Methods of Accounting  •Cash Accounting  •Accrual Accounting                        1
Cash Accounting• Transactions recorded only when  cash is received or paid  – Credit sales and purchases recorded    only ...
Accrual AccountingAccrual accountingrecognises transactions and events whenrevenues are earned and expenses areincurred.Eg...
Recognising revenue:  although cash may not have been  received, business records recognise that  the revenue has been ear...
Balance Day Adjustments• Allows matching principle to be carried  out• Adjustment entries facilitate a better  matching of...
• Adjustments are carried out at balance  day before revenues and expenses are  closed to P&L summary a/cBalance day adjus...
There are numerous balance day  adjustments. Four will be covered in  this unit:• Prepaid expenses• Accrued expenses• Unea...
Prepaid ExpensesPrepaid expensesare the portion of an expense that has beenpaid by a business in one accounting periodbut ...
The business paid $1 200 for a yearly subscription to a trade journal at the beginning of March. The Subscription a/c (an ...
• The subscription is for one year and will be  renewed in March of 2008• Balance day is 30 June 2007• Any part of the sub...
• This entry permits:  – The necessary decrease in the    Subscription a/c by the prepaid    amount and  – The temporary a...
General Ledger Date            Particulars   Debit    Credit     BalancePrepaid Expense a/c                              B...
• The very next day – July 1 a reversing  entry is required to allow:   – the reversal of the balance day adjustment     e...
General Journal Date             Particulars   Debit    Credit  Jul 1 Subscription               800           Prepaid Exp...
General Ledger                          A/c now closed Date        Particulars   Debit    Credit   Balance                ...
Accrued ExpensesAccrued expenses are costs incurred by abusiness in the current accounting periodthat have not yet been pa...
During the 2006/2007 financial year the business has paid $25 500 in rent. On balance day rent is owing of $1 200 but will...
• On balance day rent is owing of $1 200 but will not be paid until the  following week.• According to the principles of a...
• This entry permits:   – The necessary increase in the Rent a/c     by $1 200 because the amount has     been incurred in...
General Ledger Date       Particulars   Debit    Credit   Balance     Balance                                             ...
• The very next day – July 1 a reversing   entry is required.General Journal Date             Particulars   Debit     Cred...
A/c now                                                       closedGeneral Ledger                                        ...
Unearned RevenuesUnearned Revenues are income that has beenreceived by a business and recorded in the currentaccounting pe...
The business received 3 months rent on 30 April 2007 of $3 000.General Ledger Date       Particulars   Debit   Credit   Ba...
• On balance day, 30 June 2007, the business must   account for the rent that was received in advance. • This amount relat...
• This entry permits:   – The decrease in the rent revenue account of $1     000 because only $2 000 has been earned in   ...
Balance                                                         SheetGeneral Ledger Date         Particulars   Debit    Cr...
• The very next day – July 1 a reversing   entry is required.General Journal Date             Particulars   Debit     Cred...
A/c now                                                        closedGeneral Ledger                                       ...
Accrued RevenuesAccrued Revenues are revenues that have beenearned in the current financial period but not yetreceivedeg  ...
The business has earned a 5% commission on sales amounting to $1000. On 30 June the commission had still to be receivedGen...
• On balance day commission is still to be received and will    likely be received in the next accounting period.• Accordi...
• This entry permits:  – The necessary increase in the    Commission Revenue a/c by $50    because the amount has been ear...
General Ledger Date        Particulars    Debit   Credit   Balance   BalanceAccrued Revenue a/c                           ...
• The very next day – July 1 a reversing   entry is required.General Journal Date             Particulars   Debit    Credi...
A/c now                                                         closedGeneral Ledger                                      ...
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Accrual Accounting and Balance Day Adjustments

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Accrual Accounting and Balance Day Adjustments

  1. 1. Methods of Accounting •Cash Accounting •Accrual Accounting 1
  2. 2. Cash Accounting• Transactions recorded only when cash is received or paid – Credit sales and purchases recorded only when cash received from customer or paid to supplier• Does not adhere to matching principle• Does not comply with ATO 2
  3. 3. Accrual AccountingAccrual accountingrecognises transactions and events whenrevenues are earned and expenses areincurred.Eg interest earned at the end of theaccounting period will be recorded (thoughstill not received) – application of thematching principle. 3
  4. 4. Recognising revenue: although cash may not have been received, business records recognise that the revenue has been earned.Realising revenue: occurs when cash is received and recorded by business for the revenue previously recognised. 4
  5. 5. Balance Day Adjustments• Allows matching principle to be carried out• Adjustment entries facilitate a better matching of revenues and expenses• Ensures a more accurate profit figure for the period• Essential – final reports are a basis for future decisions• Information in reports are of greater relevance and more reliable 5
  6. 6. • Adjustments are carried out at balance day before revenues and expenses are closed to P&L summary a/cBalance day adjustments are general journal entries made as at balance day in order to compare (match) the revenues and expenses accurately so that the profit (loss) can be determined. 6
  7. 7. There are numerous balance day adjustments. Four will be covered in this unit:• Prepaid expenses• Accrued expenses• Unearned revenues• Accrued revenues 7
  8. 8. Prepaid ExpensesPrepaid expensesare the portion of an expense that has beenpaid by a business in one accounting periodbut will be incurred (used up) in a futureaccounting period.eg – Insurance – Subscriptions 8
  9. 9. The business paid $1 200 for a yearly subscription to a trade journal at the beginning of March. The Subscription a/c (an expense) would appear as:General Ledger Date Particulars Debit Credit BalanceSubscription a/c Mar 1 Bank 1 200 1 200Dr 9
  10. 10. • The subscription is for one year and will be renewed in March of 2008• Balance day is 30 June 2007• Any part of the subscription past this date has been prepaid and relates to the next accounting period• The prepaid amount is $800 (8 months)• The account, on balance day, must recognise this prepaid amount as belonging to the next General Journal accounting period – General journal entry is required: Debit Date Particulars Credit Jun 30 Prepaid Expense 800 Subscription a/c 800 (Balance day adjustment) 10
  11. 11. • This entry permits: – The necessary decrease in the Subscription a/c by the prepaid amount and – The temporary asset account Prepaid Expense is created to reflect the $800 paid in advance. (this is an asset because the business is owed the service of the subscription) 11
  12. 12. General Ledger Date Particulars Debit Credit BalancePrepaid Expense a/c Balance Sheet Jun 30 Subscription 800 800DrSubscription a/c Mar 1 Bank 1 200 1 200Dr Jun 30 Prepaid Expense 800 400Dr Closed to P&L Summary a/c 12
  13. 13. • The very next day – July 1 a reversing entry is required to allow: – the reversal of the balance day adjustment entries so that revenue and expenses are returned to the pre-adjusted state and – the closure of the temporary asset or liability accounts that were created on balance day to adjust the revenue and expense accounts for accrual accounting purposes. 13
  14. 14. General Journal Date Particulars Debit Credit Jul 1 Subscription 800 Prepaid Expense 800 (Reversing entry) 14
  15. 15. General Ledger A/c now closed Date Particulars Debit Credit Balance $800Prepaid Expense a/c returned toJun 30 Subscription 800 800Dr a/c – Jul 1 Subscription 800 0 representsSubscription a/c the Mar 1 Bank 1 200 1 200Dr subscriptionJun 30 Prepaid Expense 800 400Dr amount P&L Summary 400 0 which will be Jul 1 Prepaid Expense 800 800Dr consumed in this current period. 15
  16. 16. Accrued ExpensesAccrued expenses are costs incurred by abusiness in the current accounting periodthat have not yet been paideg – Rent – Wages 16
  17. 17. During the 2006/2007 financial year the business has paid $25 500 in rent. On balance day rent is owing of $1 200 but will not be paid until the following week.General Ledger Date Particulars Debit Credit BalanceRent Expense a/cJun 30 Entries to date 25 500 25 500Dr 17
  18. 18. • On balance day rent is owing of $1 200 but will not be paid until the following week.• According to the principles of accrual accounting, the expense of $1 200 for rent owing must be included in the profit calculation event though it has not been paid.• Rent needs to be adjusted to show the total expense incurred for rent in the accounting period. – General journal entry is required: General Journal Date Particulars Debit Credit Jun 30 Rent Expense 1 200 Accrued Expense 1 200 (Balance day adjustment) 18
  19. 19. • This entry permits: – The necessary increase in the Rent a/c by $1 200 because the amount has been incurred in the current accounting period and – The temporary liability account Accrued Expense is created to reflect the $1 200 that is owing by the business. (this is a liability because the business owes the amount for rent in this accounting period.) 19
  20. 20. General Ledger Date Particulars Debit Credit Balance Balance SheetAccrued Expense a/cJun 30 Rent Expense 1 200 1 200CrRent Expense a/cJun 30 Entries to date 25 500 25 500Dr Closed to P&L Summary a/c Accrued Expense 1 200 26 700Dr 20
  21. 21. • The very next day – July 1 a reversing entry is required.General Journal Date Particulars Debit Credit Jul 1 Accrued Expense 1 200 Rent Expense 1 200 (Reversing entry) 21
  22. 22. A/c now closedGeneral Ledger $1 200 Date Particulars Debit Credit Balance returned to a/Accrued Expense a/c c – representsJun 30 Rent Expense 1 200 1 200Cr the rent Rent Expense 1 200 0 amount whichRent Expense a/c will be paid in this currentJun 30 Entries to date 25 500 25 500Dr period but Accrued Expense 1 200 26 700Dr was owed in P&L Summary 26 700 0 the previous Jul 1 Accrued Expense 1 200 1 200Cr period. 22
  23. 23. Unearned RevenuesUnearned Revenues are income that has beenreceived by a business and recorded in the currentaccounting period but will not be earned until afuture accounting period.eg – Rent Revenue 23
  24. 24. The business received 3 months rent on 30 April 2007 of $3 000.General Ledger Date Particulars Debit Credit BalanceRent Revenue a/cApr 30 Bank 3 000 3 000Cr 24
  25. 25. • On balance day, 30 June 2007, the business must account for the rent that was received in advance. • This amount relates to the next accounting period. • Rent Revenue a/c needs to be adjusted to demonstrate that the one month’s rent for July (paid in April) represents a revenue that will be earned in the next accounting period. • One month’s rent is $1 000General General journal entry is required: – Journal Date Particulars Debit CreditJun 30 Rent Revenue 1 000 Unearned Revenue 1 000 (Balance day adjustment) 25
  26. 26. • This entry permits: – The decrease in the rent revenue account of $1 000 because only $2 000 has been earned in the current accounting period – The temporary liability account Unearned Revenue is created to reflect the $1 000 that has been received but not yet earned. (this is a liability because the business owes the tenant the use of the premises.) 26
  27. 27. Balance SheetGeneral Ledger Date Particulars Debit Credit BalanceUnearned Revenue a/cJun 30 Rent Revenue 1 000 1 000Cr Closed to P&LRent Revenue a/c Summary a/ Apr 1 Bank 3 000 3 000Cr c Unearned Revenue 1 000 2 000Cr 27
  28. 28. • The very next day – July 1 a reversing entry is required.General Journal Date Particulars Debit Credit Jul 1 Unearned Revenue 1 000 Rent Revenue 1 000 (Reversing entry) 28
  29. 29. A/c now closedGeneral Ledger $1 000 Date Particulars Debit Credit Balance returned to a/Unearned Revenue a/c c – representsJun 30 Rent Revenue 1 000 1 000Cr the rent Jul 1 Rent Revenue 1 000 0 revenue amount whichRent Revenue a/c will be earned Apr 1 Bank 3 000 3 000Cr in this currentJun 30 Unearned Revenue 1 000 2 000Cr period but P&L Summary 2 000 0 was received Jul 1 Unearned Revenue 1 000 1 000Cr in the previous period. 29
  30. 30. Accrued RevenuesAccrued Revenues are revenues that have beenearned in the current financial period but not yetreceivedeg – Commission Revenue – Interest Revenue – Rent Revenue 30
  31. 31. The business has earned a 5% commission on sales amounting to $1000. On 30 June the commission had still to be receivedGeneral Ledger Date Particulars Debit Credit BalanceCommission Revenue a/c 31
  32. 32. • On balance day commission is still to be received and will likely be received in the next accounting period.• According to the principles of accrual accounting, the revenue of $50 for commission revenue must be included in the profit calculation even though it has not been received.• General Journal Revenue a/c needs to be adjusted to show The Commission Datetotal revenue earned in the accounting period. Credit the Particulars Debit – General journal entry is required: Jun 30 Accrued Revenue 50 Commission Revenue 50 (Balance day adjustment) 32
  33. 33. • This entry permits: – The necessary increase in the Commission Revenue a/c by $50 because the amount has been earned in the current accounting period and – The temporary asset account Accrued Revenue is created to reflect the $50 owing to the business. 33
  34. 34. General Ledger Date Particulars Debit Credit Balance BalanceAccrued Revenue a/c SheetJun 30 Commission Revenue 50 50DrCommission Revenue a/c Closed toJun 30 Accrued Revenue 50 50Cr P&L Summary a/ c 34
  35. 35. • The very next day – July 1 a reversing entry is required.General Journal Date Particulars Debit Credit Jul 1 Commission Revenue 50 Accrued Revenue 50 (Reversing entry) 35
  36. 36. A/c now closedGeneral Ledger $50 returned to a/c – represents the Date Particulars Debit Credit Balance commissionAccrued Revenue a/c amount which will be receivedJun 30 Commission Revenue 50 50Dr in this current Commission Revenue 50 0 period but was earned in theCommission Revenue a/c previous period.Jun 30 Accrued Revenue 50 50Cr P&L Summary 50 0 Jul 1 Accrued Revenue 50 50Dr 36
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