Balance Day Adjustments

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• Balance Day Adjustments

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Objectives Balance Day Adjustments

• Distinguish between the cash basis of and
  accrual basis of accounting
• Distinguish 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 profits
• Cash basis
• Accrual Basis

Cash Basis Cash receipts Cash payments
Profits
Accrual Basis Revenue earned Expenses incurred
Profits
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Balance Day Adjustments
Jan Feb March Revenue 1000 1000
1000
Rent (cash) 300 - -
Rent (Accrual) 100 100 100

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

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The scenario-
Mr Phua rents a building from Mr Tan and incurs a
monthly rent expense of 1 000.
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.
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 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.
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• Balance Day Adjustments

• Accrued Expenses

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Your mobile phone bill shows that you have not
settled last months 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.
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Balance Day Adjustments - Accrued Expenses

• Phua CK is pretending to be calm but actually is
  very confused. He should have paid 12 000 for
  the rent for the period from January to December
  2000.

Scenario 1

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

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Let us help him.
End of accounting period December 2000

• Should have paid 12 000
• Paid only 5 000
• Owed 7 000

This owing amount of 7 000 is also known as
Accrued Rent Expense. Mr. Phua CK still owes Tan
Ah Teck Ltd 7 000 that was not paid for the year
of 2000.
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Balance Day Adjustments - Accrued Expenses

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

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Balance Day Adjustments - Accrued Expenses
What is the nature of accrued expense? Debit or
Credit entry?
Yes. Credit entry because it is a liability
(still owe people )
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Using Phua CK as an example.
If Mr. Phua remembered to pay the rent amount in
full, then the entries will be-
JOURNAL
Date Particulars
Debit Credit Year 2000 Dec 31
12 000

12 000

Rent Expense
Profit and Loss a/c
However, this is not the case.
An additional ledger needs to be created
Accrued
Rent Expense
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JOURNAL
Date Particulars
Debit Credit Year 2000
7 000 Dec 31
7 000
Rent Expense
Accrued Rent Expense
RENT EXPENSES a/c
Year 2000 Dec 31 Bank
5 000
Year 2000 Dec 31 Profit Loss
12 000
Accrued rent 7 000

Expense
12 000
12 000
ACCRUED RENT EXPENSES a/c
Year 2000 Dec 31 Bal c/d
7 000
Year 2000 Dec 31 Rent Expense
7 000
7 000
7 000
Year 2001 Jan 1 Bal b/d
7 000
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JOURNAL
Date Particulars
Debit Credit
Profit Loss a/c 12 000
Rent
Expense 12 000 (Being rent expense closing
off to PL a/c)
2000 Dec 31
Profit Loss Account
2000 Dec 31 Expenses
12 000
Balance Sheet as at Dec 2000
Liability
Accrued Rent Expense 7 000
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Balance Day Adjustments - Accrued Expenses
Summary

• Definition
• Credit/Debit nature?
• Is there a need to open another ledger for
  accrued expense?
• Post this ledger to P/L or Balance Sheet?

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• Balance day Adjustments

• Prepaid Expenses

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Assuming that the monthly subscription is 20.
You like the promotion and paid 1 200 (6x20)
immediately in order to get the new mobile phone.
Hence you are paying in advance for the expense.
The payment in advance of subscription fees (1
200) is also known as Prepaid Expense.
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Prepaid Expense/Payment in Advance
Definition

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

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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.
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Prepaid Expense/Payment in Advance
Scenario 2

• 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.

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Prepaid Expense/Payment in Advance
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.
30 June 2002
1 Jan 2001
31 Dec 2001
12 000 incurred
6 000 prepaid
18 000 paid
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JOURNAL
Date Particulars Debit Credit
Year 2001 6 000 Dec 31
6 000

Prepaid Rent Expense
Rent Expense
RENT EXPENSES a/c
Year 2001 Dec 31 Bank
18 000
Year 2001 Dec 31 Prepaid Rent
6 000 Profit Loss 12 000
18 000
18 000
PREPAID RENT EXPENSES a/c
Year 2001 Dec 31 Rent
Expense 6 000
Year 2001 Dec 31 Bal c/d
6 000
6 000
6 000
Year 2002 Jan 1 Bal b/d
6 000
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Profit Loss Account
2001 Dec 31 Expenses 12
000
Balance Sheet as at Dec 2001
Current Assets
Prepaid Rent Expense 6 000
Summary

• Definition
• Credit/Debit nature?
• What are the differences in adjustments between
  the accrued and prepaid expenses?

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• Practice!

• Accrued Prepaid Expenses

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Practice - Accrued and Prepaid Expenses

• During the year of 2001, the cash book shows
• maintenance Expense 900
• Selling Expense 1 200
• On 31 May 2001, the Balance Sheet also shows
• Prepaid Maintenance Expense 400
• Accrued Selling expense 300
• Find the actual amount of the expenses incurred
  for the year of 2001.

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1
Prepaid Maintenance Expense
Maintenance Expense


Cash at Bank 900
Profit Loss
500
Prepaid Maint Exp 400
900
900
2
Accrued Selling Expense
Selling Expense


Cash at Bank 1 200
Profit Loss
1 500
Accrued Selling Exp 300
1 500
1 500