ALDRIDGE STATE HIGH SCHOOL
YEAR 11 ACCOUNTING
CORE STUDIES TWO – END OF PERIOD REPORTS
Many assumptions or conventions underlie the preparation of accounting records.
For accounting purposes, the accounting period assumption assumes that the life of a
business is divided into arbitrary time periods. Unfortunately, many business transactions
do not fit nearly into these various accounting periods. Business transactions flow through
the life of the business, and are interrupted by the accounting period. Some adjustments,
called balance day adjustments, must, therefore, be made to recorded figures
at the end of the accounting period, on a day called the balance day (usually June
30). During every accounting period, the aim is to calculate a profit figure
that is as accurate as possible. Profit is obtained by matching revenue for
the period with the expenses incurred in earning that revenue. This is
called the matching principle.
Revenue is money coming into the business. Revenue is generally
recognized when it has been earned. For a service business, this occurs
when the service has been performed. For a trading business, this is
when the goods have been delivered.
ACCRUAL ACCOUNTING
The accrual basis of accounting recognizes transactions and events when they have an
economic impact on the entity rather than when the associated cash flows occur. This
means that assets, liabilities, revenues and expenses arising from transactions or other
events will be recognized in the financial statements of an entity when the effects occur
(that is, when revenue is earned and expenses are incurred), rather than when amounts are
received or paid. The adoption of accrual accounting will result in balance
day adjustments being made to ensure that assets, liabilities, revenues
and expenses are recognized in the correct reporting period.
Accrual accounting is to be contrasted with cash accounting, where the
effects of transactions are recognized, only when cash is received or paid
out.
BALANCE DAY ADJUSTMENTS
Balance day adjustments are entries made at balance day in order to match the revenues
and expenses accurately so that profit (or loss) can be determined, and to bring into
account assets and liabilities not previously recorded. Common balance day adjustments
are made for accrued expenses, accrued revenues, prepaid expenses and unearned
revenues.
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Accrued expenses are:
___________________________________________________________________
_________________________________________________________________
Accrued expenses are amounts owed by the business and are therefore liabilities.
Take an example! The business pays wages every Tuesday. The last
pay day was Tuesday June 27. Balance date is Friday June 30. Total
wages is $200 a day. At balance date, $600 in Wages has been
incurred by the business but has not yet been paid. According to
the Matching Process, this $600 must be recorded in this year’s profit determination.
So far the Ledger looks like this:
Wages Account
June06
13
20
27
DR
1 000.00
1 000.00
1 000.00
1 000.00
Cash at Bank
Cash at Bank
Cash at Bank
Cash at Bank
CR
BALANCE
1 000.00
2 000.00
3 000.00
4 000.00
N
DR
DR
DR
DR
It is obvious that we need to add the $600 in Wages for the three days (June 28, 29, 30)
into the Wages Account in the Ledger and therefore wages is debited. It is necessary to
credit some other Account to complete the double entry. This liability account is called
Accrued Expenses. The general journal entry to effect this is:
General Journal
June 30
Wages
Accrued Expenses
Dr
Cr
600.00
600.00
(Wages incurred but not yet paid)
Post this entry to the Wages account and Accrued Expenses account.
Accrued Expenses Account
DR
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CR
BALANCE
N
2
Accrued revenues are:
___________________________________________________________________
___________________________________________________________________
Accrued revenues are amounts owing to the business and are therefore assets.
Look at this example. The business receives Commission of $200 each fortnight. The last
receipt was June 23. At balance date of 30 June, a week’s commission of $100 has been
earned but not yet received. The matching process says this must be recorded in this
year’s profit determination.
So far as the Ledger looks as follows:
Commission Revenue Account
DR
CR
200.00
200.00
June 9 Cash at Bank
23 Cash at Bank
BALANCE
200.00
400.00
N
CR
CR
If the $100 needs to be included in this year’s profit determination, then we need to add
the $100 Commission that has been earned (but not yet received) into the Commission
Revenue Account in the Ledger in the credit column. The corresponding debit entry is
Accrued Revenue.
The general journal entry to effect this change is:
General Journal
June 30
Accrued Revenue
Commission Revenue
Dr
Cr
100.00
100.00
(Commission earned but not yet received)
Post this entry to the Commission Revenue account and Accrued Revenue account.
Accrued Revenue Account
DR
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CR
BALANCE
N
3
Prepaid expenses are:
______________________________________________________________________________
______________________________________________________________________________
Prepaid expenses are amounts owing to the business and are therefore assets. Benefits
from these prepayments will occur over the next accounting period(s).
On January 1 we paid a full year’s Insurance of $500. Six months later on balance date,
June 30, only half of that Insurance expense belongs in this year’s profit determination,
while the other half belongs in next year’s profit determination. So this time, instead of
adding it in, we take what we don’t need out and put it aside until next year’s profit
determination.
The ledger looks like this so far:
Jan
1
Insurance Account
DR
500.00
Cash at Bank
CR
BALANCE
500.00
N
DR
If $250 of this Insurance expense has to be removed from this year’s profit
determination, we have to show it being removed from the Insurance Account by crediting
Insurance.
The general journal entry to effect this change is:
General Journal
June 30
Prepaid Expenses
Insurance
Dr
Cr
250.00
250.00
(Insurance paid but not yet incurred)
Post this entry to the Insurance account and Prepaid Expenses account.
Prepaid Expenses Account
DR
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CR
BALANCE
N
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Unearned revenues are:
___________________________________________________________________
___________________________________________________________________
Unearned revenues are amounts owed by the business and are therefore liabilities.
Look at this example. The business received a week’s rent in advance of $140 on June 28.
By balance date two days later, June 30, only $40 of that $140 has been earned for this
year’s profit determination. The other $100 will be earned in next year’s profit
determination. So again, we are not adding but removing!
The ledger looks like this so far:
Rent Revenue Account
DR
June 7
14
21
28
CR
140.00
140.00
140.00
140.00
Cash at Bank
Cash at Bank
Cash at Bank
Cash at Bank
BALANCE
140.00
280.00
420.00
560.00
N
CR
CR
CR
CR
If $100 of the Rent Revenue has to be removed from this year’s profit determination, we
have to show it being removed from the Rent Revenue Account by debiting Rent Revenue.
The general journal entry to effect this change is:
General Journal
June 30
Rent Revenue
Unearned Revenue
Dr
Cr
100.00
100.00
(Revenue received but not yet earned)
Post this entry to the Rent Revenue account and Unearned Revenue account.
Unearned Revenue Account
DR
CR
BALANCE
N
Exercises: Kirkwood, Page 112, Ex 4.4, 4.5, 4.6, 4.7
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Prepare general journal entries for each of the following balance day adjustments:
a)
$200 subscription paid in advance
b)
$2600 registration of vehicles prepaid for the next accounting period
c)
$900 insurance expense has been paid in advance
d)
$10000 advertising expense has been incurred but not yet paid
e)
$1200 interest on loan is owing
f)
$500 commission revenue has been received in advance
g)
$600 rent is paid one month in advance
h)
$350 commission revenue is owing
i)
A tenant is $600 behind on their rent
j)
$200 interest revenue has been earned but not yet received
k)
Rent earned but not yet received is $230
l)
Commission received in advance is $218
m)
Wages to be paid are $2300
n)
$210 of the electricity bill has been prepaid
o)
Rent of $600 was received in advance.
PROFIT DETERMINING ACCOUNTS
To determine whether a profit or loss has been made for the
accounting period, an additional two ledger accounts, the Trading
account and the Profit and Loss account are introduced. These
accounts match the revenue for the period with the expenses
incurred in earning that revenue.
The trading account shows whether a business selling goods has
made a gross profit or a gross loss. Gross profit or gross loss is the difference between
the revenues earned from the sale of inventories and the cost of goods sold. To prepare
the trading account, ledger accounts for sales, sales returns and cost of goods sold are
transferred to the Trading account. These transfers are done by means of closing
entries.
Exercises: Kirkwood, Page 116, Ex 4.8
Net profit or net loss is the final profit or loss made by a business after taking into
account all revenues and expenses for an accounting period.
The closing entries, prepared at the end of the accounting period, perform two functions:
 They close off individual revenue and expense accounts ready for the next accounting
period
 They transfer the balances of the revenue and expense accounts relating to goods to
the Trading account so that gross profit or loss can be determined and transfer the
balances of other expenses and revenues to the Profit and Loss account so net profit
or net loss can be determined.
Exercises: Page 119-120, Ex 4.11, 4.13, 4.15
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INCOME STATEMENT
The net profit or loss for the year is disclosed by the Profit and Loss account. However,
this account is in the ledger and not available for viewing by outside parties. An Income
Statement is a report prepared outside the ledger, for presentation to interested
parties, detailing the various revenues and expenses for a period and calculating the
resultant profit or loss.
Sample
Income Statement of Aldridge Traders
For the year ended 30 June 2013
Sales
Less Sales Returns
LESS COST OF GOODS SOLD
Gross Profit
ADD OTHER REVENUE
Rent Revenue
LESS OTHER EXPENSES
Wages
Advertising
Delivery Vehicle Expenses
Office Wages
Insurance
Electricity
Interest Expense
Net Profit
10000
500
200
1 400
400
50
1 000
600
100
500
9 500
2 100
7 400
200
7 600
4 050
$3 550
BALANCE SHEET
A Balance Sheet is a detailed expression of the accounting equation for a business at a
certain point in time. It is a major report that lists the various asset, liability and owner’s
equity items. It can be presented in Account form or Narrative form.
In order to determine the net amount of GST that is payable or refundable for a period
and to show this as one figure in the Balance Sheet, the GST Collected and the GST
Credits Received accounts are cleared to the GST Clearing account.
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Sample Narrative Style
Balance Sheet of Aldridge Traders
As at 30 June 2013
ASSETS
Cash at Bank
Inventories
Accounts Receivable
Accrued Revenues
Prepaid Expenses
Delivery Vehicle
Land
Goodwill
LESS LIABILITIES
Accounts Payable
GST Clearing
Accrued Expenses
Unearned Revenues
Loan from Finance Co
NET ASSETS
OWNER’S EQUITY
Capital
Add Net Profit
2 000
11 000
2 500
25
50
26700
50 000
12 500
2 000
3 000
125
50
17 000
86 450
3 550
90 000
7 400
Less Drawings
104 775
22 175
$82 600
$82 600
Sample Account Style
Balance Sheet of Aldridge Traders
As at 30 June 2013
ASSETS
Cash at Bank
Inventories
Accounts Receivable
Accrued Revenues
Prepaid Expenses
Delivery Vehicle
Land
Goodwill
LIABILITIES
Accounts Payable
GST Clearing
Accrued Expenses
Unearned Revenues
Loan from Finance Co
2 000
11 000
2 500
25
50
26 700
50 000
12 500 OWNER’S EQUITY
Capital
Add Net Profit
Less Drawings
$104 775
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2 000
3 000
125
50
17 000
22 175
86 450
3 550
90 000
7 400
82 600
$104 775
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GST Clearing Entries
In order to determine the net amount of GST that is payable
or refundable for a period, and to show this as one figure in
the Balance Sheet, the GST Collected account and the GST
Credits Received account are cleared to the GST Clearing account. Although these entries
are not balance day adjustments, as they do not affect profit, they are necessary to
complete the accounting process and to show the net amount of GST in the Balance Sheet.
These clearing entries, generally prepared at the end of each month, perform two
functions:
 They clear the individual GST accounts reading for the next period.
 They transfer the balances of the GST accounts to the Clearing account so that
the GST Clearing account in the Balance Sheet will show the resulting GST at the
end of this period, and the amount to be paid or refunded at the appropriate time
during the next period.
The general journal entries are:
General Journal
June 30
GST Collected
GST Clearing
Dr
Cr
(GST Collected transferred to Clearing account)
GST Clearing
GST Credits Received
Dr
Cr
(GST Credits Received transferred to Clearing
account)
Exercises: Kirkwood, Page 128, Ex 4.25 – 4.29
REVERSING ENTRIES
A reversing entry needs to be made at the beginning of a new accounting
period, usually 1 July, for two reasons:


To ensure the correct amounts for revenue and expenses are taken into account in
the period to which they actually refer
To cancel the temporary asset and liability accounts created on balance day by
balance day adjustments (i.e., prepayments and accruals)
Exercises: Kirkwood, Page 147-148, Ex 4.33, 4.34
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ANALYSIS AND INTERPRETATION OF REPORTS
Three financial reports, Income Statement, Balance Sheet and Statement of Cash Flows,
are generally prepared to provide information to a wide variety of users. These reports
are analysed and interpreted so that interested parties who wish to make decisions about
the business are better informed. Analysis can be done in an objective way with the
calculation of financial ratios. Interpretation is more subjective and involves judgement,
recommendation and decision-making based on these ratios.
The main ratios prepared by businesses are:
 Gross profit ratio
 Net profit ratio
 Return on owner’s equity
These ratios are used to indicate the earning capacity or profitability of the entity.
Gross profit ratio is the ratio or percentage of gross profit to net sales and is
calculated:
Gross profit x 100
Net sales
It indicates the margin of profit available to cover expenses. Such a measure is important
because a high gross profit ratio allows the business to cover all expenses, earn a
reasonable profit and provide a satisfactory return to investors. A low ratio means that
all expenses may not be covered, a net loss may be incurred and a satisfactory return
cannot be given to investors. A business should use the current industry average as a
benchmark for performance.
A gross profit declining over a considerable period is cause for concern because the sale
of goods is usually the major source of earnings. An opportunity should be taken to
increase this ratio through:
 An increase in sales, with a less than proportional increase in the cost of goods
sold (eg through a price increase or an advertising campaign)
 A decrease in cost of goods sold, with less than proportional decrease in sales
(eg, through better buying or reducing theft or wastage)
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Net profit ratio is the ratio or percentage of net profit to net sales and is calculated:
Net profit x 100
Net sales
It shows how much of each dollar of sales represents net operating profit. If the ratio is
high, it indicates the opportunity to make high profits. Too low a figure gives less
opportunity for profits and indicates the need for investigation of factors such as:
expense control methods, pricing practices, selling techniques. A business should use the
current industry average as a benchmark for performance.
Rate of return on owner’s equity is the ratio or percentage of net profit to average
owner’s equity over the period and is calculated:
Net profit
Average owner’s equity
x 100
This ratio indicates the rate of return on owner’s equity invested in the business. Business
owners take risks. Return on owner’s equity should be considered relative to current
interest rates, and the degree of risk, in order to evaluate profitability.
When examined in terms of trends, inter-business comparisons and alternative investment
opportunities, it enables a judgement to be made on how effectively invested funds are
being employed, and whether investors should consider some of the alternative investment
opportunities open to them.
Most analysis is based on historical data. Therefore, it is important when interpreting
data and making judgements and recommendations to be aware of any relevant changes in
circumstances (technological changes, competition, management changes, etc) which may
have affected performance or which may affect future performance. This allows ratios to
be properly compared over time and trends to be observed. It will also allow further
comparisons with other firms and industries and with industry averages or predetermined
standards if they are available.
Exercises: Kirkwood, Page 151-152, Ex 4.35, 4.36
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Ex 4.40 From the following information for S Chan, who sells high quality
furniture, and who is concerned about whether it is worthwhile continuing
operating the business prepare:
1.
2.
3.
4.
5.
Journal entries for the balance day adjustments and GST clearing
Income statement
Balance Sheet
Ratios for earning capacity
A letter advising on the earning capacity of the business, specific recommendations
about whether to continue operating, and if so, how to improve profitability.
Account
Telephone
Sales
Capital
Interest Revenue
Commission Revenue
Drawings
GST Collected
GST Credits Received
Cash at Bank (Overdraft)
Loan to Brown Brothers
Accounts Payable
Cost of Goods Sold
Inventories
Sales Returns
Accounts Receivable
Wages and Salaries
Office Expenses
Insurance
Buildings
Land
Amount
400
110 000
118 000
1 000
2 000
40 000
10 000
5 000
4 000
13 000
16 800
58 000
5 000
450
1 000
23 950
3 000
2 000
50 000
60 000
Additional information:
Prepaid insurance expenses are $500
Unearned commission revenue is $1 000
Accrued Wages expenses are $1 000
Accrued interest revenue is $600
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