Adjustments for Final Accounts Prepayments and Accruals Expenses

Adjustments for Final Accounts

Prepayments and Accruals Expenses and revenues are not always paid or received on time. Cash paid and received in a year should not be entered directly into the profit and loss account of that year. Adjustment should be made.

Prepaid expenses l those to be used in the following period but have been paid for in advance. Accrued expenses l those which have been used up in the current year, but have not yet been paid for. Prepaid income l those to be earned in the following period but have been received in advance. Accrued income l those which have been earned in the current period but have not yet been received.

Example 2 firms who pay rent for buildings in Hong Kong. The rent for each building is $1, 200 a year. 1. 2. Firm A paid $1, 00 in the year. Own $200 for rent. Firm B paid $1, 300 in the year. $100 in advance for the following year.

P & L accounts for 12 months needs 12 months rent as an expense = $1, 200. 1. Firm A, $200 accrued expenses be adjusted. 2. Firm B, $100 prepaid expenses be adjusted

Accrued Expenses

Accrued expenses Assume that rent of $1, 000 per year is payable at the end of every 3 months. The rent was not always paid on time Amount $250 Rent due 31 March 2005 30 June 2005 30 Sept. 2005 31 Dec. 2005 Rent paid 31 March 2005 2 July 2005 4 Oct. 2005 5 January 2006

Rent 2005 $ Mar 31 Bank 250 Jul 2 Bank Oct 4 Bank Dec 31 Accrued c/d 250 250 2005 $ Dec 31 Profit and loss 1, 000 2006 Jan 1 Accrued b/d 250

Prepaid Expenses

Prepaid expenses Insurance for a firm is at the rate $840 a year, starting from 11 January 2005. The firm has agreed to pay this at the rate of $210 every 3 months. Amount $210 Insurance due 31 March 2005 $210 30 June 2005 $210 30 Sept. 2005 31 Dec. 2005 Insurance paid $210 28 Feb 2005 $420 31 Aug. 2005 $420 18 Nov. 2005

Insurance 2005 $ 2005 Feb 28 Bank 210 Dec 31 Profit and loss 840 Aug 31 Bank Nov 18 Bank 420 Dec 31 Prepaid c/d 210 1, 050 2006 Jan 1 Prepaid b/d 210 $ 1, 050

Prepayment will also happen when items other than purchases are bought for use in the business, and they are not fully used up in the period. For instance, stationery is normally not entirely used up over the period in which it is bought.

Example Year ended 31 December 2005 Stationery bought in the year $2, 200 Stock of stationery in hand as at 31 December 2005 $400

Stationery 2005 $ Dec 31 Bank 2, 2005 Dec 31 Profit and loss Dec 31 Stock c/d 2, 200 $ 1, 800 400 2, 2006 Jan 1 Stock b/d 400 The stock of stationery is not added to the stock of unsold goods in hand in the balance sheet, but is added to the other prepayments of expense.

Accrued Income

Accrued income Assumed our warehouse is larger than we need. We rent part of it to another firm for $800 per annum. Amount $200 Rent due Rent received 31 March 2005 4 April 2005 $200 30 June 2005 6 July 2005 $200 30 Sept. 2005 31 Dec. 2005 9 Oct. 2005 7 Jan. 2006

Rent receivable 2005 Dec 31 Profit and Loss $ 2005 800 Apr 5 800 2006 Jan 1 Accrued b/d 210 $ Bank 200 Jul 6 Bank Oct 9 Bank Dec 31 Accrued c/d 200 200 800

Expenses and revenue accounts covering more than one period Example: On 31 Dec. 2004 3 months rent of $3, 000 was owing. The rent chargeable per year was $12, 000. The following payments were made in the year 2005: 6 Jan. $3, 000; 4 April $3, 000; 7 July $3, 000; 18 Oct $3, 000 The final 3 months rent for 2005 is still owing.

Rent 2005 Jan 6 Apr 4 Jul 7 Oct 18 Dec 31 $ Bank Owing c/d 3, 000 3, 000 2005 Jan 1 Owing b/d Dec 31 Profit and loss 15, 000 $ 3, 000 12, 000 15, 000 2006 Jan 1 Owning b/d 3000

Example Rent and rates are joined together. Rent is payable of 6000 per annum Rates of $4, 000 per annum are payable by instalments. At 1 Jan 20 x 5 rent $1, 000 had been prepaid in 20 x 4. On 1 Jan 20 x 5 rates were owned of $400. During 20 x 5 rent was paid $4, 500.

During 20 x 5 rates were paid $5, 000. On 31 Dec 20 x 5 rent $500 was owing. On 31 Dec 20 x 5 rates of $600 had been prepaid.

Rent and Rates 2005 Jan 1 Rent prepaid b/d Dec 31 Bank: rent Dec 31 Bank: rates Dec 31 Owing c/d $ 2005 $ 1, 000 Jan 1 4, 500 5, 000 500 Dec 31 Profit and loss Dec 31 Rates prepaid c/d Rates owing b/d 11, 000 2006 Jan 1 Prepaid b/d 2006 600 Jan 1 Owing b/d 400 10, 000 600 11, 000 500

Expenses for the period = Cash paid – Accruals in last year + Accruals in this year + Prepayments in last year – Prepayment in this year

Income for the period = Receipt – Accruals in last year + Accruals in this year + Prepayments in last year – Prepayments in this year

Trading and Profit and Loss Account Gross profit / loss = Net sales – Cost of goods sold Net sale = Sales – Returns Inwards Cost of goods sold = Opening stock + [Purchase + Carriage inwards – Returns outwards + other purchase costs] – Closing stock

Net Profit = Gross profit + Other income – Total expenses

Name of the Company Trading and Profit and Loss Account for the year ended 31 Dec 19 xx Sales Less Returns Inwards Less cost of Goods Sold Opening Stock Purchases Add Carriage Inwards Less Returns Outwards Less Closing Stock Gross Profit $ x x x (x) Add Discount received Rent Received Profit on Disposal on M. V. Decrease in provision for bad debt Less Expenses Rent and Rates Insurance Carriage Outwards Discount Allowed Bad debts Increase in provision for bad debts Depreciation Loss on Disposal of Furniture Net Profit $ x x x x x

Name of the Company Trading and Profit and Loss Account for the year ended 31 Dec 19 xx Fixed Assets Machinery Motors Investment ($x at market value) Current Assets Stock Debtors Less provision for bad debt Prepaid expenses Accrued income Bank Cash Less: Current Liabilities Creditors Accrued expenses Prepaid income Bank overdrafts Working Capital $ Cost x x (x) $ Dep. x x x $ Net x x x x x

$ Financed by: Capital Bal as at 1 Jan 19 xx Add: Net profit / Less Net loss Less: Drawings Long-term Liabilities Debentures Bank Loans $ $ x x x x

Working capital is the amount by which current assets exceed current liabilities.

Drawings They refer to the using up of business resources by the owner(s) of the business.

Accounting entries Dr Drawings Cr Cash / Bank Dr Drawings Cr Purchases Dr Drawings Cr Expenses drawn from the cash till or business bank account goods taken by the proprietor private expenses

Losses of goods Losses of raw materials and trading stock can be classified 1. normal losses 2. abnormal losses

Normal Losses caused by wastage, obsolescence and other reasons which are expected within the ordinary activities of the business. No entry is needed for normal losses.

Abnormal Losses caused by reasons which are unexpected within the ordinary activities of the business such as fire or accidents. These should be recorded in the books as below.

(i) Losses without insurance claim Dr Fire / Burglary Loss With the total loss Cr Trading Dr Profit and loss With the total loss Cr Fire / Burglary Loss (ii) Losses with insurance claim Dr Fire/Burglary Loss With the total loss Cr Trading Dr Bank/Insurance company Insurance claim received Cr Fire/Burglary Loss Dr Profit and Loss Transferring the net loss to profit and loss account at the Cr Fire / Burglary Loss year end

Example (Normal loss) $ Purchases (100 units) 100 Sales (70 units) 210 Closing stock (20 units) 20 Expenses 50 10 units of goods were obsolete.

Abnormal loss without insurance claim Trading and Profit and Loss Account Purchase ($1 * 100) Less Closing Stock($1*20) Less Fire loss Cost of goods sold Gross profit Expenses Fire Loss Net Profit $ 100 20 80 10 70 140 210 50 10 80 140 Sales ($3 * 70) Gross Profit $ 210 ____ 210 140 ___ 140

Abnormal loss with insurance claim ($6) Trading and Profit and Loss Account Purchase ($1 * 100) Less Closing Stock Less Fire loss Cost of goods sold Gross profit Expenses Fire Loss ($10 - $6) Net Profit $ 100 20 80 10 70 140 210 50 4 86 140 Sales ($3 * 70) Gross Profit $ 210 ____ 210 140 ___ 140