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Business School

ACCT1501 Accounting and Financial Management 1A


Session 1 2015

Week 5

Accrual Accounting Adjustments


Student Handout

Lecturer:
Jeffrey Knapp
School of Accounting
UNSW
QUAD 3103
j.knapp@unsw.edu.au

Moodle: https://moodle.telt.unsw.edu.au/login/index.php

ACCT 1501 Session 1, 2015

WEEK 5: Accrual Accounting Adjustments


1.

Lecturer comments

Accrual accounting exists to provide timely information about the financial affairs of
organisations to users or stakeholders for their economic decision-making. In financial
accounting, the focus is on providing useful information to external stakeholders such as
shareholders and creditors.
The financial affairs of organisations involve financial position, financial performance,
changes in equity and cash flows. The balance sheet addresses financial position by showing
the economic resources under the organisations control (assets) and its financial and other
obligations (liabilities). The balance sheet captures the fundamental equation (A L = OE)
and it is the driving force in accrual accounting. The need at regular intervals at the end of
each accounting period to determine the assets and liabilities of the enterprise is at the heart
of accrual accounting and accrual adjustments. In the business world, analysts and investors
tend to focus on financial performance for the accounting period, that is, profit or earnings.
The profit is the income less expenses for the period. Income equals revenue plus gains. The
income statement shows the revenues for the period less the expenses incurred in generating
those revenues this is referred to as the matching principle.
Accrual accounting is superior to cash flow information to assess the financial position and
financial performance of an enterprise. Cash flow information only records the financial
effects of transactions and events on the cash balance. In contrast, accrual accounting records
the financial effects of all transactions and events that affect economic resources or
obligations of the enterprise. Consider this simple example. Assume a company sold land
that had cost $1m in return for new land valued at $5m. This transaction would not be
recorded in cash accounting. In accrual accounting we would recognise the new land as an
asset in the balance sheet $5m and we would recognise a gain of $4m in the income statement.
Keeping track of cash flow is important for business success, but it is not enough. We have to
go beyond cash flow to assess economic performance more broadly and to assess non-cash
resources and obligations. In accrual accounting, we make estimates, judgements and other
accounting choices that make the financial information more subjective than transactionbased cash flow figures. Accrual accounting information therefore tends to be more relevant
to users economic decision-making than cash-based information but less reliable.
This week, adjusting entries are the key concept. Adjusting entries are the steps required to
ensure the accounts represent the assets, liabilities, revenues and expenses once we get to the
end of the accounting period. For reasons of convenience, we dont record a wages expense
for every hour (or minute, or second, or millisecond). But at the end of the accounting
period, we must ensure that any wages owing (liability) is recorded together with the related
wages expense for the period. When preparing the financial statements for the accounting
period, we want to ensure that all assets, liabilities, revenues and expenses are recognised and
measured. To make sure this happen, we have to adjust the accounts.
This week we also consider closing entries. Only the account balances for assets, liabilities
and equity carry forward from one accounting period to the next. The accounts for revenues
and expenses must be closed at the end of the accounting period to determine the profit for
the period. An income summary account is used to facilitate this process. The profit for the
period is then transferred to the equity account of retained profits.

ACCT 1501 Session 1, 2015

Learning objectives
At the end of this topic you should be able to:
Explain how the timing of revenue and expense recognition differs from cash inflows

and outflows.


Prepare journal entries for accrual accounting adjustments.

Understand contra accounts and the impact on the financial statements.

Understand and perform the closing process.

Required Reading


Trotman, Gibbins & Carson

Chapter 4:pages 174-177

Trotman, Gibbins & Carson

Chapter 5:pages 201-242

(Note from lecturer. Please read all the learning objectives for chapter 5 on page 201 of
the textbook. These learning objectives are covered during my 4 week lecturing period.)

2.

Tutorial Questions Due in Week 6

Preparation Questions:
Students should review the following preparation questions using the solutions available from
Moodle.


Discussion Questions DQ 5.2, DQ 5.4, DQ 5.13

Problems P5.4, P5.6, P5.18, P5.20, P5.23

Case 5A

Tutorial Questions:
Students should attempt the following tutorial questions before class.


Discussion Questions DQ 5.10, DQ5.19

Problems P5.7, P5.9, P5.13

ACCT 1501 Session 1, 2015

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Topic 5: Learning Objectives (LO)

ACCT1501
Semester 1, 2015

 At the end of Topic 5, you should be able to:


LO1: Explain how the timing of revenue and expense recognition
differs from cash inflows and outflows (the accrual concept)
LO2: Prepare journal entries for accrual accounting adjustments (the
adjusting entries)
LO3: Understand contra accounts and the impact on the financial
statements
LO4: Understand and perform the closing process

Week 5
Accrual Accounting Adjustments

 Essential reading for Week 5

Jeffrey Knapp




Quad 3103

Trotman, Gibbins & Carson Chapter 4 pp. 174-177


Trotman, Gibbins & Carson Chapter 5 pp. 201-242

Recap: Cash and accrual accounting


 Accrual accounting records:


Revenues when they are earned, not received.

Expenses when they are incurred, not paid.

E.g.

 Remember, cash accounting records revenues and


expenses when

E.g.
E.g.

LO1

 Often a timing difference between the significant


economic event (earning revenue/incurring expense) and
related cash flow

Some items that have no cash flow effect.




Accrual accounting

LO1

provide a more complete picture of economic performance,


particularly in the short term

 Does not imply that the payment or receipt of cash are


unimportant events


the lifeblood of business

cash is received or paid.


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Revenue expense and recognition

Revenue recognition

LO1

Lets review the differences in how revenue and expense


are recognised under an accrual versus cash system.

LO1

1. Recognition of revenue (resource inflow) at the same time


as cash inflow.



E.g. Sale to customer for cash.


Cash entry:
Dr Cash (+A)
Cr Sales (+R)
Accrual entry:
Dr Cash (+A)

Cr Sales (+R)
Note: both entries are the same.
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Revenue recognition

Revenue recognition

LO1

2. Recognition of revenue (resource inflow) prior to cash


inflow

3. Recognition of revenue (resource inflow) after cash inflow.







E.g. Sale to customer on credit.


Cash entry:
Nothing
Accrual entry:
Dr Accounts receivable (+A)
Cr Sales (+R)

LO1

E.g. Receipt of subscription fees in advance.


Cash entry:
Dr Cash (+A)
Cr Sales (+R)
Accrual entry:
Dr Cash (+A)
Cr Unearned revenue (+L)

Note : the cash entry overstates sales.

Note : the cash entry understates sales.


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Expense recognition

1. Recognition of expense (resource outflow) at the same


time as cash outflow.



Expense recognition

LO1

2. Recognition of expense (resource outflow) prior to cash


outflow

E.g. Payment of wages.


Cash entry:
Dr Wages expense (+E)
Cr Cash (-A)
Accrual entry:
Dr Wages expense (+E)
Cr Cash (-A)




Note: both entries are the same.

LO1

E.g. wages owing at year end


Cash entry:
Nothing
Accrual entry:
Dr Wages expense (+E)
Cr Wages payable (+L)

Note: the cash entry understates expenses.

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Expense recognition
3. Recognition of expense (resource outflow) after cash
outflow



Summary: Cash versus accrual profit

LO1

E.g. Payment of insurance for the next 24-month period.


Cash entry:
Dr Insurance Expense (+E)
Cr Cash (-A)
Accrual entry:
Dr Prepaid insurance (+A)
Cr Cash (-A)

LO1

 The earning of a revenue is not necessarily accompanied


by an inflow of cash in the same period.
 The incurrence of an expense is not necessarily
accompanied by an outflow of cash in the same period.
 Accrual profit is not the same as cash profit.

Note : the cash entry overstates expenses.


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Accrual accounting adjustments

LO2

Accrual accounting adjustments

 Adjusting entries are entries necessary at the end of the


accounting period to measure all revenues and expenses
of that period.
 Types:
1.Deferrals-related
1.1 Revenue adjustment: Unearned revenue

Year End

Deferrals

1.1.Unearned revenue
Cash received
before earned Revenue earned over time
...
t-1
t
#1
#2
Expense incurred over time
Cash paid
before incurred
1.2.Prepayment

1.2. Expense adjustment: Prepayment


2. Accruals-related
2.1. Revenue adjustment: Accrued revenues
2.2. Expense adjustment: Accrued expenses
3. Valuation-related: Book value adjustments: Contra accounts

LO2

Accruals

2.1.Accrued revenue
Cash received
after earned
t+1
#1
Cash paid
after incurred
2.2. Accrued expense

Each involves two entries:


#1 One for the cash receipt or payment
#2 One for recording the revenue or expense in the proper period (Adjusting entries)

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1.1. Unearned revenue


 Cash received in advance of earning revenue.


1.1. Unearned revenue An example

LO2

LO2

On 31 May, a company received $1200 for the service to be provided in the future

Liability goods or services are owing to others

31 May Dr Cash (A)


31 May 1 Jun

Period end
30 Jun

$1,200

Cr Unearned revenue (L)

$1,200

 Examples:





insurance premiums
magazine subscriptions
rent received in advance
Qantas, Telstra

$100 of services provided


...

30 Jun Dr Unearned revenue (L)


Cr Revenue (R)
15

$100
$100

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1.2. Prepayments
 Cash paid in advance of incurring expense



1.2 Prepayments Example 1

LO2

On 31 May, a company purchased office supplies of $1000.

Assets future economic benefit


current or non-current asset?

31 May Dr Office supplies (A) $1,000


Cr Cash (A)
31 May 1 Jun

 Examples:




LO2

Period end
30 Jun

$1,000

...

At 30 June, $300 of the office supplies remained


i.e. $700 had been consumed.

prepaid insurance
prepaid rent
office supplies

30 Jun Dr Office supplies expense (E)

$700

Cr Office supplies (A)

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$700

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1.2 Prepayments Example 2

1.2 Prepayments Example 2

LO2

 On 1 May 2012, a company pays $1200 for a one-year

1 May Dr Prepaid rent (A)

rent. Financial year ended date is 30 June 2012.

$1,200

Cr Cash (A)

 What journal entries will the company make on 1 May

LO2

$1,200

Period end
30 Jun

1 May
...

2012 and 30 June 2012?

2-month rent has been used up


=$1,200/12 2 = $200

30 Jun Dr Rent expense (E)


Cr Prepaid rent (A)
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$200
$200

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1.2 Prepayments Example 3

2.1. Accrued revenue

LO2

 Opening balance prepaid rent $3000

 Revenue has been earned but cash will not be received


until the following period.

 Closing balance prepaid rent: $4000


 Rent expense:

c/d
Cash

Receivables, assets

$5000

 Examples:

 What was the cash paid for rent during the year?
Dr. Prepaid rent
Cr. Cash

LO2

Prepaid rent

(A)

$3000 Rent exp.


$6000 c/d

Dr. Rent exp.


Cr. Prepaid rent




$5000
$4000

commissions earned but not received


interest earned but not received.
Telstra, Sydney water

$3,000+X-5,000=$4,000
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2.1 Accrued revenue An example

2.1 Accrued revenue An example

LO2

 Orange company deposited $300 000 with a bank at 10


per cent per annum and interest is paid on 1 March
every year and the next payment of interest will be
received on 1 March 2013.

30 Jun

1 Mar, 2012

 Financial year ended date is 30 June 2012.

Dr Interest receivable (A)


Cr Interest revenue (R)

...

$10 000
$10 000

Period end 30 June, 2012


...

$10 000 interest


has been earned

 What journal entries will the company make on 30 June


2012 and 1 March 2013?

LO2

1 Mar, 2013

$20 000 interest


has been earned

(=$300,00010%4/12)

(=$300,00010%8/12)

1 Mar

Dr Cash (A)

$30 000

Cr Interest receivable (A)


Cr Interest revenue (R)

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$10 000
$20 000

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2.2. Accrued expense

 Expense has been incurred but cash will not be paid until
the following period


Payables, liability

 Examples:



2.2 Accrued expense An example

LO2

 A firm pays weekly wages of $50 000 each Friday (25 June,
2 July).
 Financial year ended date is 30 June, 2012 (Wednesday).
 What journal entries will the firm make on 30 June 2012
and 2 July 2012?

wages earned by employees but not paid after end of


financial period
interest payable on outstanding loan.

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2.2 Accrued expense An example


25 June Dr Wages expense (E)
Cr Cash (A)
25 June, 2012
Friday

...

30 Jun

3. Contra accounts

LO2

$50 000

Period end 30 June, 2012


Wednesday
...

2 July, 2012
Friday




$30 000
$30 000




2 July

Dr Wages expense (E)


Dr Wages payable (L)
Cr Cash (A)

is paired with and follows its related account


Its normal balance (debit or credit) is the opposite of the
balance of the related account

 Examples:

2 days wages
incurred

Dr Wages expense (E)


Cr Wages payable (L)

LO3

 A contra account

$50 000

3 days wages
incurred but not paid

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LO2

Accounts receivable Allowance for doubtful debts (ADD)


Property, plant and equipment Accumulated depreciation
Intangibles Accumulated amortisation
Inventory Provision for obsolescence.

$20 000
$30 000
$50 000
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3. Contra accounts Why are they useful?


 Allow users to ascertain:


Accounts receivable Allowance for doubtful debts (ADD)




level of doubtful debts (and changes therein), collection policies and


problems

Property, plant and equipment Accumulated depreciation




Intangibles Accumulated amortisation

Inventory Provision for obsolescence.




 Accumulated depreciation (a contra asset account, B/S)


shows all depreciation charged against an asset to date.

likely life of intangibles

 Depreciation expense (I/S) shows only this years


depreciation allocation.

levels of slow-moving, out-of-date stock, efficiency of stock


management.

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3. Contra account An example

Comprehensive class example

LO3

Asset costs $100 000 with a life of 5 years and no estimated


salvage value. Straight line depreciation each year:
Dr Depreciation expense
Cr Accumulated depreciation
After 3 years, book value is:
Asset
Accumulated depreciation
Book value

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LO3

 Allocation of the cost of a noncurrent asset to expense


over the life of an asset
 To recognise the consumption of the assets economic
value.

likely ages of assets and future cash outflows for purchases of new
assets

3. Contra account Depreciation

LO3

LO2,
3&4

 The following information relating to adjusting


entries is available at the end of June 2013


$20 000
$20 000

Transactions 9-13.

$100 000
($60 000)
$40 000

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Comprehensive class example

Comprehensive class example

LO2

 Transaction 9:
 A physical count showed supplies costing $180 on hand
at 30 June 2013.
Opening Balance
Accounts Payable
Opening Balance

 Transaction 10:
 Accrued interest on the bank loan is $240.

Supplies
A4
210 Supplies expense ?
340
$550

Closing Balance

Interest Expense
Interest Payable

180
$550

180

Supplies Expense
Supplies

Dr
370

E3
A4

LO2

E6
L2

Dr
240

Cr
240

Cr
370

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Comprehensive class example


 Transaction 11:
 Insurance costing $820 expired during the year.

Insurance Expense
Prepaid Insurance

E4
A3

Comprehensive class example

LO2

Dr
820

 Transaction 12:
 Depreciation on the vehicle is $5 350.

Cr
820

LO2
&3

Depreciation Expense MV
Accumulated Depreciation MV

Dr
Cr
E2
5,350
A5.1
5,350

 Remember, in Transaction 6. insurance on vehicle, paid in


advance was $840

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Comprehensive class example

LO2

Comprehensive class example


Closing entries for revenue accounts
Dr

 Transaction 13:
 The June telephone account for $180 has not been paid or
recorded.
Dr
Cr
Telephone Expense
E5
180
Telephone Expense Payable
L4
180

Piano Tuning Fees (-R)

28,600

Piano Repair Fees (-R)


P&L Summary

24,380
52,980

Piano tuning fees

R1

Piano repair fees

R2

$23 940

Cash

$16 800

A/R

$4 660

A/R

$7 580

Bal.

$28 660

Bal.

$24 380

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Comprehensive class example


Closing entries for expense accounts

Comprehensive class example


Closing entries for P&L summary account

LO4

Dr
P&L Summary
Petrol and Oil (-E)
Depreciation Expense (-E)
Supplies Expense (-E)
Insurance Expense (-E)
Telephone Expense (-E)
Interest Expense (-E)

Cr

LO4

Profit & Loss Summary

12,300

Closing ent (2) 12,300 Closing ent (1) 52,980

2,680
5,350
370
820
2,420
660

Retained Profits 40,680

$2 680

Bal.

$2 680

Cr
40,680

Retained Profits

Petrol and oil expense E1


Cash

Dr
40,680

P&L Summary
Retained Profits (+SE)

Before closing,

39

Cr

Before closing,

Cash

37

LO4

c/d

41,234

b/d
554
P&L Summary 40,680

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Revision Question 1

Revision Question 2

 Which of the following would be recorded as an asset?

 On 15 September 2012, a surveyor received an advance


of $7000 from a client for future services. The work was
completed to the clients satisfaction on 10 October
2012. The surveyor uses accrual accounting.
 What is the journal entry made by the surveyor on 15
September 2012?

A.
B.
C.
D.

prepayments
accrued expenses
unearned revenue
all would be recorded as assets

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A.
B.
C.
D.

Dr Cash 7000 Cr Unearned Revenue 7000


Dr Unearned Revenue 7000 Cr Cash 7000
Dr Cash 7000 Cr Surveying Revenue 7000
Dr Customer Deposits 7000 Cr Unearned Revenue 7000

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Revision Question 3

Next Lecture

 On 15 September 2012, a surveyor received an advance


of $7000 from a client for future services. The work was
completed to the clients satisfaction on 10 October
2012. The surveyor uses accrual accounting.
 What is the journal entry made by the surveyor on 10
October 2012?
A.
B.
C.
D.
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Dr Cash 7000
Cr Unearned Revenue 7000
Dr Accrued Revenue 7000
Cr Surveying Revenue 7000
Dr Unearned Revenue 7000 Cr Surveying Revenue 7000
Dr Surveying Revenue 7000 Cr Unearned Revenue 7000

Accrual adjustments continued (bad debts)


Internal control and cash

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