ch08a adjustments for stock, accruals & prepayments

7/30/2019 Ch08a Adjustments for Stock, Accruals & Prepayments

http://slidepdf.com/reader/full/ch08a-adjustments-for-stock-accruals-prepayments 1/23

Business Accounting 1

Chapter 8 continued

8a: Adjustments for stock, accruals & prepayments

On completion of this topic you should be able toDifferentiate between opening and closing stock

Differentiate between accruals and prepayments

Construct financial statements for a sole trader with post

trial balance adjustments for stock, accruals andprepayments

Independent study

Study Chapter 8

Progress test and practice question(s) as set




The story so far…

Identify, measure and classify theeconomic transactions of the business

Record monetary values in

the ledger accounts

At the end of the accounting period,

balance the accounts and construct a trial balance

Make post trial balance adjustments

Prepare the financial statements




Post trial balance adjustments

Although the records in the accounting system maybe up to date, some last minute adjustments to theledger accounts are always necessary at the end of the accounting period

This means that some of the figures in the trial balance

will need amending‘Post’ means ‘after’ in Latin, hence the term post trial balance adjustments

In this lecture we will look at the adjustments for

Stock Accruals

Prepayments




Exercise 1

Accounting principles revisited

Post trial balance adjustments are guided by UKGAAP and in particular by the following accounting

principles

Historical cost concept

Accruals conceptPrudence concept

Consistency concept

Required

Jot down a brief explanation of the principles given by

each of these concepts




Solution 1


Historical cost concept – values of assets are basedon their original acquisition cost, unadjusted for

subsequent changes in price or value

Accruals concept – revenue and costs are

recognised as they are earned and incurred, andthey are matched with one another and dealt with in

the profit and loss account of the period to which

they relate, irrespective of when cash is received or

paid(Continued)




Solution 1 (continued)


Prudence concept - revenue and profits are notanticipated, but are included in the profit and loss

account only if there is reasonable certainty that

they will be received. However, provision for all

known expenses and losses must be made,whether the amount is known with certainty or is

only a best estimate in the light of the information

available

Consistency concept - there is uniformity of accounting treatment of items of a similar nature

within each period and from one period to the next




Adjustments for stock (inventory)

Stock (inventory) refers to unsold goodsIn a manufacturing business, it includes raw materials,work-in-progress and finished goods

Stocktaking is the process of counting the stock at

the end of the accounting period to confirm the actualquantities support the figures recorded in the ledger accounts

Under UK GAAP, stock must be shown at the lower of historical cost or net realisable value (NRV)

NRV is the price the business expects to get for thestock, less any costs incurred in selling it




Closing stock and opening stock

In a continuing business, the closing stock at theend of one accounting period is the opening stock at

the beginning of the next

The value of opening stock at the start of the period

and closing stock at the end of the next are neededto calculate the cost of sales in the profit and loss

account

Closing stock is also shown under current assets

in the balance sheetIt is listed first, as it is the most permanent

(it takes the longest to turn into cash)




Example Cotswold CoolersTrading account for the year ending 30 June 2006

£ £Sales 38,500Less Cost of sales

Opening stock 0Add Purchases 29,000

29,000Less Closing stock (10,000) (19,000)Gross profit 19,500

Questions

1. Why is there no value shown for opening stock?

2. What is the value of opening stock in the profit andloss account for the year ending 30 June 2007?




Example Cotswold Coolers

Balance sheet as at 30 June 2006 (extract)

£ £Fixed assets

Vehicles (at cost) 5,000Current assets

Stock 10,000

Trade debtors 6,800Bank 15,100Cash 200

32,100

Question

Does the figure of stock in the balance sheet representopening stock or closing stock?




Accruals

An accrual is ‘an estimate of a liability that is notsupported by an invoice or a request for payment at

the time when the accounts are prepared’ (Collis

and Hussey, 2007, p. 136)

It belongs to the financial period and must be added to the trial balance figure for that expense

Jargon alert

Accrual comes from the verb to accrue, which

means to increaseIt is spelt accrual not accural




Prepayments

A prepayment is ‘revenue expenditure made inadvance of the accounting period in which the goods

or services will be received’ (Collis and Hussey,

2007, p. 137)

It belongs to the next financial period and must bededucted from the trial balance figure for that

expense




Exercise 2

Accounting for accrued expenses

Cotswold Coolers has paid several invoices for electricity used during the year, which total £1,500

for the 10 months to 30 April 2006

The bill that covers the last 2 months of the

accounting period has not yet been received Required

How much would it be fair to charge for the expense of

electricity for the year ending 30 June 2006?




Solution 2

Accounting for accrued expenses

A fair method would be to base the estimate for thetwo months on the average monthly cost

10 months = £1,500

Average for 1 month = £1,500 = £15010

Therefore, 2 months = £150 2 = £300

Total electricity expense for the year is:

£1,500 + £300 accrued = £1,800




Exercise 3

Accounting for prepaid expenses

Cotswold Coolers has paid £2,400 in rent and ratesduring the year ending 30 June 2006, but 10% of

this relates to next year

Required

How much should be charged for the expense of rent andrates for the year ending 30 June 2006?




Solution 3

Accounting for prepaid expenses

First we need to calculate the amount that has beenprepaid:

Prepayment = £2,400 10% = £240

Total rent and rates for the year is:

£2,400 - £240 prepaid = £2,160




Exercise 4

Accounting for accruals and prepayments

AccrualsIn the profit and lossaccount, show theexpense (including theaccrued amount)

In the balance sheet,show total accruals

under current liabilities

Required

Complete the profit and loss account and balancesheet for Cotswold Coolers with adjustments for stock, accruals and prepayments

PrepaymentsIn the profit and lossaccount, show theexpense (excluding theprepaid amount)

In the balance sheet,show total prepaymentsunder current assets




Exercise 4 Cotswold CoolersTrial balance at 30 June 2006

£ £ Additional information

Sales 38,500 Stock at 30 June 2006 £10,000Purchases 29,000 AccrualsVehicles (at cost) 5,000 Electricity £300Trade debtors 6,800 General expenses £50Trade creditors 9,100 PrepaymentsBank 15,100 Rent and rates £240Cash 350Rent and rates 2,400Electricity 1,500Drawings 7,000General expenses 600Interest receivable 150Capital at start of year _____ 20,000

67,750 67,750 Tip: Tick each item as you use it




Exercise 4 pro forma Cotswold CoolersProfit and loss account for the year ending 30 June 2006

£ £Sales 38,500

Less Cost of salesPurchases 29,000

Less Closing stock ( ?) ( ?)Gross profit ?

Add Interest receivable 150?

ExpensesRent and rates ?Electricity ?General expenses ? ( )?

Net profit ?




Exercise 4 pro forma Cotswold CoolersBalance sheet as at 30 June 2006

Fixed assets £ £

Vehicles (at cost) 5,000Current assets

Stock ?Trade debtors 6,800Prepayments ?Bank 15,100Cash 350

?

Less Creditors: amounts due within one year Trade creditors 9,100 Accruals ?

( )?

Net current assets ?Total net assets ?

Capital and reserves

Capital at start of year 20,000Add Net profit ?

?Less Drawings (7,000) ?




Solution 4 Cotswold Coolers

Profit and loss account for the year ending 30 June 2006

£ £Sales 38,500

Less Cost of salesPurchases 29,000

Less Closing stock (10,000) (19,000)Gross profit 19,500

Add Interest receivable 15019,650

ExpensesRent and rates (2,400 - 240) 2,160Electricity (1,500 + 300) 1,800General expenses (600 + 50) 650 (4,610)

Net profit 15,040

S l i C ld C l




Solution 4 Cotswold Coolers

Balance sheet as at 30 June 2006

Fixed assets £ £Vehicles (at cost) 5,000

Current assetsStock 10,000Trade debtors 6,800Prepayments (240) 240Bank 15,100Cash 350

32,490

Less Creditors: amounts due within one year Trade creditors 9,100 Accruals (300 + 50) 350

(9,450)

Net current assets 23,040Total net assets 28,040

Capital and reserves

Capital at start of year 20,000Add Net profit 15,040

35,040Less Drawings (7,000) 28,040




Conclusions

Post trial balance adjustments for stockIn the profit and loss account, cost of sales is:

Opening stock + Purchases – Closing stock

In the balance sheet, show (closing) stock under currentassets

Adjustments for accruals and prepaymentsIn the profit and loss account show the expenseincluding the accrued amount or excluding the prepaidamount

In the balance sheet, show

Total accruals under current liabilities

Total prepayments under current assets

ch08a adjustments for stock, accruals & prepayments

Documents