Chapter 7
Accounting Policies
Accounting Standards
• Aim to narrow areas of choice and improve
comparability.
• Apply to all accounts intended to give a
truthful presentation (true and fair view).
Slide 2
notes reference - page 65
The objective of financial statements
To provide information about the financial
position, performance and changes in
financial position of an enterprise that is useful
to a wide range of users in making economic
decisions
notes reference - page 65
Underlying assumptions
• Going concern
The financial statements are normally prepared on the
assumption that an enterprise is a going concern and
will continue in operation for the foreseeable future.
Hence, it is assumed that the enterprise has neither the
intention nor the need to liquidate or curtail
materially the scale of its operations; if such an
intention or need exists, the financial statements may
have to be prepared on a different basis and, if so, the
basis used is disclosed.
Slide 4
notes reference - page 65
Underlying assumptions
• Accruals
The effects of transactions and other events are
recognised when they occur (and not as cash or its
equivalent is received or paid) and they are recorded
in the accounting records and reported in the financial
statements of the period to which they relate
Slide 5
notes reference - page 65
Other concepts, conventions and qualities
•
•
•
•
•
•
Prudence
Consistency
Entity concept
Separate valuation principle
Materiality
Historical cost convention
Slide 6
notes reference - page 65
Chapter 8
Accruals and prepayments
Accruals
Accruals are expenses incurred by the business during the
accounting period but not yet paid for.
Shown in the balance sheet under “Current liabilities”
Slide 8
notes reference - page 71
Accruals example
Period to which bill relates
1.1.X4
1.10.X4
31.12.X4
Accounting period
Pay telephone bill
$60 on 1.1.X5
Accrue bill at 31.12.X4
Slide 9
notes reference - page 71
Prepayments
Prepayments arise when expenses are paid for before they
have been used.
Shown in the balance sheet under “Current assets”
Slide 10
notes reference - page 71
Prepayments example
Pay insurance bill
on 20.12.X4
Period to which bill relates
1.1.X4
31.12.X4
Accounting period
Prepayment at 31.12.X4
Slide 11
notes reference - page 72
31.12.X5
Lecture example 1
Electricity
Date paid
10.3.X4
12.6.X4
14.9.X4
10.12.X4
Amount
96
120
104
145
Period
2 months to 28 Feb 20X4
Quarter to 31 May 20X4
Quarter to 31 August 20X4
Quarter to 30 Nov 20X4
Rates
1.2.X4
6.4.X4
375
1,584
3 months to 31 March 20X4
12 months to 31 March 20X5
1 July 20X4 employed assistant. Paid assistant $150 per
month on 28th of each month.
6 March 20X5 received electricity bill for $168 for
quarter to 28 Feb 20X5.
Slide 12
notes reference - page 72
Lecture example 1
Total paid
Electricity
Rates
Wages
Expense for year Accrual Prepayment
to 31.12.X4
465
521 (W1)
1,959
1,563 (W3)
900 (W5)
900
(W1) 96 + 120 + 104 + 145 + (1/3 x 168)
(W2) 1/3 x 168
(W3) 375 + (9/12 x 1,584)
(W4) 3/12 x 1,584
(W5) 6 x 150
Slide 13
notes reference - page 73
56 (W2)
-
396 (W4)
-
Year-end adjustments
Accruals
Debit
Credit
Expense
Accruals
Prepayments
Debit
Credit
Slide 14
Prepayments
Expense
notes reference - page 73
Lecture example 2
10.3.X4
Cash
Electricity
96
12.6.X4
Cash
120
14.9.X4
Cash
104
10.12.X4
Cash
145
31.12.X4
Accruals
56
31.12.X4
I/S
521
31.12.X4
bal c/d
521
Accruals
56
31.12.X4
Electricity
56
56
56
1.1.X5
Slide 15
521
notes reference - page 74
bal b/d
56
Lecture example 2 part (c)
1.2.X4
Cash
6.4.X4
Cash
Rates
375
31.12.X4 Prepayments 396
1,584
31.12.X4 I/S
1,563
1,959
31.12.X4
Rent
1.1.X5
bal b/d
Slide 16
Prepayments
396
31.12.X4
396
396
notes reference - page 74
1,959
bal c/d
396
396
Lecture example 2
Wages
28.7.X4
Cash
150
28.8.X4
Cash
150
28.9.X4
Cash
150
28.10.X4
Cash
150
28.11.X4
28.12.X4
Cash
150
Cash
150
31.12.X4
900
Slide 17
notes reference - page 74
I/S
900
900
Accruals and prepayments
Situation so far:
Year end adjustment
completed
Revenues matched
expenses
Accrual or Prepayment created
Slide 18
notes reference - page 75
Reversals illustration
Bal b/d on prepayments is $396
Paid rates in X5 of $1,740 for 12 months
1.1.X5
1.4.X5
3/12 * $1,584
($396)
31.12.X5
9/12 * $1,740
($1,305)
= $1,701
The other
3/12 x $1,740
= $435 is a
prepayment
Prepayment from last year
Slide 19
Cash paid that relates to
this year
notes reference - page 75
Reversals illustration (cont’d)
Rates expense
Cash
Slide 20
1,740 Prepayment 435
Prepayments
Bal b/d 396
Rent
435
notes reference - page 76
Reversals illustration (cont’d)
Opening prepayments must therefore be reversed
Dr
Rates expense (I/S)
Cr
Slide 21
Prepayments (B/S)
notes reference - page 76
Summary - Reversals
Accruals
Debit Accruals
Credit Expense
Slide 22
Prepayments
Debit Expense
Credit Prepayments
notes reference - page 77
Steps
• Reverse the opening
accrual/prepayment
• Post cash paid
• Post closing
accrual/prepayment
Slide 23
notes reference - page 77
Lecture example 3
Rates
1.1.X5 Reverse prepayment 396 31.12.X5 Prepayments
(3/12 x 1,740)
10.4.X5 Cash
1,740
31.12.X5 I/S
2,136
435
1,701
2,136
Prepayments
1.1.X5
bal b/d
396 1.1.X5
Reverse prepayment 396
31.12.X5 Rates (3/12 x 1,740) 435 31.12.X5 bal c/d
435
831
831
bal b/d
435
1.1.X6
Slide 24
notes reference - page 77
Lecture Example 4
Date paid
Amount
$
Period
quarter
Accounting
12.3.X5
168
Feb 20X5
Opening accrual
9.6.X5
134
May 20X5
Cash paid
12.9.X5
118
Aug 20X5
Cash paid
12.12.X5
158
Nov 20X5
Cash paid
During March 20X6 Fiona received bill for $189 for
quarter to 28 February 20X6
Slide 25
notes reference - page 78
Lecture example 4
(a) The closing accrual is $63
(b) The electricity expense for the year is $585
Working
12.3.X5
Cash
Electricity
168 1.1.X5
9.6.X5
Cash
134
12.9.X5
Cash
118
12.12.X5
31.12.X5
Cash
158
Accruals
(1/3 x 189)
63
31.12.X5 I/S
641
Slide 26
Reverse accrual
notes reference - page 78
56
585
641
Chapter 9
Non-current assets and
depreciation
Definitions
Non-current assets
Intended for use on continuing basis
Property, plant and equipment
Tangible assets
– production/supply of goods/services
– rental to others
– admin purposes
AND
Expected use > 1 period
Slide 28
notes reference - page 83
Lecture example 1
•
•
•
•
Land and buildings
Plant and equipment
Motor vehicles
Furniture and fixtures
Slide 29
notes reference - page 83
Non-current asset register
A listing of all non-current assets owned by the
organisation
Details likely to be kept:
- serial number
- description of asset
- location of asset
- purchase date
- cost
- depreciation method & estimated useful life
- net book value
Slide 30
notes reference - page 83
Capital expenditure
Capital expenditure
Results in NCA on B/S
Subsequent
expenditure on NCA
Initial cost of NCA
Purchase
price
Slide 31
Improves earning
Directly attributable costs
capacity of NCA
- acquisition costs
- site preparation
more
better longer
- delivery & handling
- installation
output quality life of
- professional fees
output NCA
notes reference - page 84
Revenue expenditure
Revenue expenditure
Expense in IS
Subsequent
expenditure on NCA
To carry on trade of
business
Maintains existing
earning capacity
of NCA
e.g. rent
electricity
repairs
Slide 32
notes reference - page 85
routine
maintenance
Lecture example 2
Frodo Ltd buys a car for a sales representative.
The invoice contained the following information:
List price of the car
Road tax
Burglar alarm system
Petrol
Delivery charge
15,000
165
200
30
100
The car will be shown in the B/S at a cost of 15,300
Working
15,000
List price
200
Burglar alarm system
100
Delivery charge
15,300
Slide 33
notes reference - page 85
Depreciation
“…the systematic allocation of the
depreciable amount of an asset over its
useful life.”
All non-current assets apart from land should be
depreciated
Slide 34
notes reference - page 86
Depreciation
There are 3 methods of calculating
depreciation:
(a)
(b)
(c)
Slide 35
Straight line
Reducing balance
Machine hour
notes reference - page 86
Straight line method
Depreciation =
cost – residual value
useful economic life (years)
or
Depreciation = % x (cost – residual value)
Residual value = expected proceeds at end of UEL
Slide 36
notes reference - page 86
Lecture example 3
(a) The annual depreciation charge is $400
2,500 - 500
= 400
5 years
Slide 37
notes reference - page 87
Lecture example 3 part (b)
Year
Cost
Acc depn
1
2,500
400
2,100
2
2,500
800
1,700
3
2,500
1,200
1,300
4
2,500
1,600
900
5
2,500
2,000
500
Slide 38
notes reference - page 87
NBV
Lecture example 2 (cont’d)
Graphical representation
NBV
$
2,500
500
0
5
notes reference - page 87
Year
Reducing balance method
Depreciation = depreciation rate (%) x NBV
Cost – accumulated depn to date
Slide 40
notes reference - page 87
Lecture example 4 part (a)
Year
Depn
rate
Depn
expense
Acc
depn
NBV
1
40%
2,400
2,400
3,600
2
40%
1,440
3,840
2,160
3
40%
864
4,704
1296
4
40%
518
5,222
778
Slide 41
notes reference - page 88
Lecture example 4 (cont’d)
Graphical representation
NBV
$
6,000
3,600
2,160
1,296
778
1
2
3
4
5
notes reference - page 88
Year
Machine hour method
Depreciation =
Slide 43
cost – residual value
x actual
use p.a.
useful economic life (hours)
notes reference - page 89
Lecture example 5
(a) The depreciation rate per HOUR is £6
125,000 – 5,000
= £6
20,000 hours
Slide 44
notes reference - page 89
Lecture example 5 part (b)
Year
Actual
hours
use
Depn
expense
Acc
depn
1
8,000
48,000
48,000
77,000
2
7,000
42,000
90,000
35,000
3
5,000
30,000
120,000
5,000
Slide 45
notes reference - page 89
NBV
Accounting for depreciation
Dr Depreciation expense (I/S)
Cr Accumulated depreciation (B/S)
Slide 46
notes reference - page 90
Lecture example 6 part (a)
Machine
Cash
2,500
bal c/d
2,500
2,500
bal b/d
2,500
2,500
Depreciation expense
Year 1
Acc depn
400
Year 1
IS
400
Year 2
Acc depn
400
Year 2
IS
400
Year 3
Acc depn
400
Year 3
IS
400
Year 4
Acc depn
400
Year 4
IS
400
Year 5
Acc depn
400
Year 5
IS
400
Slide 47
notes reference - page 90
Lecture example 6 part (a)
bal c/d
Accumulated depreciation
400
Year 1
Depn exp
400
400
Year 2
bal c/d
800
bal b/d
400
Depn exp
400
800
800
Year 3
bal c/d
1200
bal b/d
800
Depn exp
400
1200
1200
Year 4
bal c/d
1600
bal b/d
Depn exp
1600
2000
2000
Slide 48
1200
400
1600
Year 5
bal c/d
400
notes reference - page 91
bal b/d
Depn exp
1600
400
2000
Lecture example 6 part (b)
Income Statement (extract)
Year 1
Expenses
Depreciation 400
Slide 49
Year 2
Year 3 Year 4 Year 5
400
400
notes reference - page 91
400
400
Lecture example 6 part (b)
Balance Sheet (extract)
Slide 50
Cost
Acc depn
NBV
Year 1
2,500
(400)
2,100
Year 2
2,500
(800)
1,700
Year 3
2,500
(1,200)
1,300
Year 4
2,500
(1,600)
900
Year 5
2,500
(2,000)
500
notes reference - page 91
Lecture example 6 part (c)
Journal entry
Debit
Depreciation expense
Credit
400
Accumulated depreciation
400
Being annual depreciation charged on machine
Slide 51
notes reference - page 92
Disposal of non current assets
Profit/loss on disposal
NBV < sales proceeds = profit
NBV > sales proceeds = loss
Accounting treatment
Everything to do with disposal is transferred to a Disposal a/c
(a) Transfer original cost of asset to disposal a/c
(b) Transfer accumulated depreciation to disposal a/c
(c) Post sales proceeds
(d) Balance off disposal a/c to find profit/loss on disposal
(e) Profit on disposal = sundry income in I/S
Loss on disposal = expense in I/S
Slide 52
notes reference - page 92
Lecture example 7
The profit/loss on disposal is $840
Machine
bal b/d
6,000
Disposal
6,000
Accumulated depreciation
Disposal
3,840
bal b/d
3,840
Disposal
Machine cost
Profit on disposal
(I/S)
6,000
840
Accum depn
3,840
Cash
3,000
6,840
Slide 53
notes reference - page 93
6,840
Lecture example 8
The profit/loss on disposal is $840
Cash paid for the new machine is $7,000
Machine
bal b/d
6,000
Disposal
6,000
Accumulated depreciation
Disposal
3,840
bal b/d
3,840
Disposal
Machine cost
Profit on disposal
(IS)
6,000
840
Accum depn
3,840
New machine
(part exchange)
3,000
6,840
Slide 54
notes reference - page 94
6,840
Lecture example 8 (cont)
New machine
Disposal (part ex)
3,000
Cash
7,000
bal c/d
10,000
bal b/d
Slide 55
10,000
notes reference - page 94
10,000
10,000
Land and Buildings
Non-current assets are depreciated
over their useful life
Property is split into land and building
elements for depreciation
Land is not normally depreciated as it
has an unlimited useful life
Slide 56
notes reference - page 94
Revaluations
If an item of property has increased in value,
IAS 16 allows the asset to be revalued to
show the increase in value on the balance
sheet.
All items in the same class must be revalued
at the same time.
Slide 57
notes reference - page 95
Land and Buildings – accounting treatment
REVALUED
Dr NCA cost
Dr Accumulated depreciation
Cr Revaluation reserve/Capital
Slide 58
notes reference - page 95
Lecture example 9
The balance on the capital a/c / revaluation surplus is $70,000
bal b/d
Revaluation
Revaluation
bal c/d
Building
100,000
50,000 bal c/d
150,000
150,000
150,000
Accumulated depreciation
20,000 bal b/d
20,000
Capital/Revaluation Surplus
Building
70,000 Accum depn
50,000
20,000
70,000
Slide 59
notes reference - page 96
70,000
Lecture example 10
Working
Date
Depn charge
Acc Depn
NBV
31.12.X5
200,000/5 = 40,000
40,000
160,000
31.12.X6
40,000
80,000
120,000
31.12.X7
40,000
120,000
80,000
Slide 60
notes reference - page 97
Lecture example 10 (cont.)
(a) Asset revalued on 1.1.X8 to 250,000. The double entry
to reflect the revaluation is:
Dr NC asset (250,000 – 200,000)
Dr Accumulated depn (Working)
50,000
120,000
Cr Revaluation surplus
170,000
Slide 61
notes reference - page 97
Lecture example 10 (cont.)
(b) Asset revalued on 1.1.X8 to 180,000. The double entry
to reflect the revaluation is:
Dr Accumulated depn (Working)
Cr NC Asset (200,000 – 180,000)
120,000
20,000
Cr Revaluation surplus
100,000
Slide 62
notes reference - page 97
End of day 2 - what to do now…
• Reinforce today’s learning
• Develop question skills
Course Companion
1.Course
notes review
Slide 63
2. Question
practice
3. Study text
review