Summary of Lecture: Introduction To Accounting and Economics

Topic 9 – Period-End Adjustments Introduction to Accounting and Economics
Introduction to Accounting
and Economics
Topic 9: Period-End Adjustments
V2.0 © NCC Education Limited
Period-End Adjustments Topic 9 - 9.2
Summary of Lecture
• Introduction
• Words you must know
• The accounting period
• Basic financial statements
• Period-end adjustments
• Basic financial statements that incorporate Period-
end adjustments
• Review of topic
V2.0 Visuals Handout – Page 1

Introduction
• This is the second stage of processing
accounting transactions
• The book keeping transactions must now

be related to an accounting period before
preparing financial statements
Words you must know

Accounting Period:
A defined period for which a business produces
financial statements. This is normally a period of
twelve months
Period-End Adjustment:
An adjustment designed to allow profit and
balance sheet values to be accurately calculated
Accruals: An accrual is a calculation of an item of expenditure

that has not been paid at the end of the accounting
period

Words you must know

Prepayments: A prepayment is a calculation of an item of
expenditure that has been paid within an
accounting period but which relates to a
subsequent accounting period.
Depreciation: A calculation designed to measure the use of

a long-term asset during an accounting
period.
Depreciation The amount of depreciation charged as an

Charge: overhead expense in the income statement.
Words you must know

Accumulated The cumulative depreciation that has
Depreciation: been provided in respect of long term
assets. This is shown on the balance
sheet.
Bad Debt: A receivable that will not be received by

the business.
Doubtful Debt: A receivable that may not be received by
the business.
Doubtful Debts An estimate of the amount of doubtful

Provision: debts.

Words you must know

Financial Reports providing information about the
Statements: financial performance and wealth of a
business.
Income A financial report showing how profit has
Statement: been calculated.
Balance Sheet: A financial report showing the wealth of a
business.
Extended Trial A trial balance that shows the effect of
Balance: Period-end adjustments. It is used to
calculate the final numbers for the financial
statements.
The Accounting Period

• This is a key concept in accounting
• Businesses must chose a period in order to
measure their performance
• This period must be of 12 months to comply with
business and tax regulations
• Each individual business is free to choose its own
period of 12 months
• This period does not have to coincide with the
calendar year

Basic Financial Statements
• Do you remember the business called

Marvel Mechanics from topic 8? You were
required to correct the trial balance
• Here is an example of some of their basic

financial statements:

Marvel Mechanics
Trial balance for the year ended
31 December 20x1
Debit Credit
£ £
Advertising 2 300
Bank 35 148
Capital 477 286
Cash Register 1 750
Computer 2 750
Electricity 2 854
Motor Vehicles 68 240
Payables 2 756
Purchases 37 500
Receivables 15 750
Sales 675 000
Telephone 2 250
Wages 108 000
Plant & Equipment 125 000
Property taxes 3 500
Freehold Premises 750 000
1 155 042 1 155 042

Income Statement
Marvel Mechanics
Income Statement for the year ended
31 December 20x1
£ £
Sales 675,000
Advertising 2,300
Electricity 2,854
Purchases 37,500
Telephone 2,250
Wages 108,000
Property taxes 3,500
Profit for the year 518,596
675,000 675,000

The Income Statement
• This is a very simple statement. It just shows sales
minus all the costs of operating the business
• Is there anything odd about the size of the profit

figure? We will look at this later
The Balance Sheet

• This shows the wealth of the business at the end of
the accounting period

The Balance Sheet

Marvel Mechanics
Balance Sheet as at
31 December 20x1 £ £
Bank 35,148
Cash Register 1,750
Computer 2,750
Motor Vehicles 68,240
Payables 2,756
Receivables 15,750
Plant & Equipment 125,000
Freehold Premises 750,000
Capital 477,286
Profit for the year 518,596
998,638 998,638

Example Balance Sheet:
• This shows the assets and liabilities and the capital
of the business at 31 December 20x1
• These financial statements are not very accurate.

They have been created by extracting numbers
from the accounting system
• Adjustments must be made to the numbers so that

they represent what has actually happened to the
business in the accounting period

Period-End Adjustments
• To record any additional or prepaid overhead charges. It is
often the case that overhead charges are paid in respect of
periods that do not coincide with the accounting year-end
• To adjust for inventories
• To record the depreciation charge (or charges) that need to

be made in respect of long-term assets
• To record any accounting provisions such as an allowance for

receivables which may not be received
Additional or prepaid overhead charges
• An overhead charge is a cost of running the business
Example
• Electricity
• Bill to Marvel Mechanics in March 20x2 for the three months
December 20x1, January 20x2 and February 20x2
• The December 20x1 charge for electricity must be calculated
• £750 x1/3 = £250

Inventory
• In its simplest form an inventory is a stock of items purchased
that has not been used up at the end of the accounting period
Example
• For Marvel Mechanics, assume that £5000 of the items
purchased have not been used at the year end
• The £5000 will be reported as inventory on the balance sheet
and purchases will be reduced by £5000
Depreciation
• Can you identify the long- term assets used by
Marvel Mechanics?
• These are:
- Cash register
- Computer
- Motor vehicles
- Plant and equipment
- Freehold premises

Depreciation
• These assets are wearing out as they are
used in the business. An estimate of this
wearing out must be calculated and shown
in the income statement and the balance
sheet as depreciation
Depreciation
• There are three elements to the calculation of
depreciation:
- An estimate of the useful working life of the asset in the

business
- An estimate of the scrap or residual value of the asset at

the end of its useful life
- A choice of depreciation method

Depreciation
• The estimates of useful life and scrap value
(if any) are judgements made by business
managers and their accountants
Methods of Depreciation
• There are many methods that can be used
to provide depreciation but the most
commonly used are:
- The straight line method
- The reducing balance method

The straight line method:
• The calculation is simply cost of the asset

minus its scrap value divided by its useful
life
• This will give an equal annual depreciation

charge over the life of the asset
The reducing balance method:
• This charges proportionally more depreciation in

the early years of the asset’s life
• This calculation is more complex: first a

depreciation rate must be calculated and this is
applied to the cost of the asset minus any
depreciation charged in previous years

Period-End Adjustments:
Depreciation
Marvel Mechanics
Long-term assets Scrap Depreciation
Cost Useful life value Method
£ Years £
Cash Register 1,750 5 0 Straight line
Computer 2,750 2 0 Straight line
Motor Vehicles 68,240 4 10,000 Reducing balance
Plant & Equipment 125,000 5 25,000 Reducing balance
Freehold Premises 750,000 25 50,000 Straight line
Depreciation
Marvel Mechanics 20x1 Net
Long-term assets Depreciation book
Cost charge value
£ £ £
Cash Register 1 750 350 1 400
Computer 2 750 1 375 1 375
Motor Vehicles 68 240 25 931 42 309
Plant & Equipment 125 000 34 375 90 625
Freehold Premises 750 000 28 000 722 000

Depreciation
Straight line depreciation:
= Cost - scrap value

Useful life
Depreciation
Straight line depreciation
• Cash register (£1 750 – 0) /5
= £350
• Computer (£2 750 – 0) /2
= £1 375
• Freehold premises (£750 000 –50 000)/25
=£28 000

Depreciation
Reducing balance depreciation
• Calculating the rate of depreciation follows a
formula involving the cost of the asset, its useful life
and any residual value. Students do not need to
know this calculation as the depreciation rate will
be given in any question.
• In this example, the depreciation rate for motor
vehicles is 38% reducing balance.
Reducing Balance Depreciation

Example: Motor vehicles
Depreciation 20x1
- £68 240 x 38% = £25 931
Depreciation 20x2
- (£68 240 – £25 931) x 38% = £16 077

Depreciation
• Net result of calculations:
Marvel Mechanics 20x1 Net
Long-term assets Depreciation book
Cost charge value
£ £ £
Cash Register 1 750 350 1 400
Computer 2 750 1 375 1 375
Motor Vehicles 68 240 25 931 42 309
Plant & Equipment 125 000 34 375 90 625
Freehold Premises 750 000 28 000 722 000
Depreciation
Net result of calculations
• This will appear in the balance sheet and the
depreciation charges will appear as overhead
expenses in the income statement
• The balance sheet values for depreciation will be

called accumulated depreciation and the income
statement values for depreciation will be called the
depreciation charge

Receivables
• Receivables represent money owed to the
business. It may be that a debtor (someone that
owes you money) will just not pay you. In this
situation you have what is called a bad debt
• To adjust for bad debt, you reduce the value of

receivables by the amount of the bad debt and
show this amount as a charge in the income
statement
Bad debt adjustment = Receivables – Bad debt
Receivables
• You may be in a situation where you don’t

know who will pay you and who may not
• In this situation you have what are called

doubtful debts

Receivables
Adjusting for doubtful debts
• Create a doubtful debts provision
• Estimate the percentage of your receivables that

may not be paid
• This value then becomes a provision that sits on

you balance sheet as a permanent deduction from
receivables. Any increases or decreases in this
provision are reflected in the income statement
Period-End Adjustments: Receivables

£
Receivables at 31 December 20x1 15 750
Bad debt 750

15 000
Provision for doubtful debts
15 000 x 10% 1 500
Presentation in financial statements

£
Income statement (extract) 20x1
Bad debt 750

Increase in doubtful debts provision 1 500
Balance sheet (extract) 20x1 £
Receivables 15 000
less: doubtful debts provision 1 500
13 500

Correcting Errors
• This is the final period-end adjustment
• Marvel Mechanics: an error has been found
Correcting Errors
Error
• The sales figure has been overstated by £300 000 because
an invoice total of £33 000 had been entered as £333 000
Adjustment
• We need to reduce sales by £300 000
• When we corrected the trial balance the capital account was
a balancing figure
• Therefore we need to increase the capital account balance by
£300 000 as the original balancing figure was incorrect

Marvel Mechanics
Summary of period end adjustments £

Accrual for electricity 250
Prepayment for advertising 500
Inventory 5,000
Depreciation
Cash Register 350
Computer 1,375
Motor Vehicles 25,931
Plant & Equipment 34,375
Freehold Premises 28,000
Receivables adjustments
Bad debt 750
Increase in doubtful debts provision 1,500
Error correction
reduction in sales and capital account 300,000
Basic Financial Statements that

show Period-End Adjustments
• A good method of making sure that we

include all the relevant Period-end
adjustments and calculate the correct
numbers for the financial statement is to
use something called an extended trial
balance

Extended Trial Balance

Marvel Mechanics
Extended trial balance for the year ended 31 December 20x1
Account names General Ledger Adjust- Adjust- Income Statement Balance Sheet
Balances ments ments
Debit Credit Debit Credit
£ £ £ £ £ £ £ £
Accruals
Accumulated Depreciation:
Cash Register
Computer
Freehold Premises
Motor vehicles
Plant & Equipment
Advertising 2 300
Bad debts
Bank 35 148
Capital 477 286
Cash Register at cost 1 750
Computer at cost 2 750
Depreciation Charge:
Cash Register
Computer
Freehold Premises
Motor vehicles
Plant & Equipment
Doubtful debts provision
Electricity 2 854
Freehold Premises at cost 750 000
Increase in doubtful debts
provision
Inventory in income statement
Inventory in balance sheet
Motor vehicles at cost 68 240
Payables 2 756
Plant & Equipment at cost 125 000
Prepayments
Purchases 37 500
Receivables 15 750
Sales 675 000
Telephone 2 250
Wages 108 000
1 155 042 1 155 042 0 0 0 0 0 0
Profit for the year 0

0 0 0
0
0
Please enlarge on screen for
student viewing
Marvel Mechanics
£ £ £ £ £ £ £ £
Accruals
Cash Register
Computer
Freehold Premises
Motor vehicles
Plant & Equipment
Advertising 2 300
Bad debts
Bank 35 148
Capital 477 286
Cash Register at cost 1 750
Computer at cost 2 750
Cash Register
Computer
Freehold Premises
Motor vehicles
Plant & Equipment
Doubtful debts provision
Electricity 2 854
Freehold Premises at cost 750 000
provision
Inventory in income statement
Inventory in balance sheet
Motor vehicles at cost 68 240
Payables 2 756
Plant & Equipment at cost 125 000
Prepayments
Purchases 37 500
Receivables 15 750
Sales 675 000
Telephone 2 250
Wages 108 000

1 155 042 1 155 042 0 0 0 0 0 0 student viewing
Profit for the year 0 0
0 0 0 0


Marvel Mechanics
Summary of period end adjustments on
extended trial balance Debit Credit
£ £
Accrual for electricity
Electricity 250
Accruals 250
Prepayment for advertising
Prepayments 500
Advertising 500
Inventory
Inventory on balance sheet 5 000
Inventory in income statement 5 000
Depreciation
Charges in income statement
Cash Register 350
Computer 1 375
Accumulated depreciation on
balance sheet
Cash Register 350
Computer 1 375
Receivables adjustments
Bad debt
Bad debt 750
Receivables 750
Increase in doubtful debts provision
Increase in doubtful debts provision 1 500
Doubtful debts provision 1 500
Error correction
Reduction in sales and increase in capital account Please enlarge on screen for
Sales 300 000
Capital account 300 000 student viewing
Marvel Mechanics Period-End Adjustments Topic 9 - 9.44

£ £ £ £ £ £ £ £
Accruals 250 250
Cash Register 350 350
Computer 1 375 1 375
Freehold Premises 28 000 28 000
Motor vehicles 25 931 25 931
Plant & Equipment 34 375 34 375
Advertising 2 300 500 1 800
Bad debts 750 750
Bank 35 148 35 148
Capital 477 286 300 000 777 286
Cash Register at cost 1 750 1 750
Computer at cost 2 750 2 750
Doubtful debts provision 1 500 1 500
Electricity 2 854 250 3 104
Freehold Premises at cost 750 000 750 000
provision 1 500 1 500
Inventory in income statement 5 000 5 000
Inventory in balance sheet 5 000 5 000
Motor vehicles at cost 68 240 68 240
Payables 2 756 2 756
Plant & Equipment at cost 125 000 125 000
Prepayments 500 500
Property taxes 3 500 3 500
Purchases 37 500 37 500
Receivables 15 750 750 15 000
Sales 675 000 300 000 375 000
Telephone 2 250 2 250
Wages 108 000 108 000

student viewing
1 155 042 1 155 042 398 031 398 031 248 435 380 000 1 003 388 871 823
Profit for the year 131 565 131 565

380 000 380 000 1 003 388 1 003 388


Marvel Mechanics
Account names General Ledger Adjust- Adjust- Adjusted balances

Debit Credit Debit Credit Debit Credit
£ £ £ £ £ £
Accruals 250 250
Advertising 2 300 500 2 300 500
Bad debts 750 750
Bank 35 148 35 148
Capital 477 286 300 000 777 286
Prepayments 500 500
Purchases 37 500 37 500
Receivables 15 750 750 15 000
Sales 675 000 300 000 375 000
Telephone 2 250 2 250
Wages 108 000 108 000
student viewing
1 155 042 1 155 042 398 031 398 031 1 252 323 1 252 323

Marvel Mechanics
Account names Adjusted balances Which statement ? Why?

Debit Credit
£ £
Accruals 250 Balance sheet Liability at year end
Cash Register 350
Balance sheet Provision at year end
Computer 1 375
Motor vehicles 25 931
Advertising 2 300 500
Income statement Expense during year
Bad debts 750 Income statement Expense during year
Bank 35 148 Balance sheet Asset at year end
Capital 777 286 Balance sheet Capital at year end
Cash Register at cost 1 750 Balance sheet Asset at year end
Computer at cost 2 750 Balance sheet Asset at year end
Cash Register 350 Income statement Expense during year
Computer 1 375 Income statement Expense during year
Freehold Premises 28 000 Income statement Expense during year
Motor vehicles 25 931 Income statement Expense during year
Plant & Equipment 34 375 Income statement Expense during year
Doubtful debts provision 1 500 Balance sheet Provision at year end
Electricity 3 104 Income statement Expense during year
Freehold Premises at cost 750 000 Balance sheet Asset at year end
provision 1500 Income statement Expense during year
Inventory in income statement 5 000 Income statement Expense reduction
Inventory in balance sheet 5000 Balance sheet Asset at year end
Motor vehicles at cost 68 240 Balance sheet Asset at year end
Payables 2 756 Balance sheet Liability at year end
Plant & Equipment at cost 125 000 Balance sheet Asset at year end
Prepayments 500 Balance sheet Asset at year end
Property taxes 3 500 Income statement Expense during year
Purchases 37 500 Income statement Expense during year
Receivables 15 000 Balance sheet Asset at year end
Sales 375 000 Income statement Income during year
Telephone 2 250 Income statement Expense during year
Wages 108 000 Income statement Expense during year Please enlarge on screen for
student viewing
1 252 323 1 252 323

Marvel Mechanics
£ £ £ £ £ £ £ £
Accruals 250 250
Advertising 2 300 500 1 800
Bad debts 750 750
Bank 35 148 35 148
Capital 477 286 300 000 777 286
Prepayments 500 500
Purchases 37 500 37 500
Receivables 15 750 750 15 000
Sales 675 000 300 000 375 000
Telephone
Wages 108
2 250
000
2 250
108 000
student viewing
1 155 042 1 155 042 398 031 398 031 248 435 380 000 1 003 388 871 823
Profit for the year 131 565 131 565

380 000 380 000 1 003 388 1 003 388
Review of Topic
• This topic has introduced simple financial statements and
shown how the trial balance can be adjusted to give more
accurate numbers
• Period-end adjustments have been used to:
- To record any additional or prepaid overhead charges. It is often

the case that overhead charges are paid in respect of periods
that do not coincide with the accounting year-end
- To adjust for inventories
- To record the depreciation charges that need to be made in
respect of long-term assets
- To record any accounting provisions such as an allowance for
receivables which may not be received
- To correct errors

Review of Topic
• Some basic financial statements were
prepared to show the effects of the Period-
end adjustments
• In the next topic we will look at how we can

improve on the presentation of the financial
statements
Topic 9
Any questions?

Summary of Lecture: Introduction To Accounting and Economics

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Topic 9 – Period-End Adjustments Introduction to Accounting and Economics

V2.0 © NCC Education Limited

Period-End Adjustments Topic 9 - 9.2

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 1

Period-End Adjustments Topic 9 - 9.3

• The book keeping transactions must now

V2.0 © NCC Education Limited

Period-End Adjustments Topic 9 - 9.4

Words you must know

Accruals: An accrual is a calculation of an item of expenditure

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 2

Period-End Adjustments Topic 9 - 9.5

Words you must know

Depreciation: A calculation designed to measure the use of

Depreciation The amount of depreciation charged as an

V2.0 © NCC Education Limited

Period-End Adjustments Topic 9 - 9.6

Words you must know

Bad Debt: A receivable that will not be received by

Doubtful Debts An estimate of the amount of doubtful

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 3

Period-End Adjustments Topic 9 - 9.7

Words you must know

V2.0 © NCC Education Limited

Period-End Adjustments Topic 9 - 9.8

The Accounting Period

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 4

Period-End Adjustments Topic 9 - 9.9

Basic Financial Statements

• Do you remember the business called

• Here is an example of some of their basic

V2.0 © NCC Education Limited

Period-End Adjustments Topic 9 - 9.10

Basic Financial Statements

1 155 042 1 155 042

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V2.0 Visuals Handout – Page 5

Period-End Adjustments Topic 9 - 9.11

Profit for the year 518,596

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Period-End Adjustments Topic 9 - 9.12

Basic Financial Statements

• Is there anything odd about the size of the profit

The Balance Sheet

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V2.0 Visuals Handout – Page 6

Period-End Adjustments Topic 9 - 9.13

The Balance Sheet

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Period-End Adjustments Topic 9 - 9.14

Basic Financial Statements

• These financial statements are not very accurate.

• Adjustments must be made to the numbers so that

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 7

Period-End Adjustments Topic 9 - 9.15

• To adjust for inventories

• To record the depreciation charge (or charges) that need to

• To record any accounting provisions such as an allowance for