Chapter 7 Accounting Policies. Slide 2 notes reference - page 65 Accounting Standards Aim to narrow...

Chapter 7

Accounting Policies

notes reference - page 65

Accounting Standards

• Aim to narrow areas of choice and improve comparability.

• Apply to all accounts intended to give a truthful presentation (true and fair view).


The objective of financial statements

To provide information about the financial position, performance and changes in

financial position of an enterprise that is useful to a wide range of users in making economic

decisions


Underlying assumptions

• Going concern

The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future.

Hence, it is assumed that the enterprise has neither the intention nor the need to liquidate or curtail

materially the scale of its operations; if such an intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the

basis used is disclosed.


Underlying assumptions

• Accruals

The effects of transactions and other events are recognised when they occur (and not as cash or its

equivalent is received or paid) and they are recorded in the accounting records and reported in the financial

statements of the period to which they relate


Other concepts, conventions and qualities

• Prudence

• Consistency

• Entity concept

• Separate valuation principle

• Materiality

• Historical cost convention

Chapter 8

Accruals and prepayments


Accruals

Accruals are expenses incurred by the business during theaccounting period but not yet paid for.

Shown in the balance sheet under “Current liabilities”


Accruals example

Accounting period

1.1.X4 31.12.X41.10.X4

Period to which bill relates

Accrue bill at 31.12.X4

Pay telephone bill$60 on 1.1.X5


Prepayments

Prepayments arise when expenses are paid for before theyhave been used.

Shown in the balance sheet under “Current assets”


Prepayments example

Accounting period

Period to which bill relates

1.1.X4 31.12.X4 31.12.X5

Pay insurance billon 20.12.X4

Prepayment at 31.12.X4


Lecture example 1ElectricityDate paid10.3.X412.6.X414.9.X410.12.X4

96Amount

120104145

Period2 months to 28 Feb 20X4Quarter to 31 May 20X4Quarter to 31 August 20X4Quarter to 30 Nov 20X4

Rates1.2.X46.4.X4

3751,584

3 months to 31 March 20X412 months to 31 March 20X5

1 July 20X4 employed assistant. Paid assistant $150 permonth on 28th of each month.

6 March 20X5 received electricity bill for $168 forquarter to 28 Feb 20X5.


Lecture example 1

Electricity

Expense for yearto 31.12.X4

Accrual Prepayment Total paid

Rates

Wages

465

1,959

900

521 (W1)

1,563 (W3)

900

56

396

-

-

--

(W1) 96 + 120 + 104 + 145 + (1/3 x 168)

(W3) 375 + (9/12 x 1,584)(W4) 3/12 x 1,584

(W4)

(W2)

(W2) 1/3 x 168

(W5) 6 x 150

(W5)


Year-end adjustments

AccrualsDebit ExpenseCredit Accruals

PrepaymentsDebit PrepaymentsCredit Expense


Lecture example 2

104Cash14.9.X4

521I/S31.12.X456Accruals31.12.X4

145Cash10.12.X4

120Cash12.6.X4

96Cash10.3.X4

56bal b/d1.1.X5

56Electricity31.12.X456bal c/d31.12.X4

Electricity

Accruals

521521

5656


1,563I/S31.12.X41,584Cash6.4.X4

375Cash1.2.X4

Rates

1,9591,959

396bal b/d1.1.X5

396bal c/d31.12.X4396Rent31.12.X4

Prepayments

396396

Lecture example 2 part (c)

396Prepayments31.12.X4


Lecture example 2

150Cash28.9.X4

900I/S31.12.X4

150Cash28.11.X4

150Cash28.10.X4

150Cash28.8.X4

150Cash28.7.X4

Wages

900900

150Cash28.12.X4


Accruals and prepayments

Situation so far: Year end adjustmentcompleted

Revenues matched expenses

Accrual or Prepayment created


Reversals illustration

Bal b/d on prepayments is $396Paid rates in X5 of $1,740 for 12 months

Prepayment from last year Cash paid that relates to this year

31.12.X51.4.X5

3/12 * $1,584($396)

9/12 * $1,740 = $1,701 ($1,305)

1.1.X5

The other 3/12 x $1,740

= $435 is a prepayment


Reversals illustration (cont’d)

Cash 1,740 Prepayment 435 Bal b/d 396

Rent 435

Rates expense Prepayments


Reversals illustration (cont’d)

Opening prepayments must therefore be reversed

Dr Rates expense (I/S)

Cr Prepayments (B/S)


Summary - Reversals

Accruals Prepayments

Debit AccrualsCredit Expense

Debit ExpenseCredit Prepayments


Steps

• Reverse the opening accrual/prepayment

• Post cash paid

• Post closing accrual/prepayment


396Reverse prepayment1.1.X5

Rates

2,1362,136

(3/12 x 1,740)435Prepayments31.12.X5

435bal b/d1.1.X6

435bal c/d31.12.X5

396bal b/d1.1.X5

Prepayments

831831

Lecture example 3

1,701I/S31.12.X5

1,740Cash10.4.X5

396Reverse prepayment1.1.X543531.12.X5 Rates (3/12 x 1,740)


Lecture Example 4

Date paid Amount Period $ quarter

12.3.X5 168 Feb 20X5

9.6.X5 134 May 20X5

12.9.X5 118 Aug 20X5

12.12.X5 158 Nov 20X5

During March 20X6 Fiona received bill for $189 for quarter to 28 February 20X6

Accounting

Opening accrual

Cash paid

Cash paid

Cash paid


Lecture example 4

(a) The closing accrual is

(b) The electricity expense for the year is

$63

$585

118Cash12.9.X5

585I/S31.12.X5

158Cash12.12.X5

134Cash9.6.X5

168Cash12.3.X5

Electricity

641641

Working

63Accruals31.12.X5(1/3 x 189)

56Reverse accrual1.1.X5

Chapter 9

Non-current assets and depreciation


Definitions

Intended for use on continuing basis

Non-current assets

Property, plant and equipmentTangible assets

– production/supply of goods/services– rental to others– admin purposes

AND

Expected use > 1 period


Lecture example 1

• Land and buildings

• Plant and equipment

• Motor vehicles

• Furniture and fixtures


Non-current asset register

A listing of all non-current assets owned by the organisation

Details likely to be kept:- serial number- description of asset- location of asset- purchase date- cost- depreciation method & estimated useful life- net book value


Capital expenditureCapital expenditure

Results in NCA on B/S

Initial cost of NCA expenditure on NCA Subsequent

Purchase

price

Directly attributable costs

- acquisition costs- site preparation- delivery & handling- installation- professional fees

Improves earningcapacity of NCA

more

output

better

quality

output

longer

life of

NCA


Revenue expenditureRevenue expenditure

Expense in IS

expenditure on NCA Subsequent To carry on trade of

business

e.g. rent

electricity

Maintains existingearning capacity

repairs routine

maintenance

of NCA


Lecture example 2Frodo Ltd buys a car for a sales representative.

The invoice contained the following information:

List price of the car 15,000Road tax 165Burglar alarm system 200Petrol 30Delivery charge 100

The car will be shown in the B/S at a cost of 15,300

List price 15,000

Burglar alarm system 200Delivery charge 100

15,300

Working


Depreciation

“…the systematic allocation of the depreciable amount of an asset over its useful life.”

All non-current assets apart from land should be

depreciated


Depreciation

There are 3 methods of calculating depreciation:

(a) Straight line(b) Reducing balance(c) Machine hour


Depreciation = cost – residual value

useful economic life (years)

Residual value = expected proceeds at end of UEL

or

Depreciation = % x (cost – residual value)

Straight line method


Lecture example 3

(a) The annual depreciation charge is $400

2,500 - 500

5 years= 400


2,5005

2,5004

2,5003

2,5002

2,5001

NBVAcc depnCostYear

400

800

1,600

2,100

1,700

1,300

900

500

Lecture example 3 part (b)

1,200

2,000


Lecture example 2 (cont’d)

Graphical representation

$2,500

500

0 5Year

NBV


Depreciation = depreciation rate (%) x NBV

Cost – accumulated depn to date

Reducing balance method


NBVYear

rate expense depn

5184

8643

1,4402

2,4001

AccDepn

2,400 3,600

2,160

1296

778

Lecture example 4 part (a)

Depn

3,840

4,704

5,222

40%

40%

40%

40%


Lecture example 4 (cont’d)

Graphical representation

778

$6,000

1 2 3 4 5Year

NBV

3,600

2,160

1,296


Machine hour method

Depreciation = cost – residual value

useful economic life (hours)x actual

use p.a.


Lecture example 5

(a) The depreciation rate per HOUR is £6

125,000 – 5,000

20,000 hours= £6


NBVYear

expense depnuse

30,0003

42,0002

48,0001

AccActual

48,000 77,000

35,000

5,000


hoursDepn

90,000

120,000

8,000

7,000

5,000


Accounting for depreciation

Dr Depreciation expense (I/S)

Cr Accumulated depreciation (B/S)


Lecture example 6 part (a)Machine

2,5002,500

Cash 2,500

bal b/d

bal c/d 2,500

2,500

Depreciation expense

Year 1 Acc depn 400

Year 2 Acc depn 400

Year 3 Acc depn 400

Year 4 Acc depn 400

Year 5 Acc depn 400

Year 1 IS 400

Year 2 IS 400

Year 3 IS 400

Year 4 IS 400

Year 5 IS 400


Lecture example 6 part (a)

400Depn exp2000bal c/d

1600bal b/dYear 5


1200bal b/dYear 4


800bal b/dYear 3


400bal b/dYear 2

400Depn expYear 1400bal c/d

400400

800800

12001200

16001600

20002000

Accumulated depreciation



Income Statement (extract)

ExpensesYear 1 Year 2 Year 3 Year 4 Year 5

Depreciation 400 400 400 400 400



Balance Sheet (extract)

Cost Acc depn NBV

Year 1

Year 2

Year 3

Year 4

Year 5

2,500 (400) 2,100

2,500 (800) 1,700

2,500 (1,200) 1,300

2,500 (1,600) 900

2,500 (2,000) 500


Lecture example 6 part (c)

Journal entry

Debit Credit

Depreciation expense 400

Accumulated depreciation 400

Being annual depreciation charged on machine


Disposal of non current assetsProfit/loss on disposal

NBV < sales proceeds = profitNBV > sales proceeds = loss

Accounting treatment

Everything to do with disposal is transferred to a Disposal a/c

(a) Transfer original cost of asset to disposal a/c

(b) Transfer accumulated depreciation to disposal a/c

(c) Post sales proceeds

(d) Balance off disposal a/c to find profit/loss on disposal

(e) Profit on disposal = sundry income in I/S Loss on disposal = expense in I/S


Lecture example 7The profit/loss on disposal is

Machine

bal b/d Disposal 6,0006,000


bal b/d 3,840Disposal 3,840

Disposal

6,8406,840

Accum depn 3,840Machine cost 6,000

Cash 3,000Profit on disposal

(I/S) 840

$840


Lecture example 8The profit/loss on disposal is

Machine

bal b/d Disposal 6,0006,000


bal b/d 3,840Disposal 3,840

Disposal

6,8406,840

Accum depn 3,840Machine cost 6,000

Profit on disposal (IS) 840

$840Cash paid for the new machine is $7,000

New machine 3,000(part exchange)


Lecture example 8 (cont)

New machine

10,00010,000

bal b/d 10,000

Disposal (part ex) 3,000

bal c/d 10,000Cash 7,000


Land and Buildings

Non-current assets are depreciated over their useful life

Property is split into land and building elements for depreciation

Land is not normally depreciated as it has an unlimited useful life


If an item of property has increased in value, IAS 16 allows the asset to be revalued to show the increase in value on the balance sheet.

All items in the same class must be revalued at the same time.

Revaluations


Land and Buildings – accounting treatment

REVALUED

Dr NCA costDr Accumulated depreciationCr Revaluation reserve/Capital


Lecture example 9The balance on the capital a/c / revaluation surplus is $70,000

Accumulated depreciationbal b/d 20,000

Building

150,000150,000

Revaluation 20,000

bal b/d 100,000Revaluation 50,000

Capital/Revaluation Surplus

Building 50,000Accum depn 20,000bal c/d 70,000

bal c/d 150,000

70,00070,000


Lecture example 10

Date Depn charge Acc Depn NBV

31.12.X5 200,000/5 = 40,000 40,000 160,000

31.12.X6 40,000 80,000 120,000

31.12.X7 40,000 120,000 80,000

Working


Lecture example 10 (cont.)

(a) Asset revalued on 1.1.X8 to 250,000. The double entry

to reflect the revaluation is:

Dr NC asset (250,000 – 200,000) 50,000

Dr Accumulated depn (Working) 120,000

Cr Revaluation surplus 170,000


Lecture example 10 (cont.)

(b) Asset revalued on 1.1.X8 to 180,000. The double entry

to reflect the revaluation is:

Dr Accumulated depn (Working) 120,000

Cr NC Asset (200,000 – 180,000) 20,000

Cr Revaluation surplus 100,000

End of day 2 - what to do now…

1.Course notes review

Course CompanionCourse Companion

2. Question practice

3. Study text review

• Reinforce today’s learning • Develop question skills

Chapter 7 Accounting Policies. Slide 2 notes reference - page 65 Accounting Standards Aim to narrow...

Documents

Transcript of Chapter 7 Accounting Policies. Slide 2 notes reference - page 65 Accounting Standards Aim to narrow...