RECORDING YEAR END

ADJUSTMENTS

2

TYPES OF ADJUSTING ENTRIES

WHAT IS ACCRUALS Accruals are either :

expenses that have been incurred but have not yet been paid in the current financial year OR

revenues that have been earned but have not yet been received in the current financial year

ACCOUNTING CONCEPT RELATED

Periodicity Assumption Accountants make the assumption that the

economic life of a business can be divided into artificial time

periods. This assumption is referred to as the periodicity or time period assumption. Many business transactions affect more than one of these arbitrary time periods. Therefore, it is necessary to determine the relevance of each business transaction to specific accounting periods.

ACCOUNTING CONCEPT RELATED

Accrual Basis of Accounting Accrual basis of accounting means that events that

change a business’s financial Statements are recorded in the periods in which the

events occur, rather than in the periods in which the business receives or pays cash. For example, revenues are recognised in the periods in which they are earned and expenses are recognised when they are incurred.

Therefore, accountants have developed two principles as part of the Generally Accepted Accounting Principles (GAAP) to help in this determination. One of these principles is the revenue recognition principle. This principle dictates that revenue is considered to be earned in a service enterprise at the time the service is performed.

ACCOUNTING CONCEPT RELATED

Matching concept In recognising expenses, accountants follow the

approach of “let the expenses follow the revenues.” The practice of expense recognition is referred to as the matching principle because it dictates that efforts (expenses) be matched with accomplishments (revenues).

HOW TO RECORD ACCRUALS?

8

ACCRUED EXPENSESExample 8.3The wages bill for Muzaffar Trading Company is RM350 a week (5 working days). On the statement of financial position dated 30 June 20x6, a total of RM17,850 had been paid for the year and wages for 3 working days of RM210 were owing. The adjusting entry must recognise the liability to employees for work done but not yet paid for, and also increase the expense account to the full amount incurred for the period. The adjusting journal entry to record this is as follows:

9

ACCRUED EXPENSES – CONT.

The ledger accounts after posting the adjustment will appear as follows:

10

ACCRUED EXPENSES – CONT.The closing journal entry would be:

After posting this entry, the accounts would appear as follows:

11

ACCRUED EXPENSES – CONT.

On the first day of the next accounting period, it will be necessary to reverse the adjustment made to avoid double counting of the wages paid. Therefore, the following reversing entry is required:

12

ACCRUED EXPENSES – CONT.After this entry is posted on the first day of the new accounting period, and after the first pay day of the new period has passed, the ledger accounts would appear as follows:

13

ACCRUED REVENUE (UNRECORDED REVENUE)

Example 8.4Muzaffar Trading Company purchased RM10,000 of 10 per cent Bank Negara Bonds on 1 November 20x5 on which interest is paid biannually on 31 March and 30 September. By 30 June 20x6, the firm will have received interest for 6 months (RM500) but have earned interest for 9 months (RM750). Therefore, there is 3 months’ interest earned (RM250) for the period, but not yet received. The adjusting journal entry to adjust the ledger accounts is as follows:

14

ACCRUED REVENUE – CONT.

The ledger accounts after this entry is posted would be as follows:

15

ACCRUED REVENUE – CONT.

As with accrued expenses, a reversing entry is necessary at the beginning of the next period to avoid double counting. The reversing entry ensures that this correct apportionment of revenue is achieved between the two periods. The entry would be:

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ACCRUED REVENUE – CONT.

After the interest is received on 30 September, the ledger account would appear as follows:

WHAT IS THE EFFECT OF ACCRUALS IN FINAL

ACCOUNTS?

ACCRUALS IN THE FINAL ACCOUNT Statement of Financial Position:

Accrued Expenses - Current LiabilitiesAccrued Revenues – Current Assets

WHAT IS PREPAYMENT Prepayments are either :

Expenses that have been paid ORRevenues that have been received in

advance

ACCOUNTING CONCEPT RELATED SAME AS ACCOUNTING CONCEPT

RELATED WITH ACCRUALS

HOW TO RECORD PREPAYMENTS?

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PREPAID EXPENSES (EXPENSES PAID IN ADVANCE)

Example 8.1

Muzaffar Trading Company pays a 12-month motor vehicle insurance premium of RM240 on 1 May. This would be recorded as a debit of RM240 to the expense account, Motor Vehicle Insurance Expense, and a credit to the asset account, Cash. On 30 June, two months later, the ledger has to be closed to determine profit. Thus, it is necessary to recognise two months or one-sixth of the RM240 (RM40) as an expense and the remaining RM200 as prepaid for the next period. The adjusting journal entry required on 30 June in the general journal would be:

23

After this entry has been posted, the ledger account would be as follows:

Prepaid Expenses (Expenses Paid in Advance)

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PREPAID EXPENSES (EXPENSES PAID IN ADVANCE)The amount in the expense account would be closed to the Statement of Profit or Loss and Other Comprehensive Income. The closing journal entry would be:

25

After this entry has been posted, the ledger account would appear as follows:

PREPAID EXPENSES (EXPENSES PAID IN ADVANCE)

26

As time passes in the next period, more and more of the insurance premium will be based, thus ceasing to be an asset. In recognition of this, the full prepayment is immediately transferred back to the expense account. The necessary reversing journal entry would be:

PREPAID EXPENSES (EXPENSES PAID IN ADVANCE)

27

After this entry is posted, the ledger accounts would appear as follows:

PREPAID EXPENSES (EXPENSES PAID IN ADVANCE)

28

PREPAID REVENUE (REVENUE RECEIVED IN

ADVANCE/UNRECORDED REVENUE)

Example 8.2

Muzaffar Trading Company received a 12-month subscription from a customer on 1 March 20x6 of RM84. This would be recorded by debiting the asset account, bank, and crediting the revenue account, subscription revenue. On 30 June 20x6, when the profit for the period is to be determined, only 4 months of the subscription period have passed, i.e. only one-third of the year’s subscription received has been earned. The remaining two-thirds, or RM56, is applicable to the next accounting period. The adjustment to ensure only RM28 of revenue is counted as earned and that liability for the remaining RM56 is recognised as follows:

29

PREPAID REVENUE – CONT.

The ledger account at the end of the period after profit determination would appear as follows:

30

To prepare the ledger for the next accounting period, it is once again necessary to reverse the adjusting entry made. The reversing journal entry would be:

PREPAID REVENUE – CONT.

31

PREPAID REVENUE – CONT.

The ledger accounts would appear as follows:

32

PREPAID REVENUE – CONT.

The ledger accounts would appear as follows:

WHAT IS THE EFFECT OF PREPAYMENTS IN FINAL

ACCOUNTS?

PREPAYMENTS IN THE FINAL ACCOUNT Statement of Financial Position:

Prepaid Expenses - Current AssetsPrepaid Revenues – Current Liabilities

END