Adjustments to Financial Statements Session 07 & 08
Session Outline • Adjustments to Financial Statements – Closing Inventory – Accruals and Prepayments – Interest – Depreciation – Bad Debts • Preparation of Financial Statements with Adjustments
Financial Source Prime Entry General Trial Statements Documents Books Ledger Balance Adjustments
Adjustments? • An adjustment is a financial transaction which has not been entered in the accounting records of a business at a particular point of time. • Adjustments are needed to ensure compliance with accounting standards and concepts, and to make a company’s financial records proper. • All adjustments have an impact on both the statement of comprehensive income and statement of financial position. • Every debit adjustment should have an equal and an opposite credit adjustment.
Closing Inventory
Closing Inventory • Closing inventory is a deduction (credit) in the statement of comprehensive income, and a current asset (debit) in the statement of financial position. • Example: Cost of Sales Opening Inventory 340,000 + Purchases 1,890,000 2,230,000 (-) Closing Inventory (420,000) Current Asset 1,810,000 Cost of Sales
Example • Following are the extracts from the Trial Balance of XYZ company as at 31 st December 2018. Opening Inventory (01/01/2018) $ 8,900 Purchases $ 56,000 Purchase Returns $ 4,200 Carriage Inwards $ 2,400 • Closing inventory as at 31 st December 2018 is $ 7,000. – Present the above in relevant financial statements.
Accruals and Prepayments • The trial balance will show the amounts paid and amounts received in the accounting period. • The statement of comprehensive income has to include the expenses/ income related to the period, whether or not they have been paid/ received. • In the statement of comprehensive income, the total expense/ revenue should be recorded (with a working showing the details). • The statement of financial position should reflect the relevant amounts as assets/ liabilities.
Accruals and Prepayments • Accrued Expenses – Expenses which relate to an accounting period but have not been yet paid for. – Should be shown in the statement of financial position as a liability (e.g. Electricity bills unpaid) • Prepaid Expenses – Expenses which have already been paid but relate to a future accounting period. – Should be shown in the statement of financial position as an asset (e.g. Rent paid in advance)
Accruals and Prepayments Accrual Expense Unpaid Already Paid Amount Total Bill Telephone Bill 800,000 80,000 880,000 Expense Electricity Bill 650,000 12,000 662,000 Expense Current Liability Prepaid Expense expense Prepaid relevent to Already Paid amount period Rent Expense 500,000 200,000 300,000 Expense Current Asset
Example • Following are the closing balances of salaries and insurance expenses at ABC Limited for the year ended 31 st December 2018. Salaries $ 135,000 Insurance $ 6,000 As at 31 st December 2018, salaries to be paid amounted • to $ 4,000 and the insurance paid in advance was $ 500. • Present the above in relevant financial statements.
Accruals and Prepayments • Accrued Revenue – Income which has been earned but not yet received. – Should be shown in the statement of financial position as an asset (e.g. Rent receivable) • Prepaid Revenue – Income which has been received in advance before the services are rendered . – Should be shown in the statement of financial position as a liability (e.g. Rent received in advance)
Accruals and Prepayments Income Receivable Income Income received receivable Total Income Dividende income 500,000 50,000 550,000 Income Current Asset Income received in advance Income Income Advance relevent to received receipt period Rent Income 300,000 25,000 275,000 Income Current Liability
Example • Following are the closing balances of rent income and commission income at ABC Limited for the year ended 31 st December 2018. Rent $ 8,000 Commission $ 12,000 As at 31 st December 2018, rent income to be received is • $ 600 and the commission income received in advance was $ 900. • Present the above in relevant financial statements .
Interest • Interest expense for an accounting period should be recorded in the financial statements; whether paid or not. • The liability (e.g. loan) will specify an interest rate, from which the relevant interest expense should be calculated. • If the interest expense has not been accounted yet, it should be calculated and reflected in the statement of comprehensive income. • If the interest expense is partly accounted, the balance has to be reflected as an addition to the current interest expense in the statement of comprehensive income.
Example • Following are the extracts regarding the closing balances of non-current liabilities and interest payments of ABC Limited as at 31 st December 2018. 8% Bank Loan $ 100,000 Interest Expenses $ 4,000 • Present the above information in financial statements.
Depreciation • Depreciation is a systematic allocation of the depreciable amount of an asset over its useful life. • This spreads the cost of assets over their useful lives, so that a charge against profit appears in the statement of comprehensive income. – Example: If an asset will help the business to create revenue for 5 years, then the cost of the asset is spread over the same five years
Depreciation • Depreciation Methods – 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 carrying amount (cost less accumulated depreciation to date).
Depreciation • Presentation in Financial Statements – Statement of comprehensive income: C urrent year’s depreciation charge is presented as an expense (Do not include the accumulated depreciation) – Statement of financial position : Should show the cost, accumulated depreciation and the carrying amount.
Depreciation Depreciation Building Cost x Depreciation percentage 750000 x 5% = 37,500 Expense Motor Vehicles Cost x Depreciation percentage 400000 x 20% = 80,000 Expense Total Accumulated Depreciation Total Accumulated Depreciation accumulated depreciation for the year depreciation Building 250000 37,500 287,500 Accumulated Depreciation Motor Vehicles 200000 80,000 280,000 Accumulated Depreciation Net Book Value Total acc. Net Book Cost Depreciation Value Building 750000 287,500 462,500 Non current asset (Net Book Value) Motor vehicles 400000 280,000 120,000 Non current asset (Net Book Value) Non current asset (Cost)
Example • Following are some extracts from the trial balance of Nova Ltd. as at 31 st December 2018. Description Dr ($) Cr ($) Land 800,000 Buildings 350,000 Vehicles 200,000 Accumulated Depreciation: Buildings 35,000 Accumulated Depreciation: Vehicles 87,500 • The company depreciates buildings on straight line method at 10% per year, where the vehicles are depreciated based on the reducing balance method at 25% per year. – Present the above information in financial statements.
Bad Debts • Bad debt is a receivable amount which is not collectible from the debtors. • If bad debts appear as an item in the trial balance, it means that the debts have already been written off. • If bad debts appear as an adjustment outside the trial balance, the amount should be stated in the statement of comprehensive income as an expense, and deducted from trade receivables in the statement of financial position. d debt and doubtful debt Trade Receivables 165,000 Bad debt expense (10,000) Expense 155,000 Current Asset Provision for doubtful debt (5%) 7,750 asse
Example • Following are some information regarding the trade receivables at Mega Ltd as at 31 st December 2018. Trade Receivables Amount Bad Debts JTK Holdings $ 180,000 5% Nadien Industries $ 290,000 $ 23,000 John Smith & Co. $ 126,000 - As at 31 st December 2018, the trial balance of Mega Ltd • showed a trade receivables balance of (Dr.) of 596,000 and a bad debt amount of (Dr.) $ 26,000. • Present the relevant information in financial statements.
Practice Question • The following Trial Balance was extracted from the books of Konik Enterprises as at 31st March 2018: Description Dr (Rs.) Cr (Rs.) Capital as at 1st April 2018 1,500,000 Cash and Bank Balance 310,000 Debtors 60,000 Creditors 59,000 Inventories as at 1st April 2018 400,000 Sales 630,000 Purchases 320,000 Land and Buildings 730,000 Office Equipment 500,000 Accumulated depreciation as at 1st April 2018 Building 50,000 Office equipment 25,000 Bank loan 100,000 Retained Earnings as at 1 st April 2018 123,000 Rent and Maintenance 45,000 Salaries and wages 52,000 Insurance 18,000 Electricity 25,000 Telephone 15,000 Sales commission 12,000 2,487,000 2,487,000
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