Chapter 8 END OF YEAR ADJUSTMENTS

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Chapter 8END OF YEAR ADJUSTMENTS
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Closing off Account

• The balances of ALL expenses and income accounts
  are closed off to the Income Statement (Trading
  and Profit and Loss Account) at the end of the
  accounting period.

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Closing off Accounts
Purchases A/c Purchases A/c Purchases A/c
 2000              
02-July Delis   375  31 July  Income Statement    4 216
02-July Cash   870        
02-July Bank   725        
02-July F. Bolth   706        
18-July Cash   430        
18-July F. Bolth   1 110        
       4 216        4 216
               
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Closing off Account

• Journal Entry

Date Details folio Dr. Cr
2000 July 31 Income Statement 4 216
Purchases A/c 4 216
To transfer the purchases account at the end of the period
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Closing off Accounts
Sales A/c
        2000
 31 July  Income Statement     04-July C. Bailey   1 430
        04-July B. Hughes   1 620
        04-July H. Spencer   1 760
        21-July B. Hughes   670
5 480 5 480
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Closing off Account

• Journal Entry

Date Details folio Dr. Cr
2000 July 31 Sales A/c 5 480
Income Statement 5 480
To transfer the sales account at the end of the period
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Adjustments

• Adjustments are any transactions or events which
  were not recorded at the time of preparation of
  the Trial Balance
• Apart from omitted transactions, many other
  adjustments occur as a result of applying the
  matching/accrual and realisation concepts
• Adjustments must be done before preparing the
  Final accounts (Manufacturing, Income Statement
  and Balance Sheet) are prepared
• Adjustments appear as notes after the Trial
  Balance totals.

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Adjustment Income
The Realisation concept states that amount for
income to be used to prepare the Income Statement
is the amount which should be collected from the
sale goods or the provision of services during
the accounting period under review even if cash
has not been collected.
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Adjustment Income
Cash collected during the accounting
period X Add owing at close x Collected in
advance at start x Less Owing at
start (x) Collected in advance at
close (x) Income for the period X
Income collected in advance current liability
Income owing current asset
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Adjustment Income
dr Income Account Income Account cr
Income owing at start x Income in advance at start x
Income Statement (Income for period) x Cash (received) x
Income in advance at close x Income owing at close x
x x
 
Income in advance current liability
Income owing current asset
NB. Assets and liabilities are also used in the
Balance Sheet
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Adjustment Expense
The matching/accrual concept states that all the
expenses incurred (supposed to be paid) in an
accounting period to produce income should be
recorded in the trading and profit and loss
account even if not paid.
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Adjustment Expense

1. The accounting period for which the Income
   Statement A/c is to be prepared must be
   identified. Pay attention to the date, the month
   and the year
2. If any amount is relevant to the accounting
   period then add to cash paid during the same
   accounting period
3. If any amount is not relevant to the accounting
   period then subtract from cash paid during the
   same accounting period.
4. A prepayment takes place if the amount of an
   expense paid during the accounting period is
   greater than the amount to be paid
5. An accrual takes place when the amount of an
   expense actually paid during the accounting
   period is less than the amount to be paid.

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Adjustment Expense
Cash paid during the accounting period X Add
owing at close x Paid in advance at
start x Less Owing at start (x) Paid in
advance at close (x) Expense for the
period X
Expense owing current liability
Prepaid expense current asset
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Adjustment Expense
dr Expense Account Expense Account cr
Prepaid expense at start x Expense owing at start x
Cash paid x Income Statement x
Expense owing at close x Prepaid expense at close x
x x
 
Prepaid expense current asset
Expense owing current liability
NB. Assets and liabilities are also used in the
Balance Sheet
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Adjustment Depreciation

• Fixed or non current assets are resources which
  allow a controlling firm to gain economic
  benefits over a period of more than one year in
  the future
• Depreciation is the portion of the cost of a
  fixed asset expended or used up during each
  accounting period for which the fixed asset is
  used or held

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Adjustment Depreciation

• Land used for development and not for mining is
  the only fixed asset that is not depreciated.
• Depreciation is therefore a non-cash expense.
• The reasons for depreciation are use wear and
  tear obsolescence (new model making the old
  model out of date) and time.

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Adjustment Depreciation
Estimating annual depreciation charge or expense
The straight line method
either Cost of the fixed asset less estimated
scrap/residual value Estimated useful life of the
fixed asset Or Cost of the fixed asset x
annual rate of the depreciation
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Adjustment Depreciation
Estimating annual depreciation charge or expense
Reducing balance method
Net book value of the fixed asset x annual rate
of the depreciation
Cost of fixed asset less total previous
depreciation expense (aggregate/accumulated/provis
ion for depreciation)
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Adjustment Depreciation
Methods compared
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Adjustment Depreciation
Methods compared

• In the earlier years the annual expense under the
  reducing balance is greater than the
  straight-line method
• While in later years the annual expense under
  the reducing balance is less than the
  straight-line method.
• Using the straight-line method gives a fixed
  annual depreciation expense. It is only if the
  cost of fixed assets changes that the annual
  expense will change.

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Adjustment Depreciation
Double Entry
Date Details folio Dr. Cr
Depreciation expense x
Provision for or accumulated depreciation x
To record the depreciation charge or expense for the period
The balance of the provision for depreciation
account is used in the Balance Sheet as a contra
asset. The account records the sum of annual
depreciation charge from the date of purchase of
the fixed asset. The balance of the depreciation
expense account is used in the Income Statement
as an expense
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Adjustment Depreciation
Balance sheet extract
Fixed Assets e.g Cost Provision for Depreciation Net Book Value
Year 1 Motor Car 450,000.00 (72,000.00) 378,000
Year 2 Motor Car 450,000.00 (144,000.00) 306,000
Year 3 Motor Car 450,000.00 (216,000.00) 234,000
Year 4 Motor Car 450,000.00 (288,000.00) 162,000
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Adjustment Bad Debts
A bad debt occurs anytime a business is unable to
collect any amount from a debtor (someone to whom
goods were sold on credit). A debtor may not be
able to pay because of death, bankruptcy or if
(s)he has flees the country.
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Adjustment Bad Debts
When a debt becomes uncollectable it is written
off as follows
Date Details folio Dr. Cr
Bad debts x
Debtors (Name) x
To record bad debt written off
The written off customer balance is transferred
to the Bad debt A/c. This reduced the value of
debtors. The bad debt a/c balance is a loss or
an expense and is used the Income Statement.
Note the above double entry must be carried out
only if a note detailing bad debts appears after
the Trial Balance totals. If bad debts only
appear in the Trial Balance, it must only be used
in the Income Statement.
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Adjustment Provision for Bad Debts

• A provision for bad debts or doubtful debts
  represents an estimation of the value of debtors
  who may not pay or may default. This is another
  example of a non cash expense
• The aim of an initial provision for bad or
  doubtful is to set aside an amount from profits
  to cover the value of debtors who may default
• The value of debtors who may be default is
  normally expressed as a percent

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Adjustment Provision for Bad Debts
The example below shows the debtors balances of a
firm for three consecutive years. A provision
for bad debts is to be establish at 5.
2001 2002 2003
Debtors 25,000 35,000 24,000
Value of ending provision _at_ 5 of debtors after bad debts 1 250 1 750 1 200

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Adjustment Provision for Bad Debts
The value of the ending provision for bad debts
is entered in the Balance Sheet for each year as
a contra asset and subtracted from debtors
Balance Sheet extract
2001 2002 2003
Debtors 25,000 35,000 24,000
Provision for bad debts (1 250) (1 750) (1 200)
Net debtors 23 750 33 250 22 800

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Adjustment Provision for Bad Debts
Only the increase or decrease in the provision
for bad debt balance is entered in the Income
Statement An increase as an expense i.e. 1 250
and 500 for the accounting period 2002 and
2001 respectively A decrease as income i.e. 550
for 2003

2001 2002 2003
Increase (decrease) (1 250-0) 1 250 (1 750 1 250) 500 (1 200 1 750) (550)
The opening balance of a provision for bad debts
will be found in the Trial Balance, while the
closing balance will be given in a note after the
Trial Balance totals
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Adjustment Provision for Bad Debts
Provision for bad debt a/c
2001
31-Dec Bal c/d 1 250 31-Dec Income Statement 1 250
2002
31-Dec Bal c/d 1 750 1-Jan Bal b/d 1 250
31-Dec Income Statement 500
1 750 1 750
2003
31-Dec Income Statement 550 1-Jan Bal b/d 1 750
31-Dec Bal c/d 1 200
1 750 1 750
2004
1-Jan Bal b/d 1 200