Accruals and Prepayments

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Accruals and Prepayments

• Accruals in the balance sheet are (current)
  liabilities, prepayments are (current) assets.
• They arise because of the accruals (or
  matching) concept - profit is not the same as
  cash and cash is not the same as profit!
• Expenses in the profit and loss account are
  recorded in the periods to which they relate -
  the balance sheet records the amounts over or
  under paid in cash

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Accruals and Prepayments Example

• Annual buildings insurance 4,000 paid in
  advance 1 July 2001. The insurance premium for
  the year to 30 June 2001 was 3,600. On 5th
  October 2001, received electricity bill for 560
  for the quarter ended 30 September 2001. Other
  electricity costs for the year ended 30 September
  2001 were 1,200. A/cing y/end is 30 September.
• PL
• B/Sheet

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Depreciation

• Annual depreciation is charged to the profit and
  loss account. It is an application of the
  accruals (matching) concept, designed to spread
  the cost of fixed assets over their useful
  economic lives.
• Accumulated depreciation is deducted from the
  fixed asset cost in the balance sheet (to give
  net book value - NBV). This is the total
  depreciation charged to date.
• Depreciation is NOT a cash flow.

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Main Methods

• Straight-Line
• annual depreciation (cost - scrap value)/UEL
• Reducing Balance
• depreciation in year 1 cost ? depn. rate
• depreciation in year 2 b/f NBV ? depn. rate
• etc.

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Example - straight-line

• Annual depreciation
• NBV

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Example - reducing balance

• Depreciation in yr 1
• yr 2
• yr 3
• yr 4

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Profit/Loss on Disposal

• When a fixed asset is sold, its NBV is no longer
  included in the balance sheet BUT the business
  may have made a profit or loss on disposal, which
  should be included in the PL a/c for the year of
  disposal.
• Profit on disposal sales proceeds - NBV

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Example

• NBV after 2 years
• Profit if sold for 50,000
• Profit if sold for 80,000

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Fixed Assets and the Cash Flow Statement

• The purchase of a fixed asset is capital
  expenditure - the cash outflow is recorded under
  this heading in the CFS for the year in which it
  occurs.
• Remember that this initial outflow does NOT go
  into the profit and loss account.
• Depreciation is a non cash item and must be added
  back in the reconciliation of op. profit to net
  cash flow from op. activities.

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• Disposals of fixed assets are a bit more
  complicated.
• Profits and losses on disposals of fixed assets
  must be adjusted in the reconciliation of op.
  profit to net cash flow from op. activities.
• Cash proceeds from the sale (an inflow) are
  shown in the body of the CFS for the year in
  which they are received.

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Bad and Doubtful Debts

• If you know you will never recover a specific
  amount from a specific debtor, WRITE-OFF
• expense in PL a/c
• deduct from debtors in B/S
• If you are unsure whether you will recover some
  of your debtors balance, PROVIDE
• charge increase/credit decrease in provision to
  PL a/c
• deduct total provision from debtors on face of B/S

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Example

• Debtors currently 120,000.
• Bad debt 20,000 (customer in liquidation)
• Doubtful debts estimated at 2. Brought forward
  provision for doubtful debts is 1,600.
• What will the B/S and PL show?
• What if the b/f provision was 2,200 ?

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Debtors and CreditorsMissing Numbers

• You will often be asked questions where there is
  a piece of information missing. You will have to
  find the missing number from the other numbers
  that you have.
• To do this, it is important that you understand
  how sales, cash receipts and debtors are related,
  and how purchases, cash payments and creditors
  are related.

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Credit Sales/Debtors
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Example

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

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Credit Purchases/Creditors
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Cost of Sales
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Cost of Sales Missing Numbers

• Sometimes we need to use information about gross
  profit margins or mark-ups to work out the sales
  or purchases figure.
• Remember, gross profit sales - cost of sales
• A mark-up is a gross profit percentage
  calculated on cost of sales.
• A margin is a gross profit percentage
  calculated on sales.

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Examples

• Sales 1,000 made at mark-up of 25. What is cost
  of sales?
• Cost of sales 500, profit margin on sales 20.
  What is sales?

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The Trial Balance

• The trial balance is a list of balance sheet
  items, separated into two columns. One column
  shows debit balances, the other credit
  balances.
• Debit balances are assets (or expenses), credit
  balances are liabilities (or income).
• If everything has been recorded correctly, it
  should balance (just like the balance sheet).
• Unfortunately, there could be a mistake and the
  TB could still balance - e.g. if you forget to
  record a transaction altogether

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Example Trial Balance
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Double-Entry Book-keeping

• Every transaction has two effects
• One effect is a debit (DR) and one effect is a
  credit (CR)
• Create T accounts for each category in the
  balance sheet (and PL)
• Debit and credit these as appropriate - must
  debit one T account and credit another each
  time. Record as journals.
• At end, close off all B/S T accounts, and put
  c/f balances into the trial balance.

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What do you debit or credit?
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Simple Example - Joe Smith Revisited
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Joe Smith Trial Balance
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• Check that you could produce the balance sheet
  and PL for the simple Joe Smith example.
• Lecture examples 5 and 6 are more complex.
• We will do example 5 in the lecture. You can work
  through example 6 yourselves (it is rather long
  and quite hard - contact me if you need extra
  help) as you have the completed ledger in the
  notes.

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Example 5 The Ashton Company Revisited

• Journal entries

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The Ashton Company Trial Balance
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Control Accounts

• Missing numbers questions involving
  debtors/sales/cash receipts or creditors/purchases
  /cash payments can be answered using control
  accounts.
• Control accounts are T accounts for either
  debtors/receivables, or creditors/payables.
• The idea is the same as we saw before (incomplete
  records) - you can use either method for
  answering questions

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Incomplete Records - Example
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• Cost of Sales for quarter
• Sales
• Less COS
• Gross Profit

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• Purchases for quarter
• Opening Stock
• Purchases
• Less Closing Stock
• Cost of Sales

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• Go through as much of Chippendale as there is
  time for