This post examines how to deal with the main possible post trial
balance adjustments, including:
·
inventory/stock
·
accruals and prepayments
·
interest
·
depreciation
·
bad debts and allowances for
receivables/debtors.
Source: http://goo.gl/mqXJLX
The most significant thing, which must be noted from the start,
is that all these adjustments have an effect on both the statement of income/profit and loss account and in the balance sheet. If the trial
balance balances, your answer must balance, and hence any changes to the
trial balance must balance. But, it is more prudent to complete
the question within the time allotted, without wasting too much time on getting the balance
sheet to balance.
INVENTORY/STOCK
This is a fairly recognized adjustment. The cost of goods sold includes opening inventory plus purchases, minus closing inventory. The
closing inventory is thus a deduction (credit) in the income statement/trading
account, and a current asset (debit) in the balance sheet.
The ledger account behind the adjustment causes problems for some
candidates. This is how the inventory/stock account will look at the time the
trial balance is being prepared. The entry is the transfer from the income
statement for the closing inventory of the previous year (figures invented):
In the current year, last year’s closing inventory is this year’s
opening inventory. It must be transferred out to this year’s income statement,
before the entry for the new closing inventory is made:
There will sometimes be a requirement to adjust inventory/stock to
allow for damaged or slow-moving items. IAS 2, Inventories and
SSAP 9, Stocks and Long-term Contractsboth require
inventories/stock to be included at the lower of cost and net realisable value.
It may therefore be necessary to reduce the inventory/stock figure to reflect a
net realisable value below cost for the items detailed.
ACCRUALS AND PREPAYMENTS
The income statement/profit and loss account has to include the
expenses relating to the period, whether or not they have been paid. The
figures in the trial balance will usually be the amounts paid in the period,
and they need adjusting for outstanding amounts and amounts paid which relate
to other periods to obtain the income statement charge.
Unpaid balances relating to the period should be included in the
balance sheet as current liabilities. If the expense has been paid in advance,
the amount prepaid is included in the balance sheet as a current asset. In the
income statement/profit and loss account, the total expense is needed with a
working showing the detail. Don’t show two figures in the outer column for the
same expense heading. For example, the trial balance shows:
$
Wages
136,000
Insurance
4,000
At 31 December 2005, wages owing amounted to $3,800, and insurance
paid in advance was $600. This is presented as follows:
$
Income statement/profit and loss account
Wages (136,000 + 3,800)
139,800
Insurance (4,000 – 600)
3,400
Balance sheet
Current assets
Inventory/stock
–
Receivables/debtors
–
Prepayments
600
Cash
–
Current liabilities
Trade payables/creditors
–
Accruals
3,400
Similar adjustments may be needed for income, such as rent
receivable. Be careful here. Income received in advance is a liability and
should be included alongside accruals for unpaid expenses, thereby changing the
heading to ‘Accruals and deferred income’. Income in arrears is an asset which
should be included with prepayments using the heading ‘Prepayments and accrued
income’.
INTEREST
Interest payable is really another accrual but there are one or
two special points. First, the question may not give explicit instructions to
accrue for interest. The trial balance may contain:
Dr
Cr
$ $
$ $
8% Loan stock/debentures
100,000
Candidates are expected to note that only half the loan interest
has been paid, and accrue for the other $4,000. Examiners generally indicate in
some way that the loan stock/debentures have been in issue for the whole year
if they want this adjustment to be made. Second, the interest is a current
liability and the loan stock/debentures are a non-current liability. Present
them appropriately and don’t combine them.
DEPRECIATION
Depreciation is a slightly more complex adjustment. Depreciation
spreads the cost of non-current/fixed assets fairly over assets’ useful lives,
so that a charge against profit appears in the income statement/profit and loss
account each year.
Methods of depreciation
There are two main methods of depreciation which are tested in
basic level examinations:
· straight line method
– a percentage of cost (or cost less residual value) is charged each year
· reducing balance
method – a percentage is charged on the written down value (cost less
accumulated depreciation to date).
Depreciation policies
Some businesses adopt a policy of charging a full year’s
depreciation in the year the asset was purchased, and none in the year of its
sale. Others take proportionate depreciation for the number of months of
ownership of the asset in the year. The first requirement, therefore, is to
read the question carefully to find out what has to be done for each
non-current/fixed asset.
Income statement/profit and loss account
The current year’s depreciation charge is calculated and appears
as an expense. Do not include the accumulated depreciation. The accumulated
depreciation is the total depreciation charged during an asset’s life (assuming
no revaluation) and as such previous costs will have been charged against
profits in earlier periods.
Balance sheet
The balance sheet shows the cost, accumulated depreciation (the
figure in the trial balance plus the current year’s charge from the income
statement), and net book value. The easiest way to present this is as a table,
as follows (figures invented):
Cost Accumulated Net
book value
depreciation
$
$
$
Buildings
800,000
80,000
720,000
Plant and equipment 390,000
260,000
130,000
Motor vehicles
210,000
100,000
110,000
1,400,000
440,000
960,000
The underlying ledger accounts
It would be possible to use just one account for each
non-current/fixed asset, showing cost and depreciation. However, they are
usually kept separate, in order to present the separate figures in the balance
sheet as shown above. This results in (figures invented):
A third account is required to handle disposals. When a
non-current/fixed asset is sold, the cost and accumulated depreciation relating
to the asset are transferred out of the accounts to a disposal account. The
proceeds of sale are credited to the account, and the balance on the account is
then the profit or loss on the sale, to be transferred to the income
statement/profit and loss account.
BAD DEBTS AND ALLOWANCE FOR
RECEIVABLES/DEBTORS
These adjustments probably cause most difficulty for candidates in
an examination.
Bad debts
Writing off a bad debt means taking a customer’s balance in the
receivables/sales ledger and transferring it to the income statement as an
expense, because the balance has proved irrecoverable. There are two separate
exam possibilities here:
· bad debts appear as
an item in the trial balance. This means the debts have already been written
off. In other words, receivables/debtors have already been reduced. All that is
necessary is to put the figure in the income statement/profit and loss account
as an expense
· bad debts appear as
an adjustment outside the trial balance. Two entries are now needed. The amount
goes into the income statement as an expense and is deducted from the
receivables/debtors figure in the balance sheet.
Allowance for receivables/debtors
This allowance is set up in order to include a realistic value for
receivables/debtors in the balance sheet, without actually writing off the
debt. The balance is left in the receivables/sales ledger so that collection
procedures continue, but the receivables/debtors in the balance sheet are
valued as if the amount is not to be recovered. The trial balance shows:
Dr
Cr
$
$
Trade receivables/debtors
180,000
Allowance for receivables/debtors
4,000
This means that the business already has an allowance, taken from
the income statement/profit and loss account in previous years. If nothing more
is to be done, this should show in the balance sheet, under current assets:
$
$
Trade receivables/debtors
180,000
Less: Allowance for receivables/debtors
4,000
176,000
Alternatively, if preparing a company balance sheet for
publication, it should show:
Trade receivables/debtors (180,000 - 4,000)
176,000
The figures in brackets are a working, not part of the balance
sheet. Continuing the example, it is more likely that the question will require
the allowance to be adjusted. Let us say that the allowance is to be increased
to $5,400. Given that there is already $4,000, $1,400 should be taken out of
this year’s income statement/profit and loss account. The result is:
Income statement/profit and loss account
$
Increase in allowance for receivables/debtors
1,400
Remember that it is only the increase or decrease in the allowance
that goes into the income statement/profit and loss account.
Balance sheet
$
$
Trade receivables/debtors
180,000
Less: Allowance for receivables/debtors 5,400
174,600
The underlying ledger accounts
There are several ways of dealing with bad debts, and allowances
for receivables/debtors, in ledger accounts. One way is to have both in one
account. However, for examination purposes, it may be easier to have two
accounts, one for debts written off and one for the allowance:
Bad debts recovered
Sometimes, a debt written off in one year is actually paid in the
next year – a debit to cash and a credit to bad debts recovered. The credit
balance on the account is then transferred to the credit of the income
statement/profit and loss account (added to gross profit or included as a
negative in the list of expenses). This is better than crediting the recovery
to the bad debts account, because that would obscure the expense from bad debts
for the year.
Tag :
ACCA,
Accountancy
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