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 those to be used in the following period but have

been paid for in advance.

Accrued expenses those which have been used up in the current

year, but have not yet been paid for.

Prepaid income those to be earned in the following period but have

been received in advance.

Accrued income those which have been earned in the current

period but have not yet been received.

Example2 firms who pay rent for buildings in Hong Kong. The rent for each building is $1,200 a year.

1. Firm A paid $1,00 in the year. Own $200 for rent.

2. 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 expensesAssume 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 Rent due Rent paid

$250 31 March 2005 31 March 2005

$250 30 June 2005 2 July 2005

$250 30 Sept. 2005 4 Oct. 2005

$250 31 Dec. 2005 5 January 2006

Rent2005 $ 2005 $

Mar 31 Bank 250 Dec 31 Profit and loss 1,000

Dec 31 Accrued c/d 250

Jan 1 Accrued b/d 250

2006

1,000 1,000

Jul 2 Bank 250

Oct 4 Bank 250

Prepaid Expenses

Prepaid expensesInsurance 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 Insurance due Insurance paid

$210 31 March 2005 $210 28 Feb 2005

$210 30 June 2005$420 31 Aug. 2005

$210 30 Sept. 2005

$210 31 Dec. 2005 $420 18 Nov. 2005

Insurance2005 $ 2005 $

Feb 28 Bank 210 Dec 31 Profit and loss 840

Aug 31 Bank 420

Nov 18 Bank 420

2006

Jan 1 Prepaid b/d 210

1,050

Dec 31 Prepaid c/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.

ExampleYear ended 31 December 2005

Stationery bought in the year $2,200

Stock of stationery in hand as at 31 December 2005 $400

Stationery2005 $ 2005 $

Dec 31 Bank 2,200 Dec 31 Profit and loss 1,800

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.

2,2002006

Jan 1 Stock b/d 400

Dec 31 Stock c/d 400

2,200

Accrued Income

Accrued incomeAssumed our warehouse is larger than we need. We rent part of it to another firm for $800 per annum.

Amount Rent due Rent received

$200 31 March 2005 4 April 2005

$200 30 June 2005 6 July 2005

$200 30 Sept. 2005 9 Oct. 2005

$200 31 Dec. 2005 7 Jan. 2006

Rent receivable2005 $ 2005 $

Dec 31 Profit and Loss 800 Apr 5 Bank 200 Jul 6 Bank 200

Oct 9 Bank 200

Dec 31 Accrued c/d 200

800

2006

Jan 1 Accrued b/d 210

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.

Rent2005 $ 2005 $

Jan 1 Owing b/d 3,000Jan 6 Bank 3,000Apr 4 Bank 3,000

Jul 7 Bank 3,000Oct 18 Bank 3,000

Dec 31 Owing c/d 3,000

Dec 31 Profit and loss 12,000

15,00015,000

2006Jan 1 Owning b/d 3000

ExampleRent 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 20x5 rent $1,000 had been prepaid in 20x4.

On 1 Jan 20x5 rates were owned of $400.

During 20x5 rent was paid $4,500.

During 20x5 rates were paid $5,000.

On 31 Dec 20x5 rent $500 was owing.

On 31 Dec 20x5 rates of $600 had been prepaid.

Rent and Rates2005 $ 2005 $

Jan 1 Rates owing b/d 400Jan 1 Rent prepaid b/d 1,000

Dec 31 Bank: rent 4,500

Dec 31 Bank: rates 5,000

Dec 31 Owing c/d 500

Dec 31 Profit and loss 10,000

Dec 31 Rates prepaid c/d 600

11,000 11,000

Jan 1 Owing b/d 500

20062006Jan 1 Prepaid b/d 600

Expenses for the period= Cash paid – Accruals in last year + Accr

uals in this year + Prepayments in last year – Prepayment in this year

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

ls 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 soldNet 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 CompanyTrading and Profit and Loss Account for the year ended 31 Dec 19xx

$ $ $Sales xLess Returns Inwards x

xLess cost of Goods Sold

Opening Stock xPurchases xAdd Carriage Inwards xLess Returns Outwards (x)Less Closing Stock (x) x

Gross Profit x

Add Discount received x Rent Received x Profit on Disposal on M.V. x Decrease in provision for bad debt x

xLess Expenses

Rent and Rates xInsurance xCarriage Outwards xDiscount Allowed xBad debts xIncrease in provision for bad debts xDepreciation xLoss on Disposal of Furniture x x

Net Profit x

Name of the CompanyTrading and Profit and Loss Account for the year ended 31 Dec 19xx

$ $ $Fixed Assets Cost Dep. NetMachinery x x xMotors x x x

x x xInvestment ($x at market value) x

xCurrent AssetsStock xDebtors xLess provision for bad debt (x) xPrepaid expenses xAccrued income xBank xCash x

xLess: Current LiabilitiesCreditors xAccrued expenses xPrepaid income xBank overdrafts xWorking Capital x

x

$ $ $

Financed by:CapitalBal as at 1 Jan 19xx xAdd: Net profit / Less Net loss x

xLess: Drawings x

xLong-term LiabilitiesDebentures xBank Loans x

x

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

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

Accounting entries

Dr DrawingsCr Cash / Bank

drawn from the cash till or business bank account

Dr DrawingsCr Purchases

goods taken by the proprietor

Dr DrawingsCr Expenses

private expenses

Losses of goods

Losses of raw materials and trading stock can be classified

1. normal losses2. 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.

Normal Loss

Abnormal Loss.

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 LossCr Trading

With the total loss

Dr Profit and lossCr Fire / Burglary Loss

With the total loss

(ii) Losses with insurance claim

Dr Fire/Burglary LossCr Trading

With the total loss

Dr Bank/Insurance companyCr Fire/Burglary Loss

Insurance claim received

Dr Profit and LossCr Fire / Burglary Loss

Transferring the net loss to profit and loss account at the 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 claimTrading and Profit and Loss Account

$ $ Sales ($3 * 70) 210

____

210

Gross Profit 140

___

140

Purchase ($1 * 100) 100

Less Closing Stock($1*20) 20

80

Less Fire loss 10

Cost of goods sold 70

Gross profit 140

210

Expenses 50

Fire Loss 10

Net Profit 80

140

Abnormal loss with insurance claim ($6)Trading and Profit and Loss Account

$ $ Sales ($3 * 70) 210

____

210

Gross Profit 140

___

140

Purchase ($1 * 100) 100

Less Closing Stock 20

80

Less Fire loss 10

Cost of goods sold 70

Gross profit 140

210

Expenses 50

Fire Loss ($10 - $6) 4

Net Profit 86

140