Chapter 8
END OF YEAR
ADJUSTMENTS
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.
Closing off Accounts
Purchases A/c
2000
02-July
Delis
375
02-July Cash
870
02-July Bank
725
02-July F. Bolth
706
18-July Cash
430
18-July F. Bolth
31 July
Income
Statement
4 216
1 110
4 216
4 216
Closing off Account
Journal Entry
Date
Details
2000
July 31
Income Statement
Purchases A/c
To transfer the purchases account at
the end of the period
folio
Dr. $
Cr $
4 216
4 216
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
5 480
670
5 480
Closing off Account
Journal Entry
Date
Details
2000
July 31
Sales A/c
Income Statement
To transfer the sales account at the
end of the period
folio
Dr. $
Cr $
5 480
5 480
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.
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.
Adjustment: Income
Cash collected during the accounting period
X
Add
owing at close
Collected in advance at start
x
x
Less
Owing at start
(x)
Collected in advance at close
(x)
Income for the period
Income owing = current asset
X
Income collected in advance =
current liability
Adjustment: Income
dr
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
Income owing = current asset
x
Income in advance = current liability
NB. Assets and liabilities are also used in the Balance Sheet
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.
Adjustment: Expense
i.
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;
ii. If any amount is relevant to the accounting period then add to
cash paid during the same accounting period;
iii. If any amount is not relevant to the accounting period then
subtract from cash paid during the same accounting period.;
iv. A prepayment takes place if the amount of an expense paid
during the accounting period is greater than the amount to be
paid;
v. An accrual takes place when the amount of an expense
actually paid during the accounting period is less than the
amount to be paid.
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
Prepaid expense = current asset
X
Expense owing = current liability
Adjustment: Expense
dr
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
Prepaid expense = current asset
x
Expense owing = current liability
NB. Assets and liabilities are also used in the Balance Sheet
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;
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.
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
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/provision for depreciation)
Adjustment: Depreciation
Methods compared
Annual Depreciation Expense
Straight line and Reducing Balance Methods Compared
140,000.00
120,000.00
Reducing Balance
100,000.00
80,000.00
Straight line
60,000.00
40,000.00
20,000.00
1
2
3
Year
4
5
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.
Adjustment: Depreciation
Double Entry
Date
Details
Depreciation expense
Provision for or accumulated
depreciation
folio
Dr. $
Cr $
x
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
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
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.
Adjustment: Bad Debts
When a debt becomes uncollectable it is written off as follows:
Date
Details
Bad debts
Debtors (Name)
folio
Dr. $
Cr $
x
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.
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
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 @
5% of debtors after bad debts
1 250
1 750
1 200
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
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
Increase (decrease)
2001
2002
2003
(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
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
1-Jan
Bal b/d
1 250
31-Dec
Income Statement
2002
31-Dec
Bal c/d
1 750
1 750
500
1 750
2003
31-Dec
Income Statement
31-Dec
Bal c/d
550
1-Jan
Bal b/d
1 750
1 200
1 750
1 750
2004
1-Jan
Bal b/d
1 200