into more classified and ordered information that is presented in journal entries. This includes things such as the use of office supplies and the depreciation of an asset. owner's equity. 2. Ledger Entries & Trial Entries A general ledger is a collection of all individual accounts for a business. Accounts are used to classify transactions and store information for similar transactions. liabilities. These include items such as cheque butts. bank statements etc. liabilities and owner's equity for a firm but the basic ones are assets. recall the definition of a transaction: "A transaction is an economic event that affects a business and needs to be reflected in its financial statements" Characteristics of an external transaction include: Exchange of items of economic value Past Event Involves a party that is external to the business Evidence Measureable in monetary units Internal transactions are adjustments made to records that introduce new data or alter that existing data. debits are placed on the left while credits are placed on the right. 3. These can be represented in Taccounts. a listing of all accounts in the general ledger.
Income Statement etc. ~ 17 ~ .There are other accounting formats used which includes the narrative format. this information is reported in the different forms such as the Balance Sheet. They are used to check the accuracy of ledgers and journals by seeing if the total debits equal the total credits. References @ Page 18-19. it is exactly the same as T-accounts. Trial entries are listings of all accounts with their related balances at certain point in time. Ways to recheck if the trial balance is not in the balance: Re-add the trial balance Check that the correct amounts are posted in the journal entries Check that each ledger is balanced correctly Check that everything balances in the journal entries 5.Published July 2004 . All it means is that there are no obvious errors in the documentation of journals and ledgers.Australian Accounting Standards Board. Although. Otherwise. Reporting Finally. Framework for the Preparation and Presentation of Financial Statements . This method is used more widespread than the T-account because it also includes a column at the right to show the net balance of the account after each debit or credit. even if all the debits equal the credits. it does not necessarily mean that it is correct.
it cannot be classed as revenue until the magazines have physically been sent out to the customers. we must find out how much should be written down as revenue and when. Revenue Recognition Revenue should only be recognised in the current period if it fits all four criteria: All or most of the good/service has been provided to the customer.Week 5 – Adjustment to Accounting Entries During the course of accounting. Expense Recognition Expenses should be recognised in the same period as when the revenue associated with it is recognised (i. remember that the accrual accounting system is used. First. As always. this is where accuracy matters. To recognise a revenue means to include it on the Income Statement for that period. Expenses are incurred for that period when there has been consumption or loss of economic benefit or service potential. ~ 18 ~ . For example: If a magazine company receives money for yearly subscriptions. such as pre-paid insurance. a business encounters inaccuracies due to the lack of time that is available to make this accurate. Adjusting the accounting entries is what makes this correct in the end. Whiteboard markers are not an expense until they have run out of ink or are lost.e. This shows a company's financial position and performance much more accurately.e. Recognising in this case is the same as revenue. it means it is included on the Income Statement for that period. The same thing is done with things that are expensed over time. By matching revenues to expenses. once at the end of the financial period. The matching principal). period assumption and going concern are also assumed. i. Revenue can be measured accurately. The company should show that the item's value is being used up each month instead of reporting on bigger loss at the end of the year. Costs to generate the revenue have been incurred and measured. Cash or a promise to pay has been received. A business with very accurate information would do more accounting than actually doing what the business is supposed to be doing! However. This can be divided up as staggered revenue for each individual magazine or as one entire subscription at the end of the year. Revenue is earned only when the goods and services related to the inflows of economic benefits or service potential have been provided. a better picture of the business is created. Buying an asset is NOT considered an expense until it has been used up.
however.) The accrual process here certainly does not imply that the receipt of cash and transactions are unimportant. This means we are forced to make estimates and assumptions. Often. Accruals Revenues Expenses Accrued revenues (an asset) Accrued expenses (a liability) Deferrals Unearned revenues (a liability) Prepayments (an asset) Unearned revenue is cash received but the good or service has not been provisioned yet to the customer. There are four types of accounts that must be adjusted at the end of the period.Adjusting The Entries The adjusting of entries is done at the end of the accounting period. He has paid for the service he wants but he is yet to receive that service from the firm. transactions recorded under the accrual process are removed from the physical reality of cash flows. Continuing on from the last example. it does make the accrual a weaker system. Accrued Expenses are when expenses are incurred in one period but the outflow of cash associated with it is not paid until the following accounting period. It may be classified as a current or non-current asset depending on how long the benefits are perceived to last for. ~ 19 ~ . Prepayments are the like unearned revenues but from the payer's perspective. Accrued Revenue is when the good or service has been provided but the cash will not be received until the next accounting period. which is assumed to be equal under the period assumption. prepayments are seen as an expense at first until the goods and services arrive. It is also known as: Revenue received in advance Advances from customers Customer Deposits An example would be a customer buying a plane ticket for next month from your firm. Cash is the life of a business and that is why it should never be regarded as insignificant. Note that these can be done in the reverse as well. This would be unearned revenue for you because you have yet to provision the plane journey for the customer. They can also split this into two parts: part prepayment and part expenses. It is intended to yield us a better picture of the performance of the business. (For example: The wages earned by an employee at the end of the last period. particularly in the short run. Sometimes. this would be from the customer's view. at which then they are not considered expenses anymore. This is considered an asset because you have already paid for goods but they have not been received yet.
all expenses should be grouped together. This has the nice effect of allowing us to both reset the temporary accounts and also provide us with the retained profit or the loss for that accounting period. In the next period. It must be emphasised that the remaining amount in the Profit & Loss account should always equal the balance in the Income Statement. they must be set back to zero in preparation for the next accounting period. To set these accounts to zero. closing entries is the completion of the following: Closing the temporary accounts (Revenue. After adjusting the entries and then closing them. This is a good way to check that the closing process has been completed correctly. These accounts only have meaning when they are used in conjunction with the control account for which they are matched with. Expenses and Dividends. Expense & Dividends/Drawings) Completing the journal entries Posting to the ledger Preparing a post-closing trial balance. expenses and dividends have been closed. We make these equal by crediting or debiting the remaining about to the Profit & Loss Account. all that remain should be the Balance Sheet items. The two most common contra accounts are: Accumulated Depreciation (Control Account: Plant. then a mistake has been made in closing the temporary accounts. and only then. All revenue should be grouped together and similarly. should these two accounts be closed. Contra Accounts Contra accounts are accounts which are used to keep accruals from being mixed with the control accounts. we can then prepare the balance sheet and the income statement for that period. ~ 20 ~ . Accounts should not be closed individually to the Profit & Loss account because it would consume too much time and resources. all revenue and expense accounts should start with a zero balance. They have the opposite balance of their respective control accounts that they are linked to (For example: DR$1000 in the control account and CR$1000 in the contra account). Property & Equipment) Allowance for Doubtful Debts (Control Account: Accounts Receivable) Summary In short. In this way. Post-Closing Now because revenues. If this is not true. we can calculate the retained profit for that period. the credits must equal the debits. Temporary accounts are only related to the current period they are in and they include: Revenue.Temporary Accounts These are temporary accounts and at the end of the accounting period.
Warranty Expense etc. these journal entries MUST include a movement in Cash. and it has no right to not pay the amount owed from the transaction. and that the cash for that transaction will be received at a later date. 2.1. Example Expense: Dr Office Supplies Expense Cr Cash By recognising both the revenue and expense at the same time as the cash flows. probably because of a past transaction. Recognising an expense or revenue at the same time as the cash flow Example Revenue: Dr Cash Cr Sales Revenue Although the expense to match this is usually put together. Example Expense: Dr Expense Cr Accounts Payable This is basically the same as the above. Example Revenue: Dr Accounts Receivable Cr Revenue This just shows that revenue has been recognised. these two are just the "cashing" of the payable/receivable accounts that occurred in Part 2 journals. 3. it is usually considered a recognition of expense after cash flow. Collecting cash from previously recognised revenues and expenses Example Revenue: Dr Cash Cr Accounts Receivable Example Expense: Dr Accounts Payable Cr Cash Basically. but a reasonably high probability cash will be received). The firm now has a liability to pay this. Recognising an expense or revenue before cash flows These are usually purchases on credit. probably due to a transaction. except from the other point of view. Other examples of such expenses include: Tax Payable. This is only done if the inflow of cash is guaranteed (not always as the owing party may go bankrupt. ~ 21 ~ .
This usually occurs when a firm is paid by the consumer the amount for a certain good/service but that certain good/service has not yet been provisioned.4. Cash flow before a recognition of a revenue or expense Example Revenue: Dr Cash Cr Unearned Revenue (Liability) Unearned revenue can also be identified as: "Revenue received in advance". another example of an expense recognised after cash flow is: Dr COGS Cr Inventory Which is the expense that matches the revenue gained in: Dr Cash Cr Sales Revenue ~ 22 ~ . If the firm pays for something but does not actually receive it. Example Expense: Dr Prepayment (Asset) Cr Cash This is the same as the revenue example except from the consumer's point of view. Recognition of a revenue or expense after cash flow Example Revenue: Dr Accrued Revenue (Asset) Cr Revenue Example Expense: Dr Depreciation Expense Cr Accumulated Depreciation (Contra) Dr Insurance Expense Cr Prepaid Insurance These two are the recognition of an expense as explained for the recognition of an expense with a cash flow before. 5. then this applies. As mentioned before. The recognition of depreciation (with assets) is deferred until that period so that these expenses can be matched with the revenue that generated them.
3. It is temporary.) Each worksheet has 10 columns (or 5 sets of 2 columns each).Adjustments Calculate your adjustments and input it into the worksheet. 5. ~ 23 ~ .Putting your IS accounts in the worksheet. all there is left to do is to transfer all information from the IS and Bs columns to their respective financial statements. in the correct format. Each set must have a debit and a credit column: 1. 4.The Trial Balance From the general ledger. Matching expenses Adjusting for prepayments (asset) for expenses and recording accrued expense (liability). The worksheet greatly simplifies the process of preparing financial statements. Trial Balance Adjustments Adjusted Trial Balance Income Statement Balance Sheet After worksheet. Step 3 .Closing Entries Step 5 . much like revenues and expenses are for that certain accounting period. 2. Step 2 . is a six-step process and is NOT a permanent accounting record (ie. Steps in creating the worksheet Step 1 . Step 6 .Week 6 – Completing the Accounting Cycle The Worksheet The worksheet lists all the accounts vertically down the page starting with the: Current assets Non current assets Current liabilities Non-current liabilities Owner's equity Revenue Expenses The worksheet is an optional. you get your "pre-adjustment" end of June balance.Calculating your adjusted trial balance Step 4 .Putting your BS accounts in the worksheet. Adjusting the Entries Adjusting entries are needed for: Recognising revenue You need to adjust your unearned revenue (a liability) and recording your accrued revenue (revenue that has been earned but not yet in the books that is an asset).
Expenses can be classified into: Selling expenses Administration expense Financing expenses Other expenses Types of systems to create a worksheet are: Manual (Mostly for small businesses) Mechanical (For larger businesses as these are machine prepared ledgers/journals/worksheets etc. Relevant general ledger accounts are called as Control Accounts. Debtors.Preparing the Financial Statements It is very important to classify your accounts properly such as "Cash at Bank". it would be very long. General ledger accounts are supported by subsidiary ledgers: which are a set of ledger accounts that collectively represent a detailed analysis of one general ledger account. Subsidiary Ledgers These are detail information about certain general ledger accounts and are recorded outside of the general ledger.) Computerized Special Journals and General Journals Special Journals Group the most commonly used transactions into special journals such as: Sales journal For sales of items on credit Purchase journal For purchases on credit Cash receipts journal Cash payments journal The advantage of special journals is that the amounts are posted to the general ledger as totals rather than thousands on small individual journal entries. The total of subsidiary ledger should equal the balance of relevant general ledger accounts (control account) after posting. Therefore. Subsidiary ledger are used for a number of general ledger accounts: ~ 24 ~ . The small written component of a journal which states what has happened in the transaction). not just "Asset". Had each person had their own account on the general ledger. Special ledgers are used to minimise the amount of things listed on the general ledger. more than one user can update accounting system and there is no need for narrations (ie. These are used in conjunction with subsidiary ledgers. e.g.
post information to the related customer's account (ie. Raw materials inventory: separate for each type of material Finished goods inventory: separate records of each type of finished goods held. Check total of subsidiary ledger against the accounts receivable control account. At the end of each month. post the totals for the period to the general ledger. Cash Payments Journal This records all cash outflows. Creditors/accounts payable: separate account for each creditor. Property/plant/equipment: for each piece of property. Sales invoice). It includes debit and credit columns. including cash purchase and disbursements. It includes debit and credit columns. Post column totals to the general ledger at the end of the month. customer name and amount from sale (These are usually from the source documents ie. At the end of the month. The Types of Special Ledgers Sales Journal This records the credit sales of inventory. Cash Receipts Journal This records all cash inflows. Post column totals to the general ledger at the end of the month. At the end of each day. The procedure is to: Post amounts in accounts receivable column daily to the subsidiary ledger. post the totals to the general ledger. Purchase Journal This records purchases of inventory on credit. The procedure is to: Enter invoice date. invoice number. Debtors/accounts receivable: separate account for each debtor. supplier's name. credit terms and amount of purchase (Usually from source documents). information should be posted to the related supplier's account in the subsidiary ledger. For some company in the subsidiary ledger). The procedure is to: Enter date of sale. General Journals are used for all other transactions including: Sales returns and purchase returns Credit transactions including other than those related to inventory such as the purchase or sale of equipment on credit Adjusting and reversing entries Closing entries ~ 25 ~ . The procedure is to: Post amounts in accounts payable column daily to the subsidiary ledger. Check total of subsidiary ledger again the accounts payable control account. including cash sales. At the end of each day.
These often include a description of the internal control system. The company will always try to maintain the fund at a specified amount. Vouchers usually provide evidence for the amounts spent. fraud that can take down the business. computer fraud and mistakes. Usually. Cash should also be physically stored safely such as in safes. It is both liquid and anonymous. Different employees should be used to handle and record cash. It contains a limited amount of funds (float) to cover payments for a short period of time. Such as: collusion among employees. Control of Cash Cash is one of the firm's most vital asset and it also has the highest inherent risk. two or more authorized people must sign a cheque for it to be able to be cashed at the bank.Week 7 – Accounting Cash Holdings & Receivables Internal Control Key elements include: Efficiency in the environment An information system for cross checking records Policies and procedures for this Competent employees (That can easily pick up errors and problems) Clear responsibilities Division and rotation of duties Companies can go bankrupt and out of business all because of one employee. This ensures that no one employee can directly commit. Petty Cash Fund A petty cash fund is set up to handle small cash expenditures. such as for miniscule amounts of $100. Always stamp documents so they are not paid twice. This results in frauds that people will not pick up except for the employee who does the records. ~ 26 ~ . It is not feasible to write a cheque for such a small amount. Physical controls and the separation of duties is usually very important. and also to receive and pay cash. himself. The fund is created by cashing a cheque from the company's regular bank account. This is usually a result where there is no division and rotation of duties in keeping the accounting records. Remember that no internal control system is without its imperfections. Disclosure in Annual Reports ASX listed companies have a requirement to include a section on corporate governance.
External are statements from banks. For each credit customer.) and the risk of not being paid. credit limit. Check off the same items in your CPJ/CRJ and the bank account. This benefit comes with costs such as: additional record keeping.Reconciliation The internal accounting records should be compared with external evidence. Ie. We sell on credit because we can earn more revenue by selling to customers who wish to buy on credit. 3. Such cases are where the customer goes bankrupt or refuses to pay. This then becomes a matter of adjusting the journal entries to account for these bad debts. Update the CPJ/CRJ to reflect this adjusted cash balance. These are made when an entity makes a sale on credit. payment history and outstanding amount. suppliers. Unpresented cheques and outstanding deposits. credit status. They represent differences between the adjusted cash balance and the balance as per the bank statement. address. creditors. thus. Items in the bank statement that have no been ticked represent new information that potentially affects the cash balance in our records (Information asymmetry). 2. ledgers etc. There must be the creation of an "allowance for doubtful debts". Items ticked in our records but not the bank are those that have timing issues. but not usually in the bank statement. Receivables These are also known as Accounts Receivables. debtors. debtors etc. ~ 27 ~ . Refer to QMA. the customer's name. DDs) Timing Issues Events in the CPJ and the CRJ are recorded. They would not show in our books (such as bank fees. Ask the question: Do they agree with each other? Internal are cash journals. 4. Satisfying a larger market. Two possible approaches to this are the direct write-off method and the allowance method. the business can get (from the credit company). trade debtors and trade receivables. Errors made by the bank or yourself in the books. the company is taking a credit risk. Bank Reconciliation Steps: 1. There is always an expectation that some people will not pay. Reasons for the difference Information asymmetry Events in the bank statement are usually not in our records. the time value of money (PV/FV.
Collection of Bad Debts If a bad debt can suddenly be collected. which is done in a two stage process. The aging method determines the desired balance for the Allowance of doubtful debts account. This is not represented with the direct write-off method. we create an "allowance for bad debts". Thus. We want the balance sheet to show net realisable value of accounts receivable. Ageing method (BS Approach) This assumes that the longer a debt has not been collected. The Matching Principle). The longer the particular debt. ~ 28 ~ . Ie. the longer the time the debt has not been paid. This method is rarely used because it doesn't give a full picture of what accounts receivable are worth. crediting the allowance for DD. We can then use this information to set the allowance for doubtful debts. Similarly. For example: from past experience. Allowance Method This method is to estimate the year's bad debt expense. Debit the bad debts expense and credit the accounts receivable for the company in question to write off this bad debt. Plant and Equipment. we can deduce that 2% of all credit sales will be bad. by determining the allowance and writing off the bad debts against the allowance. It's use may be justified if the amounts are not material (ie. then we must reinstate the receivable and record the collection of cash. the higher the allowance factor for the debts. the more allowance factor is given to that certain debt. In short. The problem here is that we are always unsure of what exact amount of debts are bad. the more likely it is that it will not be paid off. Contra Accounts Both these methods use contra accounts which is reported as a deduction from a related account.Direct Write-Off Method Debt is written off as bad when management has direct evidence to suggest that the debt in question is highly unlikely to be repaid or is significantly impaired. It does not relate expense to revenue that has been earned (ie. Allowance for doubtful debts is a contra account for accounts receivable. Accumulated depreciation is a contra account for Property. not a physical amount of cash. then debit the cash and credit the accounts receivable. Allowance factor is a percentage here. We do this by debiting the accounts receivable. Two methods to estimate the allowance for doubtful debts are: Net credit sales method (IS Approach) This assumes a certain level of credit sales will cause a given level of bad debts. Miniscule) and will not adversely affect decision makers. These accounts are generally found in the asset part of the BS with a credit/negative balance.
Financial Ratios Accounts Receivable Turnover Ratio (Debtors Turnover) Credit Sales -------------------Trade Debtors Days in Debtors (Average Collection Period/Days sales in receivables) 365 ----------------------Debtors Turnover ~ 29 ~ .
Week 8 – Accounting for Inventory Inventories are assets that are held for sale in the normal course of the business. Disclosure of this is required under accounting policies. Such as a car would be a long-term asset for most firms but would be inventory for a car retailer. Types of Inventory Types of inventory include: Raw materials WIP Finished goods inventory Merchandise inventory (These are inventory that umnare purchased for the sole purpose of reselling. Inventory Controls These include: Physical safeguards Inventory level Record-keeping as opposed to reporting. What is defined as inventory depends on what the business type is. Minus from this. any discounts and the likes. labour and overhead The COGS for each unit of inventory may not be the same as the costs of raw materials. The cost of inventory The cost of the purchase can be defined with: Purchase price Import duties and other taxes Inward transport and handling costs ONLY (Outward transport is defined as an expense) Any other costs associated with acquiring the item(s). depending on which is less (Prudence principle). Measurement and disclosure of inventory Either the cost or NRV or the item. ~ 30 ~ . The cost of conversion can be defined with: Cost of raw materials. labour and overhead can change at anytime during the course of the business.) Usually one of the largest resources for retail and manufacturing firms. The total carrying amount of inventory is the price and the expense of it is found in COGS. Such as what a retailer does.
this is a much cheaper method to maintain inventory than by using the perpetual method. Periodic inventory system Inventory is only updated at the end of the financial period and is determined by an inventory count (ie. Stocktake). however. There is always a COGS expense account. It lacks the parallel record keeping that is found in the perpetual system and what COGS is must be deduced. there is a Total inventory control account in the general ledger and subsidiary accounts for individual inventory items. contra purchases account under periodic system. It. COGS has to be derived here instead of being calculated automatically in the perpetual system. Management objectives Cost Purchase returns and allowances are not a separate account under the perpetual system as it affects the inventory account. It determines exactly how many items that SHOULD be on hand at any time.Perpetual inventory system The inventory account is updated the same time as the transactions are made. However. However. In such a case: Perpetual Dr Accounts Payable Cr Inventory Periodic Dr Accounts Payable Cr Purchase returns and allowances (Contra) To pay Accounts Payable: ~ 31 ~ . These include: The type of inventory The sophistication of the information system used to keep such records of inventory. makes it easier to account for losses. In relation to ledgers. The choice of inventory system The choice of which inventory system to adopt depends on many factors. These are: Purchases Sales Purchase returns Sales returns It provides better control but is much more costly than the periodic method as it requires entries each time inventory is updated.
The customer would receive a reduction in price of the good or a refund.Under both perpetual and periodic systems Dr Accounts Payable Cr Cash Cr Discount Received For sales on credit: Perpetual Dr Accounts Receivable Cr Sales Dr COGS Cr Inventory Periodic (As this system does not account for COGS) Dr Accounts Receivable Cr Sales Sales returns and allowances This is when the customer returns goods because they are either incorrect or faulty. In the periodic system: Opening inventory + Purchases + (Freight costs) . The journal entry to record this would be: Perpetual Dr Sales returns and allowances (Contra) Cr Accounts Receivable Dr Inventory Cr COGS Periodic Dr Sales returns and allowances (Contra) Cr Accounts Receivable Presenting in the Income Statement In the perpetual system: Sales revenue Less: Sales returns and allowances Net sales revenue Less: COGS Gross profit The COGS account must be closed to the profit and loss summary account.(Returns) = Cost of goods available for sale .Closing inventory ~ 32 ~ .
Some complications with the periodic system of generating COGS include: Costs involved with inward freight charges. This creates complications in accounting for the closing inventory balance and COGS associated with it. often. Physical Flow Method You would have probably sold the most recent inventory as those were the last to be put into storage. So for the periodic system: Sales revenue Less: sales returns and allowances Net sales revenue COGS: Cost of Opening inventory Add: Cost of purchases Less: Purchase return Cost of goods available for sale Less: Cost of ending inventory COGS Gross Profit Closing entries for COGS under the periodic system are: Dr P&L Summary Cr Inventory Dr P&L Summary Cr Purchases $opening balance $purchases for the period Dr Inventory $count(closing balance) Cr P&L Summary Cost flow assumptions We assume. So when inventory is stored for later use or sale. Cost Flow Method Some assumptions: First-in. items with different costs can be mixed together. Purchases that are returned are not available for sale. first-out (FIFO) Last-in. that inventory purchases are made at various times during the year where the price of these items may vary. first-out (LIFO) Weighted average (periodic system) Moving weighted average (perpetual system) Specific identification ~ 33 ~ .
FIFO Here. It results in a higher reported COGS and lower inventory balance than other methods in times in inflation. ~ 34 ~ . the ending inventory is assumed to consist of the latest inventory units. Inventory Measurement as required by AASB102 The lower of cost or net realisable value (It should be written down as in accordance with the prudence principle). *Note: Remember that FIFO and LIFO are cost flow assumptions that do not necessarily represent the true physical flow of inventory through the firm. This is NOT permitted under the AASB. highest gross profit. This does not necessarily match the physical flow of inventory. Weighted average results fall between FIFO and LIFO. This results in a higher profit level during times of inflation. lowest net profit and the highest COGS. This also results in an outdated inventory balance. This results in a lower profit during times of inflation. This is simple to apply and less subject to profit manipulation that FIFO or LIFO. it is popular in the US where it can help to minimize loss of cash to tax. Therefore. LIFO results in the lowest ending inventory. the ending inventory is assumed to be the earliest acquired units. lowest gross profit. Therefore. LIFO This assumes that the last goods purchased are the first goods to be sold. highest net profit and the lowest COGS. we assume that the first goods purchased are the first goods to be sold. Comparison of the two methods In periods of inflation: FIFO results in the highest ending inventory. It is a suitable assumption for perishable items or items that are subject to becoming obsolete. however. Weighted average and moving average The weighted average (Periodic) Total cost of goods available for sale for a period Unit cost = ---------------------------------------------------------------------Total number of units available for sale for a period The moving weighted average (Perpetual) Recalculate the average cost after every purchase of inventory. Cost of purchase for the retailer as mentioned above.
Balance Sheet Presentation Inventory should be split into: Current Non-current assets Sub-classified in manner suitable to operations. (Any other method than selling it and writing it down.Why would NRV<Cost? A fall in selling price Physical deterioration of inventories Obsolescence of product Demand A short-term decision to sell at a loss Miscalculations or errors in purchasing or production How to write-down inventory Dr Inventory write-down expense Cr Inventory When goods are stolen. We show the carried amount of each inventory that we have. We determine the ending inventory at retail prices and then convert this amount into a cost basis. destroyed by fire etc.) Dr Inventory losses expense Cr Inventory Estimating Ending Inventory There are two methods to estimate the ending inventory: Gross Profit Method This is based on the assumptions of : Beginning inventory + Net purchases . ~ 35 ~ .Gross Profit %) Retail Inventory Method This is usually for retail firms with high volumes or sales as it assumes an observable pattern between cost and price.COGS = Ending inventory As COGS is not found in the periodic method. we find it by using: COGS = Sales x (1 .
Financial Ratios Inventory Turnover COGS ------------------------Average Inventory Days in Inventory 365 ------------------------Inventory turnover ~ 36 ~ .
its present value (value in use) (the amount it can generate). The asset does not actually need to generate a future economic benefit itself. as you do not control them. Current vs.Week 9 – Accounting for Non-Current Assets I Assets An asset is defined by the AASB Framework as: "A resource controlled by the entity as a result of past events from which economic benefits are expected to flow to the entity. it can be classed as an asset. or the current cost (the amount you have to pay to replace it today). It must also be noted that persons cannot be considered assets. Future economic benefit is the potential for the asset to generate profits/cash flows in the future. it is considered a Non-Current Asset.AASB Framework Control of an asset is not necessarily limited to legal ownership of the asset. An item must meet all three requirements to be classed as an asset. it's realisable value (current or market value) (how much you can sell it for now). An asset should be recognised on the balance sheet if it is probable (more likely than not likely)that any future economic benefit associated with it will flow into the entity and that the asset has a cost or value that can be measured with reliability. ~ 37 ~ . Non-Current An asset is considered current if it is: Expected to be realised within 12 months of the date An unrestricted cash or cash equivalent Held primarily to be traded Expected to be settled in normal business processes If it does not meet these criteria. As long as it helps in generating future economic benefit (such as buildings). A past event is usually a transaction such as the purchase of an item or through production. The value of an asset can be measured through historical cost." . Using Non-Current Assets Non-Current Assets can be used to: Make products/services Protect or accommodate employees and equipment Transport inventory Complete tasks more efficiently Attract customers to the business Tangible and Intangible Assets Tangible assets are items that can be seen/felt physically whereas an intangible asset is not.
Installation. delivery. If it does not meet those requirements. Expensing (again) Capitalising is when the transaction is seen as a deduction in cash but an increase in asset which evens it out with no net change. to be prudent. ~ 38 ~ . the business may get into serious problems later on. Goodwill is the extra payment over the fair true value of a business when it is sold.Generally we do not recognise intangible assets on the balance sheet because their value is too hard to measure. Goodwill Goodwill is a form of intangible asset. it's realisable value (current or market value) (how much you can sell it for now). These include things such as: customer lists. its present value (value in use) (the amount it can generate). Cost of an Asset The value of an asset can be measured through historical cost. taxes and purchase price etc. distribution rights and publishing titles etc. Recall the definition of an asset. Anything that is directly related to the acquisition of an asset is part of that asset's cost (ie. insurance. donated or bartered. Expensing is when the transactions is seen as a deduction from cash and also a deduction in Owner's Equity. If a business continually classes the acquiring of an asset as capitalising (so that Owner's Equity is not affected). built. brands. or the current cost (the amount you have to pay to replace it today). All research costs must be expensed. put onto the balance sheet as an asset of the firm. Accounting for Acquisitions Assets can be acquired in a variety of ways which include: purchase. developed. Only when a business is bought/sold can goodwill can be assigned a value and hence. impairment or damage Obsolescence Capitalizing vs. consider it under expensing.) Changes to the recorded value of assets The amount of an asset can change over time due to: Betterment Revaluation Destruction. This can create issues if there are large amounts of money involved but not very much with small amounts.
These costs are unexpired because they have not been used yet.Property. Land is NOT depreciated.If an expenditure increases an asset's productivity. Natural resources are depleted and patents/copyrights are amortised. Plant & Equipment Cr Cash Repairs and Maintenance Dr Repairs & Maintenance Expense Cr Cash Using Non-Current Assets Most Non Current-Assets have a limited useful life as their value will start decreasing due to: Wear & Tear (That which cannot be restored by maintenance) Technological advances Commercial obsolescence (Fall in market demand for an asset) Depreciation Depreciation is defined as: "The systematic allocation of the depreciable amount of an asset over its useful life" . Plant & Equipment. the value of it decreases due to depreciation. It is a method used to reflect changes in "Value in use" and not "Value in exchange". then it is filed under Repairs & Maintenance and it should be expensed. They are associated with the revenues during an accounting period (Remember that we must match revenues with expenses.AASB 116 . useful life etc. Depreciable Amount This can be calculated by Cost less residual value. NOT valuation. If it keeps the same level. Residual value is the scrap value of the asset at when the asset is to be sold/scrapped etc. they are recorded at their acquisition cost at purchase (mentioned above). Unexpired and Expired Costs When assets are acquired. Expired costs include the costs of resources use up in an accounting period. ~ 39 ~ . hence Assets will decrease and Owner's Equity will also decrease as there is a consumption of economic benefit. Depreciation is a process of allocation.) Depreciation Concepts Over the life of an asset. Betterment Dr Property. Then it is a betterment and should be capitalised.
A diminishing balance should be used if it is assumed that the machine will consume more economic benefits in the earlier years than the later years. It should be: Dr Depreciation Expense Cr Accumulated Depreciation (Contra) Carrying amount (also known as book value. hence the depreciation expense is not the same each year. Some factors influencing this are: Expected usage of the asset Expected wear and tear Technological or commercial obsolescence Legal or similar limits on the use of the asset Adjusting in the Balance Sheet Do not modify the asset account directly as this would lose historical cost. Depreciation Expense = BV x (1 .e. However. Depreciation Expense = (Cost . it is not feasible to apply this method to all assets. I.Residual Value) / (Useful Life) Reducing Balance (Diminishing Balance) A single constant depreciation rate (percentage) is applied to the carrying amount each year. ~ 40 ~ . Straight-Line Depreciation This assumes an equal consumption of economic benefit every period I. If RV is zero. then a straightline method should be used.Useful Life This is the expected life of which an asset will be available for use by an entity measured in years. written down value or net carrying amount) is the acquisition value of the asset minus the accumulated depreciation. In this case. then the formula cannot be used. most firms use 150% of the straight-line depreciation percentage.e. Activity-based This provides a more theoretically correct way of depreciating an asset.[nth root](RV/Cost)) Book Value (BV) changes each time. Methods of Depreciation Depreciation can be done in two different ways: Time-based If a decline in value is expected to be equal across the entire life.
but only uses the other firm's method to contrast differences. Consistency A firm should. under all its will. is permanently changing the depreciation method used by a firm. there must be a way to reconcile this difference so that the financial statements of the firm itself and other firms can be compared properly. and even the firm itself. This means the firm should not constantly change between the methods as this would result in many irregularities when trying to compare between the firm's statements from different periods. If the rates or methods change. to compare the firm to another. try to be consistent in its choice of depreciation method. then the depreciation must be recalculated again using the new rate and/or method.Changes to the Depreciation Method Depreciation rates and methods must be reviewed at the end of every year. may use or change depreciation methods. Methods to Compare Financial Statements with Depreciation involved Because different firms. The firm still keeps its original depreciation method this way. Instead. ~ 41 ~ . the firm should change its depreciation method to match that of the firm that it is trying to compare to so that depreciation does not become a factor in the differences when contrasting the two firm's statements. Adjusting the Depreciation Method This. by no means.
An asset is usually sold on the date when depreciation is recorded. then profits could be overstated and assets overstated. Recording the sale of an asset To record the sale of an asset. another asset or a reduction in liability. The journal entry for this is: Dr Cash (or AR) Dr Accumulated Depreciation (Contra) Cr Asset Cr Gain on sale of NCA [If there is a gain from the sale of the asset] Or Dr Loss on sale of NCA [If there is a loss from the sale of the asset] Disposal of Non-Current Assets Disposal is when an asset is scrapped (ie. It will reduce your profit) Valuation of Plant. This may occur because of problems with the asset. the depreciation should be updated when it is sold. Not sold for any amount). hence. If this does not occur. The sale of an asset usually gives you: cash.e.Week 10 – Accounting for Non-Current Assets II Removal of an asset from the accounts Assets can be removed through sale or disposal. such as a fault that is unrepairable. The disposal of an asset will not yield any returns for the firm. the depreciation must be updated. Property & Equipment The cost of acquisition can be found by its: Cost This is the benchmark treatment where the carrying amount is equal to the lower of book value or the recoverable amount (the highest of "fair value less costs to sell" or "value in use") ~ 42 ~ .. or that it cannot be sold because there is no market for It. Steps to record a disposal Dr Depreciation Expense Cr Accumulated Depreciation (Contra) Dr Accumulated Depreciation (Contra) Dr Loss on Disposal Cr Asset *Note: Loss on Disposal is an expense (i. the proceeds then recorded and then the removal of the asset along with the recognising of gain or loss.
Revaluations can increase or decrease the value of an asset. That is. then all items in that class must be revalued as well. Fair value is considered as the estimated selling price obtainable in a arm's length transaction between knowledgeable and willing parties. This is called the impairment test. Nothing needs to be done if carrying amount is lower than the recoverable amount. The journal entries for this process is: Dr Depreciation Expense Cr Accumulated Depreciation Dr Accumulated Depreciation Cr Asset Then for a increment (Affects the Balance Sheet): Dr Asset Cr Revaluation Reserve (OE) For a decrement (Affects the Income Statement): Dr Loss on Revaluation (E) Cr Asset A decrement reflects the prudence principle as it does not overstate our assets or profits. an increment will not increase profits but a decrement will decrease profit as it is expensed. Only then must the remaining portion of the revaluation be put onto the opposite account (ie. then the asset must be written down. Accounting for Revaluation To account for a revaluation. Thus. If you took from "Revaluation Reserve" then the remainder should be added onto "Loss on Revaluation") ~ 43 ~ . Value in use is the present value of the future cash flows that are expected from an asset. If an item is to be revalued. If the carrying amount is higher than the recoverable amount. we must take from the "Revaluation Reserve" or "Loss on Revaluation" until it is zero. Fair Value This is the "Allowed Alternative" treatment where the carrying amount is determined through a revaluation. we must: Update depreciation Write back accumulated depreciation against the asset account Record the revaluation We ignore the effects of income taxes as this is far more advanced. Reversing a Revaluation An initial revaluation may need to be reversed in the future.
plus any extras.The effects of this should be the reverse of what the initial revaluation was. Dr Asset Cr Revaluation Gain Cr Revaluation Reserve ~ 44 ~ .
A liability should be recognised on the balance sheet with the same requirements as that of an asset. or the outflow of economic benefits is not definite.Week 11 – Accounting for Liabilities What is a Liability? A liability is defined by the AASB Framework as: "A present obligation of the entity arising from past events.) ~ 45 ~ . it is considered a Non-Current Liability. it is probable that economic benefits will flow out from the firm and that it has a cost or value that can be measured reliably. Financing Options Debt Legal or constructive obligations. Some examples include: Loan Guarantee (The guarantor here has a contingent liability because it may be probable that they will have to pay the amount and it may also be probable that he does not have to. except with an outflow of cash and not an inflow." . It is essential that the firm classifies its liabilities properly so that its users can assess the firm's liquidity and solvency. Equity Capital Same as OE. A liability is considered current if it is: Due to be settled in 12 months of the date No right to extend the settlement date past 12 months Held primarily to be traded If it does not meet these criteria. That is. Such as the planning of purchasing an asset in two years is NOT considered a liability) and the giving up of resources embodying future economic benefits is the payment of cash or the provision of services as obliged. Provisions Warranties are a provision. Contingent Liability A contingent liability is not recognized on the balance sheet probably because its cost or value cannot be determined reliably at the point in time. Hybrid Instruments Financing forms that exhibit both debt and equity characteristics.AASB Framework A present obligation may be due in the near future (A present obligation is not a future commitment. the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
I. The value of the PP&E is the present value of this which would be 10000(10000x12%x(90/360))=300) is: The entry at acquisition is: Dr Property.a.) Review of past period tax deductions (You do not know if you need to pay more tax or not. employee entitlements and warranties. Provisions These include dividends.) However.e. The journal entry to record the payment of the principal and interest at the maturity date from the borrower's perspective is: Dr Notes Payable Dr Interest Expense Cr Cash *NOTE: The number of days in a year can be simplified to 360 days for Accounting purposes.e. evidence is available). Current Tax Liabilities These are provisions for income tax and deferred income tax. as these are not recognized on the balance sheet. this is a change from a non-interest bearing liability (Accounts Payable) to an interest bearing liability (Notes Payable). The journal entry to record the issuance of a discounted note payable (This is like the future value of the asset.Law Suits (The amount to pay and also the need to pay will not be known until the law suit is settled. Interest Bearing Liabilities These must be supported by formal written documents and are usually in the form of notes payable (Accounts Payable is the non-interest bearing form of Notes Payable). Plant & Equipment ~ 46 ~ .000 for a 90-day note at a rate of 12%p. Common Liabilities Payables These are goods/services that have been received/supplied and have been invoiced (i. A yacht is exchanged for $10.Subsidiary Cr Notes Payable Therefore. Journal Entries for Interest-Bearing Liabilities (Current) The journal entry for the issuance of a note from what was Accounts Payable from the borrower's perspective is: Dr Accounts Payable . they must be mentioned in the financial statements (usually the footnotes) so that the decision-makers know of the probable outflow of cash in the future.
Discount Market Rate < Coupon Rate. Par To account for debentures. Market Rate > Coupon Rate.Dr Discount on Note Payable (Contra) Cr Notes Payable The entry at the year end is: Dr Interest Expense Cr Discount on Note Payable (Contra) The entry at maturity date is: Dr Note Payable Dr Interest Expense Cr Cash Cr Discount on Note Payable (Contra) Non-Current Liabilities Debentures These are interest-bearing long-term notes and are issued by companies and the government when large amounts of money are needed. Debentures issued at Par The journal entry to record the issue of debentures is: Dr Cash Cr Debentures To record semi-annual interest expense: Dr Interest Expense Cr Interest Payable Debentures issued at Discount The journal entry to record the issue of a debenture is: Dr Cash Dr Discount on Debenture (Contra) Cr Debenture ~ 47 ~ . higher return due to leverage and shareholder control is not affected. Premium Market Rate = Coupon Rate. The price depends on the coupon rate and current market interest rates for investments with similar risk. we need to consider many factors. This has many advantages including: tax savings. The price of a debenture is the present value of its future cash flow to investors.
The journal entry required at the end of the year is: Dr Interest Expense Cr Interest Payable Cr Discount on Debenture (Contra) To record coupon payments: Dr Interest Payable Cr Cash Debentures issued at Premium The journal entry to record the issue of a debenture is: Dr Cash Cr Debenture Premium (Contra) Cr Debenture The journal entry required at the end of the year is: Dr Interest Expense Dr Debenture Premium Cr Interest Payable (Contra) To record coupon payments: Dr Interest Payable Cr Cash *Interest Payable can be replaced with Coupon Payable. Working Capital Working Capital = Current Assets .Current Liabilities Current Ratio Current Ratio = Current Assets/Current Liabilities Quick Ratio Quick Ratio = (Cash + Market Securities + Net Accounts Receivable)/Current Liabilities ~ 48 ~ . Financial Statement Analysis Liquidity Ratios These ratios measure the ability of the entity to meet its current obligations.
Debt to Equity Ratio Total Liabilities / Total Owner's Equity Debt to Total Assets Ratio Total Liabilities / Total Assets ~ 49 ~ .Financial Structure and Solvency Ratios These measure the ability of the entity to meet its obligations in the long term.