Notes to teachers - TWGHs Wong Fut Nam Collegeaerodrive.twghwfns.edu.hk/~why/BAFS/Textbook... · 1 Chapter 1 Accruals and Prepayments Notes to teachers 1 Start with Chapter 4 of Frank

1

Chapter 1 Accruals and Prepayments

Notestoteachers

1 Start with Chapter 4 of Frank Wood’s Introduction to Accounting and briefly explain to students how to record expenses and other revenues in the cash book and post entries to the general ledger.

2 Refer to Chapter 10 of Frank Wood’s Introduction to Accounting and briefly explain to students the accrual concept.

3 Explain the meaning of accrued expenses, prepaid expenses, accrued revenues and unearned revenues with the aid of real-life examples, and why they are treated as current assets or current liabilities.

4 Students should know the alternative names of the above items.

5 Most students have difficulty understanding why accrued revenues and unearned revenues are treated as current assets and current liabilities, respectively. Teachers should clarify the meaning of ‘current assets’ and ‘current liabilities’ by doing Try This Activity A3 and A7 with students.

6 If the entries in the accounts of expenses and other revenues are posted from the cash book, they are said to be made on a cash basis. Students should know that the accrual concept is one of the fundamental principles underlying financial reporting. To correspond with the accrual concept, adjustments are required in the accounts of expenses and other revenues at the end of an accounting period. As a result, financial statements can then be prepared on an accrual basis.

7 Two methods are used to adjust for accruals and prepayments. Students should master both methods.

8 Timing is very important in deciding whether an item and how much of an item is accrued or prepaid. Teachers always need to remind students to note the financial year’s closing date.

Q1 According to the accrual concept, a firm should only record revenues generated by goods sold or services rendered during a period, rather than the amounts actually received during that period. Similarly, a firm should only record expenses which have been incurred in generating those revenues during the same period, rather than the amounts actually paid during that period.

Q2 Under cash accounting, revenues are recognised when received and expenses are recognised when paid.

Under accrual accounting, revenues are recognised when earned and expenses are recognised when incurred.

Q3 Accruals refer to expenses that have been incurred during a period but have not been paid by the end of that period. Accruals can also refer to revenues that have been earned during a period but have not been received by the end of that period.

Chapter 1

Notestoteachers

M01_FWFA_TB_HKG_9645_C01_6.indd 1 2009/11/4 3:45:57 PM

�

Q4 Prepayments refer to expenses that have been paid during a period but have not been incurred by the end of that period. Prepayments can also refer to revenues that have been received during a period but have not been earned by the end of that period.

Q5 Accrued expenses are liabilities of the firm and therefore the accrued expense account should be classified as a real account.

Q6 Accrued revenues are assets of the firm and therefore the accrued revenue account should be classified as a real account.

Q7 AccruedWaterCharges

2010 $ 2010 $Jan 1 Watercharges 1,240 Jan 1 Balanceb/f 1,240

WaterCharges

2010 $ Jan 1 Accruedwatercharges 1,240

AccruedInterestRevenue

2010 $ 2010 $Jan 1 Balanceb/f 1,600 Jan 1 Interestrevenue 1,600

InterestRevenue

2010 $ Jan 1 Accruedinterestrevenue 1,600

A1 This is because accrued expenses are liabilities that are expected to be repaid within one year.

A2 Total expenses for the period will be understated and the net profit for the period will be overstated.

A3 This is because accrued revenues are assets that are expected to be converted into cash within one year.

A4 Total revenues for the period will be understated and the net profit for the period will also be understated.

A5 This is because prepaid expenses represent goods or services that are expected to be consumed within one year.

A6 Total expenses for the period will be overstated and the net profit for the period will be understated.

A7 This is because unearned revenues represent goods or services that a business has to provide to its customers within one year.

A8 Total revenues for the period will be overstated and the net profit for the period will also be overstated.


�

A9 KHui IncomeStatementfortheyearended31March2010(extract)

$Other revenues: Rentrevenue 80,000Commissionrevenue 2,680

Expenses: Rentexpense 100,000Telephoneexpense 1,140

A10 Insurance

2009 $ 2009 $Feb 26 Bank 1,800 Dec 31 Profitandloss 3,000Aug 24 Bank 1,800 " 31 Prepaidinsurance 600 3,600 3,600

2010 Jan 1 Prepaidinsurance 600

PrepaidInsurance

2009 $ 2009 $Dec 31 Insurance 600 Dec 31 Balancec/f 600

2010 2010 Jan 1 Balanceb/f 600 Jan 1 Insurance 600

RentRevenue

2009 $ 2009 $Dec 31 Profitandloss 30,000 Sept24 Bank 10,000" 31 Unearnedrentrevenue 10,000 Oct 25 Bank 10,000 Nov 26 Bank 10,000 Dec 28 Bank 10,000 40,000 40,000

2010 Jan 1 Unearnedrentrevenue 10,000

UnearnedRentRevenue

2009 $ 2009 $Dec 31 Balancec/f 10,000 Dec 31 Rentrevenue 10,000

2010 2010 Jan 1 Rentrevenue 10,000 Jan 1 Balanceb/f 10,000

A11 In the income statement:

• ‘Net profit’ for the year would be total revenues received minus total expenses paid during the year.

• ‘Sales’ would be the amount actually received from sales during the year. ‘Discounts allowed’ would not be separately shown.

• ‘Purchases’ would be the amount actually paid for purchases during the year. ‘Discounts received’ would not be separately shown.

• The matching concept (which will be explained in Chapter 17 of Frank Wood’s Financial Accounting 2) would no longer apply. Therefore, no adjustments for opening/closing inventory would be required.

• ‘Rent received in advance’ would be recognised as revenue for the year.

• ‘Interest revenue’ would not be recognised as revenue for the year because it had not been received by the year end.

• No adjustments for accrued wages and prepaid telephone charges would be required.


�

In the balance sheet:

• The items ‘inventory’, ‘accounts receivable’, ‘accrued revenues’ and ‘prepaid expenses’ would not appear in current assets.

• The items ‘accounts payable’, ‘accrued expenses’ and ‘unearned revenues’ would not appear in current liabilities.

A13 Accrual accounting can more accurately measure the financial performance (i.e., profitability and liquidity) of an entity.

Under cash accounting, revenues represent the amounts received during an accounting period, whether they have been earned or not. The amounts earned but not yet received would not be recorded as revenues while the amounts received but not yet earned would not be excluded and not treated as revenues.

Under accrual accounting, revenues represent the amounts earned during an accounting period, whether they have been received or not. The amounts earned but not yet received or received but not yet earned would be shown as current assets and liabilities, respectively, in the balance sheet.

Likewise, under cash accounting, expenses represent the amounts paid during an accounting period, whether they have been incurred or not. The amounts incurred but not yet paid would not be recorded as expenses while the amounts paid but not yet incurred would not be excluded and not treated as expenses for the period.

Under accrual accounting, expenses represent the amounts incurred during an accounting period, whether they have been paid or not. The amounts paid but not yet incurred or incurred but not yet paid would be shown as current assets and liabilities, respectively, in the balance sheet.

ASSESSMENT

Short QuestionsShort Questions

1 (i) Rent

2008 $ 2008 $Dec 31 Bank 16,000 Dec 31 Profitandloss 20,000" 31 Accruedc/f 4,000 20,000 20,000

(ii) Insurance

2008 $ 2008 $Dec 31 Bank 900 Dec 31 Profitandloss 635 " 31 Prepaidc/f 265 900 900

(iii) Rates

2008 $ 2008 $Jan 1 Bank 750 Dec 31 Profitandloss 1,500Jul 1 Bank 1,125 " 31 Prepaidc/f($1,125×) 375 1,875 1,875

3939


�

(iv) RentRevenue

2008 $ 2008 $Dec 31 Profitandloss($4,000×12) 48,000 Apr 15 Bank 20,000" 31 Inadvancec/f 16,000 Dec 15 Bank 44,000 64,000 64,000

2X (i) GeneralExpenses

2009 $ 2009 $Mar 31 Bank 6,150 Mar 31 Profitandloss 5,590 " 31 Prepaidc/f 560 6,150 6,150

(ii) CommissionRevenue

2009 $ 2009 $Mar 31 Profitandloss 3,231 Mar 31 Bank 3,056 " 31 Accruedc/f 175 3,231 3,231

(iii) CarriageOutwards

2009 $ 2009 $Mar 31 Bank 666 Mar 31 Profitandloss 788" 31 Accruedc/f 122 788 788

(iv) Insurance

2008 $ 2009 $Apr 1 Bank 1,080 Mar 31 Profitandloss 1,4402009 " 31 Prepaidc/f($1,080×69) 720Jan 1 Bank 1,080 2,160 2,160

3 (i) Rent AccruedRent

2008 $ 2008 $ 2008 $ 2008 $Dec31 Bank 16,000 Dec31 Profitand Dec31 Balancec/f 4,000 Dec31 Rent 4,000" 31 Accrued loss 20,000 rent 4,000 20,000 20,000

TheJournal

Date Details Dr Cr

2008Dec 31 Rent

Accruedrent

$4,000

$

4,000

(ii) Insurance PrepaidInsurance

2008 $ 2008 $ 2008 $ 2008 $Dec31 Bank 900 Dec31 Profitand Dec31 Insurance 265 Dec31 Balancec/f 265 loss 635 " 31 Prepaid insurance 265 900 900


�

TheJournal

Date Details Dr Cr

2008Dec 31 Prepaidinsurance

Insurance

$265

$

265

(iii) Rates PrepaidRates

2008 $ 2008 $ 2008 $ 2008 $Jan 1 Bank 750 Dec31 Profitand Dec31 Rates 375 Dec31 Balancec/f 375Jul 1 Bank 1,125 loss 1,500 " 31 Prepaid rates 375 1,875 1,875

TheJournal

Date Details Dr Cr

2008Dec 31 Prepaidrates

Rates

$375

$

375

(iv) RentRevenue UnearnedRentRevenue

2008 $ 2008 $ 2008 $ 2008 $Dec31 Profitand Apr 15 Bank 20,000 Dec31 Balancec/f Dec31 Rentrevenue loss 48,000 Dec15 Bank 44,000 16,000 16,000" 31 Unearnedrent revenue 16,000 64,000 64,000

TheJournal

Date Details Dr Cr

2008Dec 31 Rentrevenue

Unearnedrentrevenue

$16,000

$

16,000

4X (i) GeneralExpenses PrepaidGeneralExpenses

2009 $ 2009 $ 2009 $ 2009 $Mar31 Bank 6,150 Mar31 Profitand Mar31 General Mar31 Balancec/f loss 5,590 expenses 560 560 " 31 Prepaidgeneral expenses 560 6,150 6,150

TheJournal

Date Details Dr Cr

2009Mar 31 Prepaidgeneralexpenses

Generalexpenses

$560

$

560


�

(ii) CommissionRevenue AccruedCommissionRevenue

2009 $ 2009 $ 2009 $ 2009 $Mar31 Profitand Mar31 Bank 3,056 Mar31 Commission Mar31 Balancec/f loss 3,231 " 31 Accrued revenue 175 175 commission revenue 175 3,231 3,231

TheJournal

Date Details Dr Cr

2009Mar 31 Accruedcommissionrevenue

Commissionrevenue

$175

$

175

(iii) CarriageOutwards AccruedCarriageOutwards

2009 $ 2009 $ 2009 $ 2009 $Mar31 Bank 666 Mar31 Profitand Mar31 Balancec/f Mar31 Carriage" 31 Accruedcarriage loss 788 122 outwards 122 outwards 122 788 788

TheJournal

Date Details Dr Cr

2009Mar 31 Carriageoutwards

Accruedcarriageoutwards

$122

$

122

(iv) Insurance PrepaidInsurance

2008 $ 2009 $ 2009 $ 2009 $Apr 1 Bank 1,080 Mar31 Profitand Mar31 Insurance 720 Mar31 Balancec/f 7202009 loss 1,440 Jan 1 Bank 1,080 " 31 Prepaid insurance 720 2,160 2,160

TheJournal

Date Details Dr Cr

2009Mar 31 Prepaidinsurance

Insurance

$720

$

720


�

5 CChan IncomeStatementfortheyearended31December2008

$ $Sales 92,950Less Cost of goods sold: Openinginventory 10,250 Add Purchases 55,850 66,100 Less Closinginventory (19,550) (46,550)Grossprofit 46,400Less Expenses: Rent($6,400–$1,600) 4,800 Wagesandsalaries($21,400+$2,900) 24,300 Insurance($590–$190) 400 Telephone($300+$110) 410 Generalexpenses 1,800 (31,710)Netprofit 14,690

6X KChu IncomeStatementfortheyearended31March2009

$ $Sales 108,380Less Returnsinwards (2,000) 106,380Less Cost of goods sold: Openinginventory 8,620 Add Purchases 61,120 69,740 Less Closinginventory (12,120) (57,620)Grossprofit 48,760Less Expenses: Wagesandsalaries($24,800+$1,020) 25,820 Motorexpenses 2,120 Rentandrates($12,000–$800) 11,200 Discountsallowed 290 Lightingexpenses($580+$170) 750 Computeroperatingexpenses($1,210–$280) 930 Generalexpenses 3,600 (44,710)Netprofit 4,050

7 HappyWong IncomeStatementfortheyearended31December2008

$ $Hairdressingrevenue 100,400Less Expenses: Advertising 2,300 Carexpenses($4,800×) 3,200 Rates($1,400–$300) 1,100 Telephone 1,100 Sundryexpenses 1,200 Cleaning 150 (9,050)Netprofit 91,350

2323


�

HappyWongBalanceSheetasat31December2008

$ $Non-current assetsShoppremises 60,000Equipment 7,200Car 26,400 93,600Current assetsPrepaidexpenses 300Bank 5,400Cash 400 6,100Less Current liabilities Accruedexpenses (150)Netcurrentassets 5,950 99,550

Financed by:Capitalasat1January2008 14,300Add Netprofitfortheyear 91,350 105,650Less Drawings[$4,500+($4,800×)] (6,100) 99,550

8X LTang IncomeStatementfortheyearended31December2009

$ $ $Sales 120,320Less Returnsinwards (1,384) 118,936Less Cost of goods sold: Openinginventory 30,816 Add Purchases 84,290 Less Returnsoutwards (810) 83,480 Add Carriageinwards 309 114,605 Less Closinginventory (36,420) (78,185)Grossprofit 40,751Add Other revenues: Discountsreceived 506 Rentrevenue 2,500 3,006 43,757Less Expenses: Discountsallowed 410 Carriageoutwards 218 Motorexpenses($4,917+$330) 5,247 Repairstopremises 1,383 Salariesandwages 16,184 Sundryexpenses($807+$162) 969 Ratesandinsurance($2,896–$332) 2,564 Loaninterest 4,000 (30,975)Netprofit 12,782

1313


10

9 (a) TLee IncomeStatementfortheyearended30June2009

$ $Feescharged 108,600Less Expenses: Wagesandsalaries($31,960+$2,320) 34,280 Postageandstationery($2,140+$220) 2,360 Telephone 1,250 Computeroperatingexpenses 2,190 Travelexpenses($1,620×90%) 1,458 Insurance($890–$170) 720 Rent($23,000–$600) 22,400 Sundryexpenses 520 (65,178)Netprofit 43,422

TLeeBalanceSheetasat30June2009

$ $Non-current assetsOfficefurniture 10,800Equipment 25,400 36,200Current assetsAccountsreceivable 11,100Prepaidexpenses($600+$170) 770Bank 8,090Cash 120 20,080Less Current liabilities Accruedexpenses($220+$2,320) (2,540)Netcurrentassets 17,540 53,740Financed by:Capitalasat1July2008 19,680Add Netprofitfortheyear 43,422 63,102Less Drawings[$9,200+($1,620×10%)] (9,362) 53,740

(b) No, both types of firms treat revenues and expenses in the same manner if they adopt accrual-basis accounting. For trading firms, revenues are recognised when goods are sold. For service firms, revenues are recognised when services are provided. As for expenses, they are recognised by both types of firms when they are incurred.


11

Application Problems

10XTheJournal

Date Details Dr Cr

2009 $ $Mar 31

" 31

" 31

" 31

Bank Rentrevenue

Rentrevenue Profitandloss($340,000+$24,000–$65,000–$38,000+$42,000)

Insurance Bank

Profitandloss Insurance[$18,000+($12,000×)–($18,000×)]

340,000

303,000

18,000

16,500

340,000

303,000

18,000

16,500

11X Salaries

2007 $ 2007 $Mar 31 Balanceb/f 9,880 Mar 31 Profitandloss 12,180" 31 Accruedc/f 2,300 12,180 12,180

Electricity

2007 $ 2007 $Mar 31 Balanceb/f 5,875 Mar 31 Profitandloss 6,500" 31 Accruedc/f 625 6,500 6,500

RentalIncome

2007 $ 2007 $Mar 31 Profitandloss 150,000 Mar 31 Balanceb/f 162,500" 31 Prepaidc/f 12,500 162,500 162,500

12 (a) One of the main differences between cash accounting and accrual accounting lies in the treatment of accruals and prepayments of revenues and expenses.

Under cash accounting, revenues are recorded when cash is received and expenses are recorded when cash is paid. This means that revenues are recognised when received and expenses are recognised when paid.

Under accrual accounting, a firm should only record revenues generated by goods sold or services rendered during a period and the expenses which have been incurred in generating those revenues during the same period, rather than the amounts actually received or paid during that period. This means that revenues are recognised when earned and expenses are recognised when incurred.

(b) Cash accounting often leads to misleading results as a firm may have earned certain revenues during a period but those revenues have not been recognised because they have not been received by the end of that period. Likewise, it may have incurred certain expenses during a period but those expenses have not been recognised as they have not been paid by the end of that period. Owing to its inadequacy, cash accounting is not commonly used by businesses.

312312

312312


1�

13 (a) JimmyChan IncomeStatementfortheyearended31March2010

$ $Sales 182,480Less Purchases (97,200)Grossprofit 85,280Less Expenses: Administrativeexpenses 42,570 Sellinganddistributionexpenses 21,230 (63,800)Netprofit 21,480

(b) JimmyChan IncomeStatementfortheyearended31March2010

$ $Sales($182,480+$12,130) 194,610Less Cost of goods sold: Purchases($97,200+$7,790) 104,990 Less Closinginventory (14,700) (90,290)Grossprofit 104,320Add Interestrevenue($50,000×6%×) 1,000 105,320Less Expenses: Administrativeexpenses($42,570+$6,000) 48,570 Sellinganddistributionexpenses[$21,230–($2,400×)] 19,430 (68,000)Netprofit 37,320

(c) • In (a), sales were recognised when cash was received. In (b), sales were recognised when sales were made, thus including trade receivables which arose during the year.

• In (a), purchases were recognised when cash was paid. In (b), purchases were recognised when goods were obtained, thus including trade payables which arose during the year.

• In (a), the gross profit was calculated by deducting purchases paid during the year from sales receipts for the year. In (b), the gross profit was calculated by deducting the cost of goods sold for the year from sales for the year. The cost of goods sold equalled the purchases made during the year less the value of unsold goods at the year end.

• In (a), interest revenue was not recognised because it had not been received by the year end. In (b), interest revenue was recognised because it had been earned during the year.

• In (a), expenses were recognised when paid. In (b), expenses were recognised when incurred, thus including the amounts accrued and deducting the amounts prepaid.

• As a result, the net profits calculated in (a) and (b) were different.

14X (a) (i) AdvertisingandPromotions

2008 $ 2008 $Jul 28 Bank 7,500 Apr 1 Accruedb/f 2,220Oct 15 Bank 12,600 2009 Mar 31 Profitandloss 14,400 " 31 Prepaidc/f 3,480 20,100 20,100

4124

12

912912


1�

(ii) PrintingandStationery

2008 $ 2009 $Apr 1 Stationeryb/f 20,400 Mar 31 Profitandloss 13,110Sept14 Bank—Stationery 5,100 " 31 Stationeryc/f 18,6002009Feb 12 Bank—Printing 2,520Mar 31 Accruedprintingc/f 3,690 31,710 31,710

(iii) RentalIncome

2009 $ 2008 $Mar 31 Profitandloss(12months) 15,780 Apr 1 Inadvanceb/f(3months) 3,780" 31 Inadvancec/f(3months:$8,880×12) 4,440 Jul 1 Bank(6months) 7,560 Oct 1 Bank(6months) 8,880 20,220 20,220

(iv) Rates

2008 $ 2009 $Apr 1 Prepaidb/f(3months) 4,680 Mar 31 Profitandloss(12months) 19,800Jul 1 Bank(6months) 10,080 " 31 Prepaidc/f(3months:$10,080×12) 5,040Oct 1 Bank(6months) 10,080 24,840 24,840

(b) FinancialServices BalanceSheetasat31March2009(extract)

Current assets $ Current liabilities $Stationeryinventory 18,600 Accruedexpenses 3,690Prepayments($3,480+$5,040) 8,520 Unearnedrevenues 4,440

Past Exam QuestionsPast Exam Questions

15 InsuranceAccount

2006 $ 2006 $Mar 31 Balanceb/f 8,100 Mar 31 Profitandloss 7,405 " 31 Prepaymentc/f($2,780×) 695 8,100 8,100

ElectricityAccount

2006 $ 2006 $Mar 31 Balanceb/f 6,480 Mar 31 Profitandloss 8,040" 31 Accrualc/f 1,560 8,040 8,040

CommissionIncomeAccount

2006 $ 2006 $Mar 31 Profitandloss 188,000 Mar 31 Balanceb/f 200,000" 31 Prepaidincomec/f 12,000 200,000 200,000

RentalIncomeAccount

2006 $ 2006 $Mar 31 Profitandloss 140,000 Mar 31 Balanceb/f 120,000 " 31 Accruedincomec/f 20,000 140,000 140,000

3123

12


Documents

Notes to teachers - TWGHs Wong Fut Nam Collegeaerodrive.twghwfns.edu.hk/~why/BAFS/Textbook... · 1 Chapter 1 Accruals and Prepayments Notes to teachers 1 Start with Chapter 4 of Frank