Ch 6 accruals and prepayment

CHAPTER 6CHAPTER 6

ADJUSTMENTS FOR ADJUSTMENTS FOR ACCRUALS ACCRUALS

AND AND PREPAYMENTSPREPAYMENTS

LEARNING OBJECTIVESLEARNING OBJECTIVESTo make adjustments for accrued & To make adjustments for accrued &

prepaid expensesprepaid expensesTo make adjustments for revenues To make adjustments for revenues

owing & revenues received in advanceowing & revenues received in advanceTo ascertain the actual amount of To ascertain the actual amount of

expense & revenues in the Profit & Loss expense & revenues in the Profit & Loss AccountAccount

To show the recording of accruals & To show the recording of accruals & prepayments in the Balance Sheetprepayments in the Balance Sheet

INTRODUCTIONINTRODUCTION In the trial balance, as far as expenses are In the trial balance, as far as expenses are

concerned, it records only the expenses paid for concerned, it records only the expenses paid for the period.the period.

So do the revenues where it records only the So do the revenues where it records only the revenues received during the period.revenues received during the period.

Therefore, adjusting entries are made at the end Therefore, adjusting entries are made at the end of the accounting period to ensure that revenues of the accounting period to ensure that revenues are recorded in the period in which they are are recorded in the period in which they are earned, & expenses are recognized in the period earned, & expenses are recognized in the period which they are incurred.which they are incurred.

This is to get the correct figure for net profit This is to get the correct figure for net profit during the period.during the period.

TYPES OF ADJUSTING ENTRIES FOR TYPES OF ADJUSTING ENTRIES FOR NOMINAL ACCOUNTSNOMINAL ACCOUNTS

Revenues & expenses accounts Revenues & expenses accounts are considered as nominal are considered as nominal accounts. Adjusting entries for accounts. Adjusting entries for nominal accounts can be nominal accounts can be classified into the following classified into the following categories:categories:

ExpensesExpenses RevenuesRevenuesPrepaid Prepaid expenses or expenses or expenses paid expenses paid in advancein advance

Revenues Revenues received in received in advance or advance or unearned unearned revenuesrevenues

Accrued Accrued expenses or expenses or expenses expenses owingowing

Accrued Accrued revenues or revenues or revenues revenues owingowing

- Before making - Before making adjustments, one must adjustments, one must observed the following:observed the following:

• The accounting periodThe accounting period• Any balances b/d at the Any balances b/d at the

beginning of the yearbeginning of the year• Any balances b/d at the Any balances b/d at the

end of the yearend of the year• Amount actually paid Amount actually paid

during the yearduring the year• Amount actually charged Amount actually charged

to the TPL accounts during to the TPL accounts during the yearthe year

PREPAID EXPENSESPREPAID EXPENSESPrepaid expenses are Prepaid expenses are

payment of expenses payment of expenses that will benefit more that will benefit more than one accounting than one accounting period.period.

Prepaid expenses often Prepaid expenses often occur with regard to occur with regard to insurance, rent & insurance, rent & advertising.advertising.

An asset-expense An asset-expense relationship exists with relationship exists with prepaid expenses.prepaid expenses.

Prepaid expenses will be Prepaid expenses will be treated as current asset treated as current asset in the Balance Sheetin the Balance Sheet

Journal Entries:Journal Entries:DebitDebit CreditCredit

a)a) To record the To record the expenses paidexpenses paid

ExpenseExpensess

Bank / Bank / cashcash

b)b) To record the To record the adjusting entriesadjusting entries

ExpenseExpenses s PrepaidPrepaid

ExpenseExpensess

c)c) To transfer the To transfer the expenses expenses incurred during incurred during the year to P&L the year to P&L a/c (closing a/c (closing entries)entries)

Profit & Profit & Loss Loss

ExpenseExpensess

e)e) Balance for Balance for prepaid expense prepaid expense should be should be transferred to transferred to the insurance the insurance expense a/c.expense a/c.

ExpenseExpensess

ExpenseExpenses s PrepaidPrepaid

PREPAID EXPENSES (cont’d)PREPAID EXPENSES (cont’d)Example Example Dani Trading took a yearly insurance policy of RM600 on 1 Dani Trading took a yearly insurance policy of RM600 on 1 June 2005. The accounting period ends 31 December each June 2005. The accounting period ends 31 December each year. The business has agreed to pay insurance premium at year. The business has agreed to pay insurance premium at the rate of RM200 every 4 month. Payment made are as the rate of RM200 every 4 month. Payment made are as follows:follows:

Show the appropriate adjusting entries on 31 December 2005Show the appropriate adjusting entries on 31 December 2005Monthly insurance premiumMonthly insurance premium :: RM600/12 = RM50RM600/12 = RM50Insurance ExpenseInsurance Expense :: 1 June to 31 December1 June to 31 December

:: 7 months x RM50 = RM3507 months x RM50 = RM350Insurance PrepaidInsurance Prepaid :: 1 month x RM50 = RM501 month x RM50 = RM50

Date of PaymentDate of Payment Amount Amount PaidPaid

MonthMonth

1 June 20051 June 2005 RM200RM200 June 2005 to Sept. June 2005 to Sept. 20052005

1 October 20051 October 2005 RM200RM200 Oct. 2005 to Jan. 2006Oct. 2005 to Jan. 20061 February 20061 February 2006 RM200RM200 Feb. 2006 to May Feb. 2006 to May

20062006

PREPAID EXPENSES (cont’d)PREPAID EXPENSES (cont’d)Journal Entries:Journal Entries:DateDate Recording ProcessRecording Process DebitDebit CreditCredit2005 2005 June 1June 1

a)a)To record insurance To record insurance expenses paid amount RM expenses paid amount RM 200200

Insurance Insurance ExpenseExpense

BankBank

Oct 1Oct 1 b)b)To record insurance To record insurance expenses paid amount RM expenses paid amount RM 200200


BankBank

Dec Dec 3131

c)c) To record insurance prepaid To record insurance prepaid amount RM50 amount RM50

Insurance Insurance PrepaidPrepaid


Dec Dec 3131

d)d) To transfer insurance To transfer insurance expenses to P&L a/c expenses to P&L a/c amount RM 350amount RM 350

Profit & Profit & Loss a/cLoss a/c


2006 2006 Jan 1Jan 1

e)e) Balance for prepaid expense Balance for prepaid expense should be transferred to the should be transferred to the insurance expense a/c.insurance expense a/c.


Insurance Insurance PrepaidPrepaid

Insurance ExpenseInsurance Expense01/06/05 Bank 200 31/12/05 Insurance01/06/05 Bank 200 31/12/05 Insurance Prepaid Prepaid

505001/10/05 Bank 200 31/12/05 Profit & Loss 35001/10/05 Bank 200 31/12/05 Profit & Loss 350 400 400

40040001/01/06 Insurance Pre. 5001/01/06 Insurance Pre. 50

Insurance PrepaidInsurance Prepaid31/12/05 Insurance exp. 31/12/05 Insurance exp. 50 50 31/12/05 Balance c/d 31/12/05 Balance c/d 50 5001/01/06 Balance b/d 01/01/06 Balance b/d 50 50 01/01/06 Insurance Exp. 01/01/06 Insurance Exp. 50 50

Profit and LossProfit and LossInsurance Expense 350Insurance Expense 350

Balance Sheet as at 31/12/05Balance Sheet as at 31/12/05Current AssetsCurrent AssetsInsurance Prepaid 50Insurance Prepaid 50

PREPAID EXPENSES (cont’d)PREPAID EXPENSES (cont’d)

ACCRUED EXPENSESACCRUED EXPENSESAccrued expenses Accrued expenses

are expenses are expenses incurred but unpaid.incurred but unpaid.

A liability-expense A liability-expense relationship exists relationship exists with accrued with accrued expenses.expenses.

Accrues expenses Accrues expenses will be treated as will be treated as current liability in current liability in the balance sheet.the balance sheet.


a)a) To record the To record the expenses paidexpenses paid

ExpenseExpensess


b)b) To record the To record the adjusting adjusting entriesentries

ExpenseExpensess

Accrued Accrued ExpenseExpensess

c)c) closing entriesclosing entries Profit & Profit & Loss Loss

ExpenseExpensess

d)d)Transfer the Transfer the balance to the balance to the credit side of credit side of the expense the expense a/c (opening a/c (opening entries)entries)

Accrued Accrued ExpenseExpensess

ExpenseExpensess

ACCRUED EXPENSES (cont’d)ACCRUED EXPENSES (cont’d)Example Example Dani Trading rent a stall on 1 October 2005 at the rate of Dani Trading rent a stall on 1 October 2005 at the rate of RM100 per month payable at the end of each month. The RM100 per month payable at the end of each month. The accounting period ends 31 December each year. Payment accounting period ends 31 December each year. Payment made are as follows:made are as follows:

Rental for the month of December 2005 was only paid in Rental for the month of December 2005 was only paid in January 2006. Show the appropriate adjusting entries at the January 2006. Show the appropriate adjusting entries at the end of accounting period.end of accounting period.Rental paid ( Oct & Nov 2005)Rental paid ( Oct & Nov 2005) :: 2 months x RM100 = 2 months x RM100 = RM200 Accrued Rental (Dec 2005)RM200 Accrued Rental (Dec 2005) :: 1 month x RM100 1 month x RM100 = RM100= RM100


MonthMonth

31 October 200531 October 2005 RM100RM100 October 2005October 200530 November 30 November 20052005

RM100RM100 November 2005November 2005

5 January 20065 January 2006 RM100RM100 December 2005December 2005

ACCRUED EXPENSES (cont’d)ACCRUED EXPENSES (cont’d)Journal Entries:Journal Entries:DateDate Recording ProcessRecording Process DebitDebit CreditCredit2005 2005 Oct 31Oct 31

a)a)To record rental paid To record rental paid amount RM 100amount RM 100

Rent Rent ExpensesExpenses

BankBank

Nov Nov 3030

b)b)To record rental paid To record rental paid amount RM 100amount RM 100


BankBank

Dec Dec 3131

c)c) To record accrued rental To record accrued rental amount RM100 amount RM100


Rent Rent AccruedAccrued

Dec Dec 3131

d)d)To transfer Rent Expenses To transfer Rent Expenses to P&L a/c amount RM 300to P&L a/c amount RM 300



2006 2006 Jan 1Jan 1

e)e) Balance for accrued Balance for accrued expense should be expense should be transferred to the Rent transferred to the Rent Expenses a/c.Expenses a/c.



Rent ExpenseRent Expense31/10/05 Bank 100 31/12/05 Profit & Loss 30031/10/05 Bank 100 31/12/05 Profit & Loss 300

30/11/05 Bank 100 30/11/05 Bank 100 31/12/05 Rent Accrued 10031/12/05 Rent Accrued 100 300 300300 300

01/01/06 Rent Accrued 10001/01/06 Rent Accrued 100

Rent AccruedRent Accrued31/12/05 Balance c/d 31/12/05 Balance c/d 100100 31/12/05 Rent Expense 31/12/05 Rent Expense 10010001/01/06 Rent Expense 01/01/06 Rent Expense 100100 01/01/06 Balance b/d 01/01/06 Balance b/d 100100

Profit and LossProfit and LossRent Expenses 300Rent Expenses 300

Balance Sheet as at 31/12/05Balance Sheet as at 31/12/05 Current LiabilitiesCurrent Liabilities Accrued Expenses 100Accrued Expenses 100

ACCRUED EXPENSES (cont’d)ACCRUED EXPENSES (cont’d)

REVENUE RECEIVED IN ADVANCEREVENUE RECEIVED IN ADVANCE Also known as unearned Also known as unearned

revenuerevenue Payment received for Payment received for

services to be provided in services to be provided in a future accounting a future accounting period, revenue received period, revenue received in advance a/c should be in advance a/c should be credited.credited.

An adjusting entry is An adjusting entry is made to record the made to record the revenue that has been revenue that has been earned & to show the earned & to show the liability that remains.liability that remains.

Revenue received in Revenue received in advance treated as advance treated as current liabilities in the current liabilities in the balance sheet.balance sheet.


a)a) To record the To record the payment payment receivedreceived


Revenue Revenue ReceivedReceived

b)b) To record To record revenue revenue received in received in advanceadvance


Revenue Revenue Received Received in in advanceadvance

c)c) Closing entriesClosing entries Revenue Revenue ReceivedReceived

Profit & Profit & LossLoss

d)d) Transfer the Transfer the balance to the balance to the credit side of the credit side of the revenue revenue received received (opening (opening entries)entries)

Revenue Revenue Received Received in in advanceadvance


REVENUE RECEIVED IN ADVANCE REVENUE RECEIVED IN ADVANCE (cont’d)(cont’d)

Example Example Dani Trading rent out part of its office on 1 October Dani Trading rent out part of its office on 1 October 2005 at a rental of RM200 per month & receivable at the 2005 at a rental of RM200 per month & receivable at the end of each month. The accounting period ends 31 end of each month. The accounting period ends 31 December each year. Rental received is as follows:December each year. Rental received is as follows:


MonthMonth



31 December 31 December 20052005

RM400RM400 Dec. 2005 & Jan. 2006Dec. 2005 & Jan. 2006

Journal Entries:Journal Entries:DateDate Recording ProcessRecording Process DebitDebit CreditCredit2005 2005 Oct 31Oct 31

a)a) To record Rent received To record Rent received amount RM 200amount RM 200

BankBank Rent Rent ReceivedReceived

Nov 30Nov 30 b)b) To record Rent received To record Rent received amount RM 200amount RM 200


Dec 31Dec 31 c)c) To record Rent received To record Rent received amount RM 400amount RM 400


Dec 31Dec 31 d)d) To record Rent received in To record Rent received in advance amount RM 200advance amount RM 200

Rent Rent ReceivedReceived

Rent Rent Received in Received in advanceadvance

Dec 31Dec 31 e)e) To transfer Rent received to To transfer Rent received to P&L a/c amount RM 300P&L a/c amount RM 300



2006 2006 Jan 1Jan 1

f)f) Balance for unearned revenue Balance for unearned revenue should be transferred to the should be transferred to the Revenue Received a/c.Revenue Received a/c.

Rent Rent Received in Received in advanceadvance


REVENUE RECEIVED IN ADVANCE (cont’d)REVENUE RECEIVED IN ADVANCE (cont’d)

Rent ReceivedRent Received31/10/05 Rent Received 200 31/10/05 Bank 20031/10/05 Rent Received 200 31/10/05 Bank 200 in advancein advance31/12/05 Profit & Loss 600 30/11/05 Bank 20031/12/05 Profit & Loss 600 30/11/05 Bank 200 31/12/05 Bank 31/12/05 Bank 400400 800800

800 800 01/01/06 Rent Received01/01/06 Rent Received in advance 200in advance 200

Rent Received in AdvanceRent Received in Advance31/12/05 Balance c/d 31/12/05 Balance c/d 200200 31/12/05 Rent Received 31/12/05 Rent Received 20020001/01/06 Rent Received 01/01/06 Rent Received 200200 01/01/06 Balance b/d 01/01/06 Balance b/d 200200

Profit and LossProfit and Loss Rent Received 600Rent Received 600

Balance Sheet as at 31/12/05Balance Sheet as at 31/12/05 Current LiabilitiesCurrent Liabilities Rent Received 200Rent Received 200 in Advancein Advance

REVENUE RECEIVED IN ADVANCE (cont’d)REVENUE RECEIVED IN ADVANCE (cont’d)

ACCRUED REVENUEACCRUED REVENUERevenues earned Revenues earned

from services that from services that have been have been performed but performed but neither billed nor neither billed nor collected or collected or recorded.recorded.

Accrued Revenue Accrued Revenue treated as current treated as current assets in the assets in the balance sheet.balance sheet.


a)a) To record the To record the cash receivedcash received



b)b) To record To record Accrued Accrued RevenuesRevenues

Accrued Accrued RevenueRevenue


c)c) Closing entriesClosing entries Revenue Revenue ReceivedReceived

Profit & Profit & LossLoss

d)d) Transfer the Transfer the balance to the balance to the debit side of the debit side of the revenue revenue received received (opening (opening entries)entries)


Accrued Accrued RevenueRevenue

Example Example Dani Trading rent out part of its office on 1 October 2005 at a Dani Trading rent out part of its office on 1 October 2005 at a rental of RM200 per month & receivable at the end of each rental of RM200 per month & receivable at the end of each month. The accounting period ends 31 December each year. month. The accounting period ends 31 December each year. The rent received schedule is as follows:The rent received schedule is as follows:


MonthMonth



10 January 200610 January 2006 RM400RM400 December 2005December 2005

ACCRUED REVENUE ACCRUED REVENUE (cont’d)(cont’d)

Journal Entries:Journal Entries:DateDate Recording ProcessRecording Process DebitDebit CreditCredit2005 2005 Oct 31Oct 31

a)a)To record Rent received To record Rent received amount RM 200amount RM 200


Nov Nov 3030

b)b) To record Rent received To record Rent received amount RM 200amount RM 200


Dec Dec 3131

d)d)To record Rent accrued To record Rent accrued amount RM 200amount RM 200



Dec Dec 3131

e)e) To transfer Rent received to To transfer Rent received to P&L a/c amount RM 600P&L a/c amount RM 600



2006 2006 Jan 1Jan 1

e)e) Balance for accrued revenue Balance for accrued revenue should be transferred to the should be transferred to the Revenue Received a/c.Revenue Received a/c.



ACCRUED REVENUE (cont’d)ACCRUED REVENUE (cont’d)

Rent ReceivedRent Received31/12/05 Profit & Loss 600 31/10/05 Bank 20031/12/05 Profit & Loss 600 31/10/05 Bank 200 30/11/05 Bank 20030/11/05 Bank 200 31/12/05 Rent Accrued 31/12/05 Rent Accrued 200200 600600

600 600 01/01/06 Rent Accrued 20001/01/06 Rent Accrued 200

Rent AccruedRent Accrued31/12/05 Rent Received 31/12/05 Rent Received 200200 31/12/05 Balance c/d 31/12/05 Balance c/d 20020001/01/06 Balance b/d 01/01/06 Balance b/d 200200 01/01/06 Rent Received 01/01/06 Rent Received 200200

Profit and LossProfit and Loss Rent Received 600Rent Received 600

Balance Sheet as at 31/12/05Balance Sheet as at 31/12/05Current AssetsCurrent Assets Rent Accrued 200Rent Accrued 200

ACCRUED REVENUE (cont’d)ACCRUED REVENUE (cont’d)

Documents

Ch 6 accruals and prepayment