11

22

Objectives – Balance Day Adjustments

Distinguish between the cash basis of and accrual basis of accountingDistinguish the followings – Accrued Expenses– Prepaid Expenses– Accrued revenues – Prepaid revenues

And able to prepare the necessary adjustments for the above followings.Understand the effects of the adjustments on:– The Profit and Loss Account – The Balance Sheet

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Balance Day Adjustments

– Basis of accounting for profitsBasis of accounting for profits

–Cash basisCash basis–Accrual BasisAccrual Basis

Accrual Basis:Revenue earned – Expenses incurred = Profits

Cash Basis: Cash receipts – Cash payments = Profits

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• Rationale for using the accrual basisRationale for using the accrual basis– Businesses MOSTLY conducted on credit Businesses MOSTLY conducted on credit

termsterms

Jan Feb March

Revenue 1000 1000 1000

Rent (cash) 300 - -

Rent (Accrual) 100 100 100

Which is a more accurate

calculation?

Balance Day Adjustments

55

The scenario:-

Phua Chu Kang Pte Ltd The very best in Singapore & JB & some say Batam!

Tan Ah Teck Pte Ltd The very best in Bishan & some say Sentosa!

Scenario 1

Mr Phua forgets to pay his rent expenses of $12 000 in full to Mr Tan by the end of the accounting year of 2000. Instead he pays $5 000.

Scenario 2

Mr Phua pays his rent expenses of $18 000, which is MORE THAN the actual amount, to Mr Tan by the end of the accounting year of 2001.

Mr Phua rents a building from Mr Tan and incurs a monthly rent expense of $1 000.

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77

Your mobile phone bill shows that you have not settled last month’s amount. This month mobile phone bill shows an outstanding amount of $100 and the current amount of $80.

Hence this outstanding amount of $100 is also known as accrued expense.

Balance Day Adjustments - Accrued Expenses– Phua CK is pretending to be Phua CK is pretending to be

calm but actually is very calm but actually is very confused. He confused. He should haveshould have paid $12 000 for the rent for paid $12 000 for the rent for the period from January to the period from January to December 2000. December 2000.

– However, at the end of However, at the end of the period, he the period, he only paidonly paid $5 000 to Tan Ah Teck Pte $5 000 to Tan Ah Teck Pte Ltd due to negligence. He Ltd due to negligence. He still owes the company still owes the company $7 000. He does not know $7 000. He does not know the correct entries to the correct entries to reflect this!reflect this!

Scenario 1 Scenario 1

Let us help him.Let us help him.

– Should have paidShould have paid : : $ 12 000$ 12 000

– Paid onlyPaid only :: $ 5 000$ 5 000

– OwedOwed :: $ 7 000$ 7 000

This owing amount of $7 000 is also This owing amount of $7 000 is also known as known as Accrued Rent ExpenseAccrued Rent Expense. Mr. . Mr. Phua CK still owes Tan Ah Teck Ltd $7 Phua CK still owes Tan Ah Teck Ltd $7 000 that was not paid for the year of 000 that was not paid for the year of 2000.2000.

End of accounting period – December End of accounting period – December 20002000

Balance Day Adjustments - Accrued Expenses

Definition:Definition:

• Are expense that have been incurred Are expense that have been incurred for the accounting period for the accounting period BUTBUT amount amount not yet paid for by the business.not yet paid for by the business.

Balance Day Adjustments - Accrued Expenses

Yes…. Credit entry because it is a liability

(still owe people $)

What is the nature of accrued

expense?Debit or Credit

entry?

JOURNAL JOURNAL

Date Date Particulars Debit Credit Particulars Debit Credit

Year 2000Year 2000

Dec 31 Dec 31 $12 000 $12 000

$12 000$12 000

Rent Expense Rent Expense

Profit and Loss a/cProfit and Loss a/c

Using Phua CK as an example.Using Phua CK as an example.

If Mr. Phua remembered to pay the rent If Mr. Phua remembered to pay the rent amount in full, then the entries will be:-amount in full, then the entries will be:-

However, this is not the However, this is not the case.case. An additional ledger needs to

be created – Accrued Rent Expense

RENT EXPENSES a/c RENT EXPENSES a/c Year 2000 Year 2000 Dec 31 Bank Dec 31 Bank $5 000$5 000

Year 2000Year 2000 Dec 31 Profit & Loss Dec 31 Profit & Loss $12 000$12 000

Accrued rent $7 000 Accrued rent $7 000

Expense Expense

JOURNAL JOURNAL Date Date Particulars Particulars Debit CreditDebit Credit

Year 2000Year 2000 $7 000 $7 000

Dec 31 Dec 31 $7 000 $7 000

Rent Expense Rent Expense

Accrued Rent ExpenseAccrued Rent Expense

ACCRUED RENT EXPENSES a/c ACCRUED RENT EXPENSES a/c Year 2000 Year 2000 Dec 31 Bal c/d Dec 31 Bal c/d $7 $7 000000

Year 2000Year 2000 Dec 31 Rent Expense Dec 31 Rent Expense $7 000$7 000

$7 000$7 000 $7 000$7 000Year 2001 Year 2001 Jan 1 Bal b/d Jan 1 Bal b/d $7 000$7 000

$12 000$12 000 $12 000$12 000

Profit & Loss Account Profit & Loss Account

2000 2000 Dec 31 Dec 31 Expenses Expenses $12 000$12 000

Balance Sheet as at Dec 2000 Balance Sheet as at Dec 2000 LiabilityLiability

Accrued Rent Expense $7 000Accrued Rent Expense $7 000

JOURNAL JOURNAL

Profit & Loss a/c Profit & Loss a/c $12 000 $12 000

Rent ExpenseRent Expense $12 000$12 000

(Being rent expense closing off to P&L a/c)(Being rent expense closing off to P&L a/c)

Date Date Particulars Particulars Debit CreditDebit Credit

20002000

Dec 31Dec 31

• DefinitionDefinition

• Credit/Debit nature?Credit/Debit nature?

• Is there a need to open another Is there a need to open another ledger for accrued expense?ledger for accrued expense?

• Post this ledger to P/L or Balance Post this ledger to P/L or Balance Sheet?Sheet?

SummSummaryary

Balance Day Balance Day Adjustments - Accrued Adjustments - Accrued ExpensesExpenses

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Singtel has a promotion for new subscribers. If you paid the 6 months of mobile-phone monthly subscription upfront NOW, you get a free Nokia 8250.

Assuming that the monthly subscription is $20. You like the promotion and paid $1 200 (6x$20) immediately in order to get the new mobile phone. Hence you are paying in advance for the expense.

The payment in advance of The payment in advance of subscription fees ($1 200) is also subscription fees ($1 200) is also known as Prepaid Expense.known as Prepaid Expense.

Prepaid Expense/Payment Prepaid Expense/Payment in Advancein Advance

Are expenses that have been paid in advance but NOT yet incurred for the current accounting period.

Definition

Since expense is a debit entry. If the expense had been prepaid, what will be the nature of the entry? ?

Prepaid expense is like an asset to the firm as it is similar to people owing services to the firm. Hence a DEBIT ENTRY.

Prepaid Expense/Payment in Advance

Phua CK learnt his lesson last time of not paying on time last year, so he decides to pay in advance to “save his face” this year. The rent expense for the accounting year of 2001 is $12 000, but he pays $18 000. Hence he prepaid $6 000 for expenses that has not been incurred in 2001.

Scenario 2 Scenario 2

Prepaid Expense/Payment in Advance

$ 12 000 incurred $6 000 prepaid

30 June 30 June

20022002

$18 000 paid

1 Jan 20011 Jan 2001 31 Dec 31 Dec

20012001

Recall that the monthly rent expense is $1 000. Hence from January to December 2001, the total rent is $12 000.

Phua CK prepaid rent expense of $6 000 for January to June 2002.

RENT EXPENSES a/c RENT EXPENSES a/c Year 2001 Year 2001 Dec 31 Bank Dec 31 Bank $18 $18 000000

Year 2001Year 2001 Dec 31 Prepaid Rent $ 6 000 Dec 31 Prepaid Rent $ 6 000

Profit & LossProfit & Loss $12 000$12 000

JOURNAL JOURNAL

Year 2001Year 2001 $6 000 $6 000

Dec 31 Dec 31 $6 000 $6 000

Prepaid Rent Expense Prepaid Rent Expense

Rent ExpenseRent Expense

PREPAID RENT EXPENSES a/c PREPAID RENT EXPENSES a/c Year 2001 Year 2001 Dec 31 Rent Expense $6 000 Dec 31 Rent Expense $6 000

Year 2001Year 2001 Dec 31 Bal c/d Dec 31 Bal c/d $6 000$6 000

$6 000$6 000 $6 000$6 000

Year 2002 Year 2002 Jan 1 Bal b/d Jan 1 Bal b/d $6 000$6 000

$18 000$18 000 $18 000$18 000

Date Date ParticularsParticulars Debit Debit Credit Credit

Profit & Loss Account Profit & Loss Account

20012001 Dec Dec 31 Expenses 31 Expenses $12 000$12 000

Balance Sheet as at Dec 2001 Balance Sheet as at Dec 2001 Current AssetsCurrent Assets

Prepaid Rent Expense $6 000Prepaid Rent Expense $6 000

• DefinitionDefinition

• Credit/Debit nature?Credit/Debit nature?

• What are the differences in adjustments What are the differences in adjustments between the accrued and prepaid expenses?between the accrued and prepaid expenses?

SummSummaryary

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2626

During the year of 2001, the cash book shows:During the year of 2001, the cash book shows:maintenance Expensemaintenance Expense $ 900$ 900Selling ExpenseSelling Expense $1 200$1 200

On 31 May 2001, the Balance Sheet also showsOn 31 May 2001, the Balance Sheet also showsPrepaid Maintenance ExpensePrepaid Maintenance Expense $ 400$ 400Accrued Selling expenseAccrued Selling expense $ 300$ 300

Find the Find the actual amount of the expenses amount of the expenses incurred for the year of 2001.for the year of 2001.

Practice - Accrued and Prepaid Practice - Accrued and Prepaid ExpensesExpenses

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Maintenance Expense

Prepaid Maintenance Expense

$ $

Cash at Bank 900

Prepaid Maint Exp 400

Profit & Loss 500

900 900

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Selling Expense

Accrued Selling Expense

$ $

Cash at Bank 1 200

Accrued Selling Exp 300

Profit & Loss 1 500

1 500 1 500