1
Objectives – Balance Day Adjustments
Distinguish between the cash basis of and
accrual basis of accounting
Distinguish the followings
–
–
–
–
Accrued Expenses
Prepaid Expenses
Accrued revenues
Prepaid revenues
And able to prepare the necessary adjustments
for the above followings.
Understand the effects of the adjustments on:
– The Profit and Loss Account
– The Balance Sheet
2
Balance Day Adjustments
– Basis of accounting for profits
–Cash basis
–Accrual Basis
Cash Basis:
Cash receipts
Accrual
Basis: – Cash payments = Profits
Revenue earned – Expenses incurred = Profits
3
Balance Day Adjustments
Revenue
Rent (cash)
Jan
Feb
1000
1000
Which is a1000
more
accurate
calculation?
300
Rent (Accrual) 100
100
March
100
• Rationale for using the accrual basis
– Businesses MOSTLY conducted on credit
terms
4
The scenario:Mr Phua rents a building
from Mr Tan and incurs a
monthly rent expense of
$1 000.
PhuaScenario
Chu Kang 1Pte Ltd
Tan Ah Teck Pte Ltd
TheMr
veryPhua
bestforgets
in
in Bishanof
to payThe
hisvery
rentbest
expenses
Singapore
JB &
someby
saythe
Sentosa!
$12 &000
insome
full to Mr&Tan
end of
say Batam!
the accounting year of 2000. Instead he
pays $5 000.
Scenario 2
Mr Phua pays his rent expenses of $18 000,
which is MORE THAN the actual amount,
to Mr Tan by the end of the accounting
year of 2001.
5
6
Your mobile phone bill shows
that you have not settled
last month’s amount. This
month mobile phone bill
shows an outstanding
amount of $100 and the
current amount of $80.
Hence this outstanding
amount of $100 is also
known as accrued expense.
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Balance Day Adjustments - Accrued Expenses
– Phua CK is pretending to be
calm but actually is very
confused. He 1
should have paid
Scenario
$12 000 for the rent for the
period from January to
December 2000.
– However, at the end of the
period, he only paid $5 000
to Tan Ah Teck Pte Ltd due to
negligence. He still owes the
company $7 000. He does
not know the correct entries
to reflect this!
Let us help him.
End of accounting period – December 2000
– Should have paid
:
$ 12 000
– Paid only
:
$ 5 000
– Owed
:
$ 7 000
This owing amount of $7 000 is also known as
Accrued Rent Expense. Mr. Phua CK still
owes Tan Ah Teck Ltd $7 000 that was not paid
for the year of 2000.
Balance Day Adjustments - Accrued Expenses
Definition:
• Are expense that have been incurred for
the accounting period BUT amount not
yet paid for by the business.
Balance Day Adjustments - Accrued Expenses
What isCredit
the
Yes….
nature
of
entry
because
accrued
it is
a liability
expense?
(still owe
Debit
or Credit
people
$)
entry?
Using Phua CK as an example.
If Mr. Phua remembered to pay the rent amount
in full, then the entries will be:JOURNAL
Date
Particulars
Year 2000
Dec 31
Rent Expense
Profit and Loss a/c
Debit
Credit
$12 000
However, this is not the case.
An additional ledger needs to be
created
– Accrued Rent Expense
$12 000
JOURNAL
Date
Particulars
Year 2000
Debit
Rent Expense
$7 000
Accrued Rent Expense
Dec 31
Credit
$7 000
RENT EXPENSES a/c
Year 2000
Dec 31 Bank
Accrued rent
Expense
$5 000
Year 2000
Dec 31 Profit & Loss
$12 000
$7 000
$12 000
$12 000
ACCRUED RENT EXPENSES a/c
Year 2000
Dec 31 Bal c/d
$7 000
$7 000
Year 2000
Dec 31 Rent Expense
Year 2001
Jan 1
Bal b/d
$7 000
$7 000
$7 000
JOURNAL
Date
2000
Dec 31
Particulars
Profit & Loss a/c
Debit
Credit
$12 000
Rent Expense
$12 000
(Being rent expense closing off to P&L a/c)
Profit & Loss Account
2000
Dec 31 Expenses
$12 000
Balance Sheet as at Dec 2000
Liability
Accrued Rent Expense
$7 000
Balance Day Adjustments - Accrued Expenses
Summary
• Definition
• Credit/Debit nature?
• Is there a need to open another ledger for
accrued expense?
• Post this ledger to P/L or Balance Sheet?
16
Singtel has a promotion for
new subscribers. If you
paid the 6 months of
mobile-phone monthly
subscription upfront
NOW, you get a free
Nokia 8250.
Assuming that the monthly
subscription is $20. You
like the promotion and paid
$1 200 (6x$20)
immediately in order to get
the new mobile phone.
Hence you are paying in
advance for the expense.
The payment in advance of subscription
fees ($1 200) is also known as Prepaid
Expense.
Prepaid Expense/Payment in Advance
Definition
Are expenses that have been
paid in advance but NOT yet
incurred for the current
accounting period.
Since
expense
Prepaid
isexpense
a debit is
entry.
the
like anIfasset
expense
hadas
to the firm
been
prepaid,
it is similar
to
what
will
be
people
owing
the
naturetoof
services
the
theentry?
firm.
Hence a
DEBIT ENTRY.
Prepaid Expense/Payment in Advance
Scenario 2
Phua CK learnt his lesson last time of not
paying on time last year, so he decides to
pay in advance to “save his face” this year.
The rent expense for the accounting year
of 2001 is $12 000, but he pays $18 000.
Hence he prepaid $6 000 for expenses
that has not been incurred in 2001.
Prepaid Expense/Payment in Advance
Recall that the monthly rent expense is
$1 000. Hence from January to December
2001, the total rent is $12 000.
Phua CK prepaid rent expense of $6 000
for January to June 2002.
1 Jan 2001
31 Dec 2001 30 June 2002
$ 12 000 incurred
$18 000
paid
$6 000
prepaid
JOURNAL
Date
Year
2001
Credit
Particulars
Debit
Prepaid Rent Expense
$6 000
Rent Expense
Dec 31
$6 000
RENT EXPENSES a/c
Year 2001
$18 000 Dec 31 Prepaid Rent
Profit & Loss
Year 2001
Dec 31 Bank
$ 6 000
$12 000
$18 000
$18 000
PREPAID RENT EXPENSES a/c
Year 2001
Dec 31 Rent Expense $6 000
$6 000
Year 2002
Jan 1
Bal b/d
$6 000
Year 2001
Dec 31 Bal c/d
$6 000
$6 000
Profit & Loss Account
2001
Dec 31 Expenses
$12 000
Balance Sheet as at Dec 2001
Current Assets
Prepaid Rent Expense
$6 000
Summary
• Definition
• Credit/Debit nature?
• What are the differences in adjustments
between the accrued and prepaid expenses?
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Practice - Accrued and Prepaid
Expenses

During the year of 2001, the cash book shows:
 maintenance
Expense
 Selling Expense

On 31 May 2001, the Balance Sheet also shows
 Prepaid
Maintenance Expense
 Accrued Selling expense

$ 900
$1 200
$ 400
$ 300
Find the actual amount of the expenses incurred
for the year of 2001.
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1
Prepaid Maintenance Expense
Maintenance Expense
$
Cash at Bank
900
$
Profit & Loss
500
Prepaid Maint Exp
400
900
2
900
Accrued Selling Expense
Selling Expense
$
Cash at Bank
Accrued Selling Exp
1 200 Profit & Loss
$
1 500
300
1 500
1 500
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