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					                  International Programs


             Diploma of Financial Services
                              (FNS50104)



                Prepare Financial Reports
                           (BSBADM408A)

                     (Notes, Examples and Exercises)




NMIT OFFSHORE PROGRAMS
                                                        Table of Contents

UNIT OUTLINE .......................................................................................................................... 3
1. INTRODUCTION ................................................................................................................... 4
   Terms and Principles ............................................................................................................. 4
   The Accounting Cycle ............................................................................................................ 5
2. BALANCE DAY ADJUSTMENTS .......................................................................................... 6
   Accrual Accounting ................................................................................................................ 6
     Examples: ........................................................................................................................... 6
   The Need for Balance Day Adjustments ................................................................................ 7
   Types of Balance Day Adjustments ....................................................................................... 7
     Accrued Expenses ............................................................................................................. 7
     Exercises ............................................................................................................................ 9
     Accrued Revenue ............................................................................................................... 9
     Exercises .......................................................................................................................... 10
     Prepaid Expenses ............................................................................................................ 11
     Exercises: ......................................................................................................................... 12
     Prepaid Revenue (Revenue Received in Advance) ......................................................... 12
     Exercise: ........................................................................................................................... 13
     Stock of Stationery on Hand............................................................................................. 14
     Exercise: ........................................................................................................................... 15
     Provision for Annual Leave .............................................................................................. 15
     Exercises .......................................................................................................................... 16
     Provision for Long Service Leave .................................................................................... 16
     Bad Debts and Doubtful Debts ......................................................................................... 17
     Exercises .......................................................................................................................... 21
     Depreciation ..................................................................................................................... 21
     Exercises: ......................................................................................................................... 26
3. PREPARATION OF FINAL REPORTS ............................................................................... 33
   The Income Statement (Retail or Wholesale Businesses) .................................................. 33
     Exercise ............................................................................................................................ 36
     Classification of operating expenses ................................................................................ 36
     Exercises .......................................................................................................................... 38
     Disclosure of ‘material’ items in the Income Statement ................................................... 39
   The Balance Sheet .............................................................................................................. 40
     Classification in the Balance Sheet .................................................................................. 40
     Exercises .......................................................................................................................... 44
   Final Reports for Service Businesses .................................................................................. 49
4. CLOSING THE LEDGER .................................................................................................... 50
   The Trading Account ............................................................................................................ 50
   The Profit and Loss Account ................................................................................................ 51
   The Closing Procedure ........................................................................................................ 51
     Exercises .......................................................................................................................... 60
5. REVERSING ENTRIES ....................................................................................................... 62
   Accrued expenses (expenses owed but not yet paid) ......................................................... 62
   Accrued Revenue (revenue owing but not yet received) ..................................................... 62
   Prepaid Expenses (expenses paid but not yet incurred) ..................................................... 62
   Prepaid Revenue (revenue received but not yet earned) .................................................... 63
   Stock of Stationery ............................................................................................................... 63
     Exercises .......................................................................................................................... 66




NMIT OFFSHORE PROGRAMS                                               2
UNIT OUTLINE
Competency:              Prepare Financial Reports

Code:                    BSBADM408A

Unit Description:        This unit covers the competency for recording general
                         journal adjustment entries and preparing end-of-period
                         financial reports (income statement and balance sheet) for
                         a non-reporting entity.

Competency Elements:     1. Record accounting entries for balance day
                            adjustments.
                         2. Prepare end-of-period financial reports.
                         3. Prepare final general ledger accounts

Topic Order:             1. Preparation of accounting entries for the following
                         balance day adjustments:
                             - Accrued revenue and expenses
                             - Prepaid revenue and expenses
                             - Stock of stationery
                             - Provisions for annual and long service leave
                             - Bad and doubtful debts
                             - Depreciation.
                         2. Preparation of the following financial reports:
                             - Income Statement
                             - Balance Sheet.
                         3. Preparation of accounting entries to close the ledger.
                         4. Preparation of reversing entries.

Textbook:                Material prepared by NMIT

Assessment:              Assessment for this unit will consist of two closed book
                         tests.
                         Test 1:
                             - 70%
                             - Balance day adjustments and preparation of
                                 financial reports.

                         Test 2:
                            - 30%
                            - Closing the ledger and reversing entries.




NMIT OFFSHORE PROGRAMS                  3
1. INTRODUCTION

Terms and Principles
Before commencing this unit it will be useful to revise or note the following important terms
and principles.

Accounting (Reporting)       This principle recognises the need to divide the life of a business into smaller
Period:                      time periods so that the progress of the business can be assessed at regular
                             intervals.

                             This period is usually every 12 months but can be shorter depending on the
                             needs of the business. In Australia, many businesses have an accounting
                                                          st                       th
                             period commencing on 1 July and ending on 30 June the following calendar
                             year as this coincides with the financial year, and the business needs to know
                             its profit or loss for this period for taxation purposes.

                             Example:

                             1/7/07_______________________1/1/08_______________ ________30/6/08
                             Start of                                                                End of
                             Accounting                                                              Accounting
                             Period                                                                  Period
                                                                                                     th
Balance Date:                The last day of the accounting period. Usually, but not always, the 30 June.

Trial Balance:               A listing of all general ledger accounts separating those with debit balances
                             from those with credit balances. Both the debit balances and credit balances
                             are totalled to ensure that they agree. This will ensure that for every debit entry
                             in ledger accounts there were corresponding credit entries in other accounts.

                             Remember, that the trial balance does not necessarily mean that all entries in
                             the ledger accounts are correct. That is, it will not pick up errors such as
                             recording incorrect amounts, recording amounts into incorrect ledgers or
                             simply not recording a transaction at all.

                             A Trial balance can be prepared at any time to prove that debits equal credits;
                             however, it is usually prepared at the balance date. The balances of the ledger
                             accounts in the trial balance are then used to prepare the financial reports at
                             the end of the particular accounting period.

Income Statement:            A Statement showing how the profit or loss of a business was ascertained for
                             a given accounting period. That is, it indicates all revenue earned for the
                             period less all expenses incurred in earning that revenue for the period.

Balance Sheet:               A statement showing what the business owns (assets), what the business
                             owes (liabilities) and the owner’s investment in the business (owner’s equity)
                             at the particular balance date.

                             It indicates the financial position of the business and also ensures that the
                             accounting equation (i.e. A = L + OE) balances.

Accounting Standards:        Accounting Standards have been developed to achieve greater harmony and
                             consistency in the way in which business information is recorded, valued and
                             reported. These Accounting Standards are rules of accounting which can
                             include specific methods of accounting and/or requirements to include
                             particular information in financial reports.




NMIT OFFSHORE PROGRAMS                            4
Reporting Entity:            A business required by law to prepare financial reports, such as Income
                             Statements and Balance Sheets, so that others can evaluate and make
                             decisions about the business. These types of businesses are usually
                             companies and they are required by law to follow Accounting Standards where
                             they are applicable.

                             The financial reports covered in this unit, however, are for ‘non-reporting
                             entities’ (i.e. sole traders) and although they are not required by law to
                             abide by the Accounting Standards, the Standards are expected to be
                             applied whether the business is a reporting entity or not.



The Accounting Cycle
It will also be beneficial to review the accounting cycle so that we can see where the
preparation of financial reports and related year-end activities occur in the cycle.


                                        TRANSACTIONS

                                                

                                      SOURCE DOCUMENTS

                                                

                                    ANALYSE TRANSACTIONS

                                                

                             RECORD TRANSACTIONS IN JOURNALS
                                           

                             POST JOURNALS TO LEDGER ACCOUNTS
                                             

                                        TRIAL BALANCE

                                                

                                  BALANCE DAY ADJUSTMENTS

                                                

                                   ADJUSTED TRIAL BALANCE

                                                

                                 PREPARE FINANCIAL REPORTS

                                                

                                      CLOSE THE LEDGER



In the previous unit ‘Maintain Financial Records’, we covered the accounting cycle up to the
preparation of the Trial Balance at the end of the accounting period.

This unit will now cover the remainder of the accounting cycle, which takes place on the
balance date, including balance day adjustments, preparation of an adjusted trial balance,
preparation of financial reports and closing the ledger. It will also include a section on
reversing entries which is a process that takes place on the first day of the next accounting
period rather than on the balance day of the current accounting period.




NMIT OFFSHORE PROGRAMS                          5
2. BALANCE DAY ADJUSTMENTS

Accrual Accounting
Many businesses use an accounting system based on accrual accounting. The accrual basis
of accounting assumes that transactions are accounted for and relate to the accounting
period in which they are earned or incurred regardless of when the cash is received or paid.

This concept complies with the accounting period convention which implies that the profit or
loss of a business for a particular accounting period should be calculated using only revenue
and expense items that relate to the particular accounting period in question.


Examples:

For each of the following examples, assume that they relate to a business owned and
operated by Peter Pan and that the accounting period is as follows:

1/7/07___________________________________1/1/08_______________ _____________________30/6/08
Start of                                                                                     End of
Accounting                                                                                   Accounting
Period                                                                                       Period


                                                        st
a) Peter pays rent on shop premises of $1,500 on 1 June 2008 for the next three
months.

If we assume, therefore, that the rent expense is $500 per month, then only $500 of the
                 st                                                               th
amount paid on 1 June is an expense for the current accounting period ending 30 June
2008. The remaining $1,000 is for the months of July and August which are the first two
months of the next accounting period.
                                                                                             rd
b) Peter pays his employees on a fortnightly basis and pays wages of $2,000 on 23
June 2008 for the previous two weeks.

If we assume, therefore, that the wages expense is $1,000 per week, then employees have
                                             th
earned another $1,000 in wages by the 30 June that will not be paid until the end of the first
                                                                                         th
week in July. Although this $1,000 was not paid in the accounting period ending 30 June
2008 it is still regarded as an expense for this period as this is the period in which it was
incurred.
                                                             th
c) Peter receives commission revenue of $600 on 28 June 2008 from a client in
                                                        th
anticipation of work that Peter will undertake on the 10 July 2008.
                                                                                        th
Although Peter has received the money during the current accounting period ended 30 June
2008, it should not be regarded as revenue for this period. As it will not be earned until July
2008 (which is the first month of the next accounting period) it should be regarded as revenue
for the next accounting period.
                                              st
d) Peter invested $10,000 with a bank on 1 July 2007 at an interest rate of 5% per
                  th
annum. By the 30 June 2008 Peter had not yet received the interest on his investment.

Although Peter had not received the interest revenue of $500 during the current accounting
period, it should still be regarded as revenue for this period as that was when it was earned.




NMIT OFFSHORE PROGRAMS                         6
The Need for Balance Day Adjustments
Profit or loss is calculated by matching revenue earned for a particular accounting period
against expenses incurred in gaining that revenue. Adjustments to the balances in some
ledger accounts may be necessary at the end of the accounting period to ensure that all items
of revenue and expense relating to the particular accounting period have been included in the
accounts.

Some of these adjustments are necessary because the bookkeeper records many of the
revenue and expense items in the accounting records when cash associated with the
transaction is either received or paid. As we saw in the previous section, this may result some
revenue and expenses being recorded in ledger accounts in a particular accounting period
before they have been earned or incurred. These amounts will need to be taken out of the
ledger accounts for the current accounting period and transferred to the next accounting
period.

On the other hand, it may also result in some revenue and expenses being earned or incurred
in the current accounting period but not being recorded in ledger accounts because the cash
did not change hands and therefore the bookkeeper did not record the transaction. These
amounts will need to be included in the ledger accounts for the current accounting period.

Other adjustments may be necessary because the business may not be aware of, or be able
to calculate certain revenue or expenses until the end of the accounting period.

Because these adjustments are completed at the end of an accounting period they are
referred to as Balance Day Adjustments.

All individual balance day adjustments are recorded in the general journal on the last day of
the accounting period and then transferred to the general ledger. As this will lead to changes
in the balances of some ledger accounts and/or the introduction of additional ledger accounts,
a new trial balance will need to be prepared after balance day adjustments have been
completed. This new trial balance is referred to as the Adjusted Trial Balance.

The financial reports of the business (Income Statement and Balance Sheet) are then
prepared using the account balances in the adjusted trial balance.


Types of Balance Day Adjustments
Some of the more common types of balance day adjustments include the following:

       Accrued expenses
       Accrued revenue
       Prepaid expenses
       Prepaid revenue
       Stock of stationery on hand
       Provision for annual leave
       Provision for long service leave
       Bad debts
       Doubtful debts
       Depreciation


Accrued Expenses

These are expenses that have been incurred by the business during the current accounting
period but are still unpaid at the balance date. Because they haven’t been paid, a cheque has
not been issued and therefore the bookkeeper has not yet recorded the expense in the


NMIT OFFSHORE PROGRAMS                         7
accounting records. Remember, the bookkeeper will not record an expense in the cash
payments journal until he/she receives evidence of the transaction – i.e. the cheque butt.

Usually, the bookkeeper will not complete any balance day adjustments until an internal
memo is received from the owner or accountant at the end of the period. Once the
bookkeeper has received advice to complete an adjustment for an accrued expense, he/she
will prepare a general journal entry to include the amount in the relevant expense ledger and
to create a liability ledger (called accrued expenses) for the amount owing.

When the expense is actually paid during the next accounting period, a cheque will be issued
for the payment. The relevant cheque butt will be given to the bookkeeper to be recorded in
the cash payments journal in this next period. This will mean that the same expense has then
been recorded in the accounting records twice. Once when the balance day adjustment was
recorded to include the expense in the current period and then again in the next period when
the cheque was issued.

To avoid this double-counting, this balance day adjustment is considered to be a temporary
adjustment only. That is, the relevant ledger accounts are adjusted on the balance date and
the financial reports are prepared using the adjusted balances. Once this has been done the
adjustment has served its purpose and on the first day of the next period, before the cheque
is issued for the actual payment, the adjustment is reversed which in affect cancels out the
adjustment. When the cheque is then issued and recorded in the next period there is no
longer any double-counting. (Note – reversals will be covered in more detail at the end of this
unit)

Accrued expenses may include:
   - Wages of employees not yet paid
   - Interest incurred but not yet paid
   - Electricity, gas, telephone, advertising etc incurred but not yet paid.

Example:

This example relates to the accounting period from 1/7/07 to 30/6/08. Total wages paid up to
28/6/08 was $238,000. Wage records show that employees earned a total of $2,000 in wages
         th       th
on the 29 and 30 June which have not yet been paid.

On the balance date an adjustment needs to be made to include the $2,000 in the wages
expense ledger and also to create a liability ledger (called accrued expenses) for the amount
owing to employees.

When recording balance day adjustments in the general journal the rules of double-entry
bookkeeping still apply. That is, for the above adjustment we need to increase the wages
expense ledger and an increase in an expense is a debit entry. Also, we need to create a
liability called accrued expenses and an increase in a liability is a credit entry.

The general journal and ledger entries for the above adjustment are as follows:

                                   GENERAL JOURNAL
  Date                          Particulars                            Debit         Credit
 30/6/08   Wages expense                                                 2,000
             Accrued expense                                                            2,000
           Wages owing but not yet paid

                                GENERAL LEDGER (Extract)

                                       Wages Expense
  Date                Details            Jrn. Ref.  Debit ($)       Credit ($)    Balance ($)
 28/6/08   Balance                                                                 238,000 dr
 30/6/08   Accrued expenses                   GJ           2,000                   240,000 dr




NMIT OFFSHORE PROGRAMS                         8
                                      Accrued Expenses
  Date               Details              Jrn. Ref.  Debit ($)      Credit ($)        Balance ($)
 30/6/08     Wages expense                   GJ                        2,000              2,000 cr


         Remember, the accrued expenses account is a liability as it represents the amount
          that is still owed by the business.




Exercises

2.1
                                     th
A review of accounting records at 30 June 2009 indicates the following:

- Advertising of $400 is owed but not yet paid.
- Interest on mortgage due, but not yet paid is $1,000.

You are required to:
                                                                          th
a) Prepare general journal entries for each of the above adjustments at 30 June 2009.
b) Post the adjustments to the general ledger.

2.2
                                     th
A review of accounting records at 30 June 2009 reveals an invoice for delivery expenses
               th                                th
received on 26 June 2009 will not be paid until 5 July 2009.
                                                                                 th
You are required to record the above adjustment in the general journal on 30 June 2009 and
then post the journal entry to the general ledger.



Accrued Revenue

This is revenue that has been earned by the business during the current accounting period
but has not been received by the balance date. Because the amount(s) has not been
received, a receipt has not been issued and therefore the bookkeeper has not yet recorded
the amount in the accounting records. Remember, the bookkeeper will not record a revenue
item in the cash receipts journal until he/she receives evidence of the transaction – i.e. a copy
of the receipt.

Once the bookkeeper has received advice to complete an adjustment for accrued revenue,
he/she will prepare a general journal entry to include the amount in the relevant revenue
ledger and to create an asset account (called accrued revenue) for the amount owing to the
business.

When the revenue is actually received during the next accounting period, a receipt will be
issued and copy given to the bookkeeper to be recorded in the cash receipts journal in this
next period. This will mean that the same revenue item has then been recorded in the
accounting records twice. Once when the balance day adjustment was recorded to include
the revenue in the current period and then again in the next period when the receipt was
issued.

To avoid this double-counting, this balance day adjustment is considered to be a temporary
adjustment only. That is, the relevant ledger accounts are adjusted on the balance date and
the final reports are prepared using the adjusted balances. Once this has been done the


NMIT OFFSHORE PROGRAMS                          9
adjustment has served its purpose and on the first day of the next period, before the amount
is actually received and a receipt is issued, the adjustment is reversed which in affect cancels
out the adjustment. When the amount is then received and recorded in the next period there
will not be any double-counting.

Accrued revenue may include:
   - Interest earned but not yet received
   - Commission earned but not yet received

Example:

This example relates to the accounting period from 1/7/07 to 30/6/08. Total commission
received up until 1/6/08 was $10,000. However the bookkeeper is advised on the 30/6/08 that
commission earned during June of $800 will not be received until 5/7/08.

On the balance date an adjustment needs to be made to include the $800 in the commission
revenue ledger and also to create an asset ledger (called accrued revenue) for the amount
owing to the business.

When recording the adjustment in the general journal we need to credit the commission
revenue ledger as the balance in the ledger will be increasing. Also, we need to create an
asset called accrued revenue. This account will be debited as the balance in the ledger will be
increasing.

The general journal and ledger entries for the above adjustment are as follows:

                                     GENERAL JOURNAL
  Date                            Particulars                          Debit         Credit
 30/6/08     Accrued revenue                                                800
               Commission revenue                                                         800
             Commission earned but not yet received.

                                  GENERAL LEDGER (Extract)

                                     Commission Revenue
  Date                  Details            Jrn. Ref.  Debit ($)       Credit ($)   Balance ($)
 1/6/08      Balance                          GJ                                     10,000 cr
 30/6/08     Accrued revenue                                                800      10,800 cr

                                       Accrued Revenue
  Date               Details                 Jrn. Ref. Debit ($)      Credit ($)   Balance ($)
 30/6/08    Commission revenue                  GJ          800                         800 dr


         Remember, the accrued revenue account is an asset as it represents the amount
          that is still owed to the business.


Exercises

2.3

For the year ended 30/609 a business has earned, but did not receive, $1,000 in interest.

You are required to record the above adjustment in the general journal on the 30/6/09 and
post the journal entry to the relevant ledger accounts in the general ledger.




NMIT OFFSHORE PROGRAMS                        10
2.4

A business completed work for a client on the 20/6/09 which earned the business $1,200 in
commission. The business had still not received this commission by the balance date of
30/6/09.

Record the above adjustment in the general journal on 30/6/09 and post the journal entry to
the relevant ledger accounts in the general ledger.


Prepaid Expenses

These are expenses that have been paid in the current accounting period but relate to the
next accounting period. Because the expense has been paid, a cheque has been issued and
the bookkeeper has recorded the amount in the cash payments journal and in the relevant
expense ledger during the current accounting period.

However, because the expense does not relate to the current accounting period, an
adjustment needs to be made to take the prepaid amount out of the relevant expense account
and temporarily transfer it to an asset account called prepaid expenses. The prepaid expense
ledger is an asset because our business has paid for something for which it has not yet
received a benefit at the balance date. That is, this benefit is still owed to the business.

This adjustment is also only a temporary adjustment. That is, the relevant ledger accounts are
adjusted on the balance date and the financial reports are prepared using the adjusted
balances. Once this has been done, the adjustment has served its purpose and on the first
day of the next period the adjustment is reversed. The reversal has the affect of putting the
expense back into the relevant expense ledger for the period to which it relates and also of
cancelling the asset (prepaid expenses). That is, the prepaid amount is not an asset in the
next period as the benefit will actually be received by the business in this next period.

Prepaid expenses usually include:
   - Insurance paid in advance.
   - Rent paid in advance.
   - Motor vehicle registration paid in advance

Example:

This example relates to the accounting period from 1/7/07 to 30/6/08. The rent expense
ledger shows a balance of $18,500 at 30/6/08. The bookkeeper is advised, however, that a
cheque for the last rent payment of $1,500 was issued and recorded in the accounting
records on the 1/5/08 for the three months ending 31/7/08.

This means that $500 of the amount paid relates to the month of July 2008 which is the first
month of the next accounting period. This amount needs to be taken out of the rent expense
ledger as it does not relate to the current accounting period and temporarily transferred to the
asset account – prepaid expenses.

When preparing the general journal entry for the adjustment, the prepaid expense ledger
needs to be debited as it is an asset and is increasing. The rent expense ledger needs to be
credited as it is an expense and is decreasing.

The general journal entry for the adjustment would be prepared and posted to the general
ledger as follows:




NMIT OFFSHORE PROGRAMS                         11
                                     GENERAL JOURNAL
  Date                            Particulars                            Debit         Credit
 30/6/08     Prepaid expenses                                                 500
                Rent expense                                                                   500
             Rent expense paid in advance.

                                  GENERAL LEDGER (Extract)

                                         Rent Expense
  Date                  Details              Jrn. Ref.     Debit ($)   Credit ($)   Balance ($)
 1/5/08      Balance                            GJ                                    18,500 dr
 30/6/08     Prepaid expenses                                                500      18,000 dr

                                       Prepaid Expenses
  Date                 Details               Jrn. Ref.  Debit ($)      Credit ($)   Balance ($)
 30/6/08     Rent expense                       GJ           500                         500 dr


         Remember, the prepaid expense account is an asset as it represents a benefit that
          is owed to the business.


Exercises:

2.5

The balance in the insurance expense ledger for the year ended 30/6/08 is $6,000. The
bookkeeper is sent a memo from the owner advising that this balance includes an account of
$1,200 that was paid for the period commencing 1/10/07 and ending 30/9/08.

You are required to record the necessary adjustment in the general journal on 30/6/08 and
post the journal entry to the relevant ledger accounts in the general ledger.

2.6

For the year ended 30/6/08, the balance in the motor vehicle expenses ledger of $6,000
includes an amount of $650 relating to registration of vehicles for the next financial year.

Record the necessary adjustment in the general journal and post the journal entry to the
relevant ledger accounts in the general ledger.


Prepaid Revenue (Revenue Received in Advance)

These are items of revenue that have been received during the current accounting period but
which will not be earned by the business until the following period. Because the revenue has
actually been received, a receipt has been issued and the bookkeeper has recorded the
amount in the cash receipts journal and in the relevant revenue ledger during the current
accounting period.

However, because the revenue does not relate to current accounting period, an adjustment
needs to be made to take the prepaid amount out of the relevant revenue account and
temporarily transfer it to a liability account called prepaid revenue (or revenue received in
advance). The prepaid revenue ledger is a liability because it represents an amount received
by our business that has not yet been earned. Therefore, our business owes something.

Like the previous accruals and prepayments this is only a temporary adjustment. The relevant
ledger accounts are adjusted on the balance date and the financial reports are prepared using



NMIT OFFSHORE PROGRAMS                         12
the adjusted balances. Once this has been done, the adjustment has served its purpose and
on the first day of the next accounting period the adjustment is reversed. The reversal has
the affect of putting the revenue back into the relevant revenue ledger for the period to which
it relates and of cancelling the liability (prepaid revenue). That is, the prepaid amount is not a
liability in the next accounting period because the business will deliver what it owes during
this next period.

Revenue received in advance usually relates to rent revenue, fees or commission revenue.

Example:

During the year ended 30/6/08, a business received $26,000 in rent revenue. Business
records reveal, however, that $2,000 of this amount was prepaid for the month of July 2008.
Because this $2,000 was not earned in the current accounting period, it needs to be taken out
of the rent revenue ledger and temporarily transferred to the liability account – prepaid
revenue.

When preparing the general journal entry for the adjustment, the rent revenue ledger will be
debited as it is decreasing. The prepaid revenue ledger will be credited as it is a liability and is
increasing.

The general journal entry for the adjustment would be prepared and posted to the general
ledger as follows:

                                     GENERAL JOURNAL
  Date                            Particulars                             Debit          Credit
 30/6/08     Rent revenue                                                   2,000
               Prepaid revenue                                                              2,000
             Rent revenue received in advance.

                                  GENERAL LEDGER (Extract)

                                          Rent Revenue
  Date                  Details               Jrn. Ref.     Debit ($)    Credit ($)   Balance ($)
 30/6/08     Balance                                                                    26,000 cr
             Prepaid revenue                      GJ            2,000                   24,000 cr

                                        Prepaid Revenue
  Date                 Details                Jrn. Ref. Debit ($)        Credit ($)   Balance ($)
 30/6/08     Rent revenue                        GJ                         2,000        2,000 cr


         Remember, the prepaid revenue account is a liability as it represents an amount
          still owed by our business


Exercise:

2.7

The balance in the rent revenue ledger for the year ended 30/6/08 is $9,600. This includes an
amount $3,200 received on 1/4/08 for the four-month period ending 31/7/08.

You are required to record the appropriate adjustment in the general journal on 30/6/08 and
post the journal entry to the general ledger.




NMIT OFFSHORE PROGRAMS                          13
Stock of Stationery on Hand

For our purposes, stationery will include office stationery such as computer paper, ink, pens,
staples etc or cleaning materials.

When a business purchases stationery a cheque will be issued for the payment and the
amount recorded by the bookkeeper in the cash payments journal. This will result in a debit
entry in the stationery expense ledger. If, however, the business has not used all the
stationery that has been purchased during the current accounting period the amount that is
unused at the balance date should appear in the financial reports as an asset (called stock of
stationery) rather than an expense.

An adjustment therefore needs to be completed to temporarily transfer the value of unused
stationery out of the stationery expense ledger and into the stock of stationery ledger. Stock
of stationery is regarded as an asset at the balance date as it represents something of value
owned by the business.

This adjustment is also a temporary adjustment. Once the relevant ledger accounts have
been adjusted on the balance date the financial reports are prepared using the adjusted
balances. Once this has been done the adjustment has served its purpose and on the first
day of the next period, the adjustment is reversed. The reversal has the affect of putting the
amount back into the stationery expense ledger for the period in which it will be used and also
of cancelling the asset (stock of stationery). That is, the unused amount will be used in the
next period and therefore cease to be an asset.

Example:

For the 12-month accounting period ending 30/6/08 the stationery expense ledger has a
balance of $2,500 representing stationery purchased during the period. However a stock-take
undertaken on 30/6/08 indicates unused stationery valued at $200.

This means that this $200 worth of stationery will not be used until the next period. The
stationery expense for the current period should be the cost of stationery used, not
purchased. In this case, the cost of stationery used during the current period was $2,300 not
$2,500. The $200 of stationery needs to be taken out of the stationery expense ledger and
temporarily transferred to the asset ledger – stock of stationery.

When preparing the general journal entry for the adjustment, the stock of stationery needs to
be debited because it is an asset and is increasing. The stationery expense ledger needs to
be credited as it is an expense and is decreasing.

The general journal entry for the adjustment would be prepared and posted to the general
ledger as follows:

                                    GENERAL JOURNAL
  Date                           Particulars                           Debit         Credit
 30/6/08   Stock of stationery                                              200
              Stationery expense                                                          200
           Stock of unused stationery on hand.

                                 GENERAL LEDGER (Extract)

                                     Stationery Expense
  Date                 Details              Jrn. Ref.  Debit ($)      Credit ($)   Balance ($)
 30/6/08   Balance                                                                    2,500 dr
           Stock of stationery                   GJ                         200       2,300 dr




NMIT OFFSHORE PROGRAMS                        14
                                      Stock of Stationery
  Date                   Details             Jrn. Ref.    Debit ($)   Credit ($)   Balance ($)
 30/6/08     Stationery expense                 GJ             200                      200 dr




Exercise:

2.8

A stock-take carried out on 30/6/08 revealed unused stationery valued at $500.

Assuming the balance date is 30/6/08 you are required to prepare the general journal entry
for the adjustment and post the journal entry to the general ledger.


Provision for Annual Leave

Annual leave for most employees in Australia is four weeks per annum. For those employed
on a weekly award rate or an annual salary, the entitlement to annual leave accrues after
each week of service, and the full four weeks available after 12 months of continuous service.

Under the accrual method of accounting it is important to recognise and record the annual
leave expense in the accounting period that staff work and therefore earn the annual leave
rather than the period in which staff take and are paid their annual leave.

There may therefore need to be an adjustment where staff annual leave has been earned but
not yet taken during a particular accounting period. The amount earned during the current
accounting period but not yet taken will need to be recorded in the debit of the annual leave
expense ledger as it is an expense and is increasing. To complete the double entry, the
amount will also be credited in a ledger called Provision for Annual Leave. This is a liability
account as it represents the annual leave owing by the business to its employees. This
liability will be paid during the next accounting period when staff take their annual leave.

The balance in the Provision Annual Leave ledger will be reduced when the payment is made
to employees (i.e. debit Provision for Annual Leave and credit Bank) and there is therefore no
need to prepare a reversing entry for this adjustment.

Example 1:

An employee has earned two weeks annual leave for the accounting period ending 30/6/08
but this leave will be taken during the next accounting period. The employee earns $800 per
week.

The general journal entry for this adjustment would be prepared as follows:

                                      GENERAL JOURNAL
  Date                           Particulars                           Debit         Credit
 30/6/08     Annual leave expense                                        1,600
               Provision for annual leave                                               1,600
             Annual leave earned but not yet taken.

Example 2:

The balance in the Provision for Annual Leave ledger at the balance date of 30/6/08 is
$30,000. An investigation of personnel records indicates that balance in the Provision for
Annual Leave Ledger for unused annual leave should be $34,000,




NMIT OFFSHORE PROGRAMS                        15
The general journal entry for this adjustment would be prepared and posted to the general
ledger as follows:

                                    GENERAL JOURNAL
  Date                         Particulars                               Debit          Credit
 30/6/08   Annual leave expense                                            4,000
              Provision for annual leave                                                   4,000
           To increase the provision for annual leave.

                                  GENERAL LEDGER (Extract)

                                   Provision for Annual Leave
  Date                  Details               Jrn. Ref.   Debit ($)     Credit ($)   Balance ($)
 30/6/08   Balance                                                                     30,000 cr
           Annual leave expense                  GJ                         4,000      34,000 cr

                                   Annual Leave Expense
  Date                 Details             Jrn. Ref. Debit ($)          Credit ($)   Balance ($)
 30/6/08   Provision for annual leave         GJ        4,000                           4,000 dr




Exercises

2.9

The balance in the Provision for Annual leave on the balance date 30/6/08 is $16,500. The
owner asks the bookkeeper to make an adjustment to increase the provision by $2,500.

You are required to prepare a general journal entry for the adjustment and post the journal
entry to the general ledger.

2.10

On the balance date of 30/6/08, the Provision for Annual Leave ledger has a balance of
$24,000. The bookkeeper receives a memo advising that the provision should be increased to
$25,500.

Prepare a general journal entry for the adjustment and post the journal entry to the general
ledger.


Provision for Long Service Leave

A similar provision to annual leave is made for long-service leave.

There are variations to the entitlement of long service leave depending on the conditions of
employment. In many cases, however, employees are entitled to 13 weeks of paid leave after
ten years of continuous employment.

It is normal to account for long-service leave after a period of five years. As for annual leave,
the accrual accounting concept means that the long service leave should be recognised and
recorded as an expense in the period that it is earned rather than the period that it is taken
and paid.

There may therefore need to be an adjustment where staff long service leave has been
earned but not yet taken during a particular accounting period. The amount earned during the



NMIT OFFSHORE PROGRAMS                          16
current accounting period but not yet taken will need to be recorded in the debit of the Long
Service Leave expense ledger as it is an expense and is increasing. To complete the double
entry, the amount will also be credited in a ledger called Provision for Long Service Leave.
This is a liability account as it represents the long-service leave owing by the business to its
employees. This liability will be paid in some future accounting period when staff take their
long service leave.

The balance in the Provision for Long Service Leave ledger will be reduced when the
payment is made to employees (i.e. debit Provision for Long Service Leave and credit Bank)
and there is therefore no need to prepare a reversing entry for this adjustment.

Example:

The following example relates to the accounting period 1/7/07 to 30/6/08.

On the balance date, the bookkeeper has been asked to bring the balance in the Provision for
Long Service ledger to $7,500. The balance in the ledger at 1/7/07 was $5,000 and no long
service leave was taken during the year.

The general journal entry for the adjustment would be prepared and posted to the general
ledger as follows:

                                    GENERAL JOURNAL
  Date                          Particulars                              Debit         Credit
 30/6/08   Long service leave expense                                      2,500
              Provision for long service leave                                             2,500
           To increase the provision for long service leave.

                                   GENERAL LEDGER (Extract)

                                  Provision for Long Service Leave
  Date                  Details                  Jrn. Ref.  Debit ($)   Credit ($)   Balance ($)
 30/6/08   Balance                                                                      5,000 cr
           Long service leave expense              GJ                       2,500       7,500 cr

                                 Long Service Leave Expense
  Date                  Details             Jrn. Ref.  Debit ($)        Credit ($)   Balance ($)
 30/6/08   Prov’n for long service leave       GJ         2,500                         2,500 dr




Bad Debts and Doubtful Debts

From past experience, and by analysing individual debtor’s accounts in the debtor’s
subsidiary ledger, it is more than likely that some debtors will not pay their accounts.

Bad debts are those debtors’ accounts that are known to be uncollectible. Bad debts can
occur during the accounting period and there may be additional bad debts when debtors’
accounts are reviewed at the balance date. Bad debts are an expense to the business.

When recording bad debts, the Bad Debts ledger will be debited as this is an expense ledger
and the balance is increasing. The Debtors’ Control ledger will then be credited as this is an
asset and the amount to be received from debtors has decreased.

Because the extent of the bad debts is not normally known until the accounting period
following the period in which the sales were made, an estimate of the debts not likely to be
collected on the current period’s sales is made and recorded as an expense (called doubtful
debts) at the end of the current period. This procedure is consistent with accrual accounting



NMIT OFFSHORE PROGRAMS                           17
as the estimate of doubtful debts allows the estimated cost to be matched against the
revenue earned in the same accounting period.

Doubtful debts are normally estimated using a percentage (based on past experience) of the
closing debtors’ balance.

When recording doubtful debts, the Doubtful Debts ledger will be debited as this is an
expense ledger and balance is increasing. An account called Allowance (or provision) for
Doubtful Debts will then be credited. This account is, in effect, a ‘negative asset’. That is, the
balance in the Allowance for Doubtful Debts ledger will be subtracted from the Debtors’
Control balance in the Balance Sheet at the end of the accounting period to indicate the likely
amount to be collected from debtors.

It should be noted; that bad debts identified at the end of the period should be recorded and
deducted from the debtor’s balance before estimated doubtful debts is calculated. Note also,
that where bad debts appear in a Trial Balance it indicates bad debts that have already been
written off during the accounting period and thus the amount has already been deducted from
the Debtors’ Control balance.

Example 1:

An extract of a Trial Balance (before adjustments) for the year ended 30/6/08 indicated the
following:

                                                                         Debit ($)     Credit ($)
 Debtors’ control                                                           60,000
 Bad debts                                                                    2,000
 Allowance for doubtful debts                                                               1,000

The bookkeeper is advised at the balance date that the balance in the Allowance for Doubtful
Debts ledger should be 2% of the Debtors’ Control balance.

The general journal for the above adjustment would be prepared and posted to the general
ledger as follows:

                                     GENERAL JOURNAL
  Date                            Particulars                              Debit         Credit
 30/6/08     Doubtful debts                                                     200
                Allowance for doubtful debts                                                  200
             To increase the allowance for doubtful debts.

                                  GENERAL LEDGER (Extract)

                                  Allowance for Doubtful Debts
  Date                  Details               Jrn. Ref.   Debit ($)       Credit ($)   Balance ($)
 30/6/08     Balance                                                                      1,000 cr
             Doubtful debts                      GJ                             200       1,200 cr

                                         Doubtful Debts
  Date                  Details              Jrn. Ref.       Debit ($)    Credit ($)   Balance ($)
 30/6/08     Allowance for doubtful debts       GJ                200                       200 dr


Note:
   -    2% of the debtors’ balance is $1,200 ($60,000 x 2%). However, because there is
        already a balance of $1,000 in Allowance for Doubtful Debts, only a further $200 is
        necessary to make the balance in the ledger $1,200.




NMIT OFFSHORE PROGRAMS                          18
Example 2:

An extract of a Trial Balance (before adjustments) for the year ended 30/6/08 indicated the
following:

                                                                         Debit ($)     Credit ($)
 Debtors’ control                                                           80,500
 Bad debts                                                                    1,000
 Allowance for doubtful debts                                                                 600

The bookkeeper is advised at the balance date that an additional bad debt of $500 (for which
no previous allowance was made) was identified and that the balance in the Allowance for
Doubtful Debts ledger should be 2% of the Debtors’ Control balance.

The general journal for the above adjustments would be prepared and posted to the general
ledger as follows:

                                      GENERAL JOURNAL
  Date                             Particulars                             Debit         Credit
 30/6/08     Bad debts                                                          500
                Debtors’ control                                                              500
             To record additional bad debts.
 30/6/08     Doubtful debts                                                   1,000
                Allowance for doubtful debts                                                1,000
             To increase the allowance for doubtful debts.

                                   GENERAL LEDGER (Extract)

                                         Debtors’ Control
  Date                   Details              Jrn. Ref.   Debit ($)       Credit ($)   Balance ($)
 30/6/08     Balance                                                                     80,500 dr
             Bad debts                            GJ                            500      80,000 dr

                                            Bad Debts
  Date                   Details              Jrn. Ref.      Debit ($)    Credit ($)   Balance ($)
 30/6/08     Balance                                                                      1,000 dr
             Debtors’ control                     GJ              500                     1,500 dr

                                   Allowance for Doubtful Debts
  Date                   Details               Jrn. Ref.   Debit ($)      Credit ($)   Balance ($)
 30/6/08     Balance                                                                        600 cr
             Doubtful debts                       GJ                          1,000       1,600 cr

                                         Doubtful Debts
  Date                  Details              Jrn. Ref.       Debit ($)    Credit ($)   Balance ($)
 30/6/08     Allowance for doubtful debts       GJ              1,000                     1,000 dr


Notes:
   - The balance in the Allowance for Doubtful Debts ledger needs to be $1,600 ($80,500
       less additional bad debts of $500 = $80,000 x 2% = $1,600). However, because there
       is already a balance in the ledger of $600, we only need an adjustment of $1,000 to
       increase the balance to $1,600.

    -   In this example, the additional bad debt of $500 was not allowed for as a doubtful
        debt in a previous period. Therefore, it most likely related to sales made in the current
        period and was debited to the bad debts expense ledger for the current period. If,
        however, this bad debt was allowed for as a doubtful debt in a previous period it must



NMIT OFFSHORE PROGRAMS                          19
        have related to sales in a previous period and would have already been recorded as
        an expense in this previous period. To record this bad debt as an expense in the
        current period would have the affect of recording the same expense twice. Therefore,
        if a bad debt identified in the current period has already been recorded as a doubtful
        debt in a previous period the general journal entry for the adjustment at the end of the
        current period would be as follows:

                                     GENERAL JOURNAL
  Date                            Particulars                          Debit         Credit
 30/6/08     Allowance for doubtful debts                                   500
                Debtors’ control                                                          500
             To record additional bad debts previously recorded
             as doubtful.

    -   Because this debt is no longer doubtful, the Allowance for Doubtful Debts balance is
        reduced by debiting the account.

    -   For simplicity, however, we will assume that additional bad debts identified at
        the balance date for any future examples and exercises have not previously
        been recorded as doubtful.

Example 3:

An extract of a Trial Balance (before adjustments) for the year ended 30/6/08 indicated the
following:

                                                                     Debit ($)     Credit ($)
 Debtors’ control                                                       61,000
 Bad debts                                                                2,000
 Allowance for doubtful debts                                                            1,400

The bookkeeper is advised at the balance date that an additional bad debt of $1,000 was
identified and that the balance in the Allowance for Doubtful Debts ledger should be 2% of the
Debtors’ Control balance.

In this case, the balance in the Allowance for Doubtful Debts ledger needs to be $1,200
($61,000 less additional bad debts $1,000 = $60,000 x 2% = $1,200). However, because the
balance in this ledger is already $1,400, it needs to be reduced by $200.

The general journal for the above adjustments would be prepared and posted to the general
ledger as follows:

                                      GENERAL JOURNAL
  Date                             Particulars                         Debit         Credit
 30/6/08     Bad debts                                                   1,000
                Debtors’ control                                                         1,000
             To record additional bad debts.
 30/6/08     Allowance for doubtful debts                                    200
                Doubtful debts                                                            200
             To increase the allowance for doubtful debts.

                                   GENERAL LEDGER (Extract)

                                        Debtors’ Control
  Date                   Details             Jrn. Ref.   Debit ($)    Credit ($)   Balance ($)
 30/6/08     Balance                                                                 61,000 dr
             Bad debts                           GJ                       1,000      60,000 dr




NMIT OFFSHORE PROGRAMS                         20
                                          Bad Debts
  Date                 Details              Jrn. Ref.     Debit ($)   Credit ($)   Balance ($)
 30/6/08   Balance                                                                    2,000 dr
           Debtors’ control                     GJ           1,000                    3,000 dr

                                 Allowance for Doubtful Debts
  Date                 Details               Jrn. Ref.   Debit ($)    Credit ($)   Balance ($)
 30/6/08   Balance                                                                    1,400 cr
           Doubtful debts                       GJ             200                    1,200 cr

                                       Doubtful Debts
  Date                Details              Jrn. Ref.      Debit ($)   Credit ($)   Balance ($)
 30/6/08   Allowance for doubtful debts       GJ                            200         200 cr


       The adjustments for Bad or Doubtful debts do not need to be reversed in the next
        period.


Exercises

2.11

An extract of a Trial Balance at 30/6/08, before balance day adjustments, showed the
following ledger balances:
- Debtors’ control $54,000 debit
- Bad debts $300 debit
- Allowance for doubtful debts $560 credit

A memo from the owner indicates that the following adjustments need to be made:
- Additional bad debts of $2,000 are to be written off
-The Allowance for doubtful debts is to be adjusted to 2% of the final debtors balance.

You are required to:
a) Prepare general journal entries to record the above adjustments at 30/6/08.
b) Post the journal entries to the relevant ledgers in the general ledger.

2.12

At the 30/6/08 a business wishes to create an Allowance for doubtful debts at 2.5% of the
debtors’ balance. The balance in the debtors’ ledger is $40,000; however additional bad debts
of $2,000 are yet to be written off.

You are required to prepare general journal entries to:
a) Write off the additional bad debts.
b) Create the allowance for doubtful debts.


Depreciation

During the life of a business a number of non-current assets will be purchased to help run and
earn income for the business. Non-current assets are assets that are purchased in one
accounting period but the benefits received and the revenue they help generate are earned
over one or several future accounting periods.




NMIT OFFSHORE PROGRAMS                        21
Examples of non-current assets include the following:

    -   Land and buildings
    -   Fixtures and fittings
    -   Equipment
    -   Machinery
    -   Furniture
    -   Motor vehicles

When a non-current asset is purchased, the cost of the asset is recorded in an asset account,
not an expense account. That is, if a motor vehicle was purchased for $20,000 cash, the
transaction would result in a debit entry in the Motor Vehicles ledger (an asset) and a credit
entry in the Bank ledger (also an asset). At the time of the purchase there is no expense as
the business has basically swapped one asset for another.

However, as the years go by and the asset gets older, the benefits received from the asset
become less and less until no benefits are received or the asset is sold. That is, the value of
the asset to the business gradually becomes less. Depreciation is an estimate of this loss of
value and is an expense of the business. Statement of Accounting Concepts 4 (SAC4) states
that expenses include ‘consumptions or losses of future economic benefits in the form of
reductions in assets’.

Depreciation is a means of allocating a share of the original cost of an asset as an expense to
each accounting period that uses the asset to generate revenue. Depreciation is therefore
consistent with the accrual accounting concept that requires revenue earned for a period to
be matched against expenses incurred in earning that revenue.

There are two main methods for calculating depreciation at end of an accounting period.

Method 1 – ‘Straight- Line’ Method

For this method, the cost of the asset is allocated evenly over the ‘useful life’ of the asset.
That is, the depreciation expense will be the same amount for each full accounting period that
the business owns and uses the asset.

Example 1:

Office equipment is purchased on 1/7/07 for $20,000. The business expects the equipment to
have a useful life of four years and to have a residual value of $2,000 at the end of this
period. The residual value of an asset is its expected resale or scrap value at the end of its
useful life.

The depreciation calculation is:

 Asset cost – residual value
    Life of the asset              =   Depreciation per annum

 $20,000 - $2,000
     4 years          =   $4,500 per annum

For most businesses, a pre-determined percentage rate is used to calculate depreciation. In
the above example, the percentage rate would be 100% divided by 4 years equals 25%.

The depreciation would then be calculated as follows:

$20,000 less $2,000 = $18,000 x 25% = $4,500 per annum

Alternatively, we could calculate a percentage rate based on the original cost of the asset.
That is:




NMIT OFFSHORE PROGRAMS                          22
 Depreciation per annum
 Original cost of asset       X 100      = Depreciation rate

 $4,500
 $20,000     X 100     = 22.5% on cost

For all future examples and exercises straight-line depreciation will calculated using a
pre-determined percentage rate based on the original cost of the asset.

Example 2:

A business purchased a motor vehicle on the 1/7/07 for $25,000. The business calculates
depreciation using the straight-line method by applying a predetermined rate of 20% to the
original cost of the asset. Another way of wording this would be:

Depreciation is calculated at 20% on cost. (Because the cost of the asset does not change,
the depreciation amount will be the same each year and thus the straight-line method is
assumed)

In this case, the depreciation per annum is: $25,000 x 20% = $5,000

Two ledger accounts are affected when the adjustment for depreciation is recorded in the
general journal on the balance date. A Depreciation ledger is opened for each non-current
asset to be depreciated. The Depreciation ledger is an expense and will therefore be debited
with the amount calculated. The balance in the depreciation ledger should be the depreciation
amount related to the current period only.

The other ledger affected is called Accumulated Depreciation. Like the depreciation ledger,
there is an Accumulated Depreciation ledger for each non-current asset to be depreciated.
This ledger is a ‘negative asset’ and will be credited with the amount calculated. The balance
in the Accumulated Depreciation ledger after the adjustment is completed should be the total
depreciation recorded for the particular asset since the asset was purchased. That is, the
accumulated balance.

Example 3:

An extract of a trial balance (before balance day adjustments) for the year ended 30/6/08
reveals the following:

                                                                   Debit ($)      Credit ($)
 Motor vehicles – cost                                                40,000
 Accumulated depreciation – motor vehicles                                            16,000
 Office equipment – cost                                               20,000
 Accumulated depreciation – office equipment                                           5,000

- Both motor vehicles and office equipment were purchased in a previous period which is why
  there is existing balances in the accumulated depreciation accounts.
- There is no balance in the depreciation expense ledgers as this account records the
  depreciation for the current period only and we have yet to record the depreciation for the
  current period.
- Motor Vehicles are depreciated at 20% on cost and Office Equipment is depreciated at 25%
  on cost.

The adjustment for depreciation of the above assets would be recorded in the general journal
and transferred to the general ledger as follows:




NMIT OFFSHORE PROGRAMS                        23
                                   GENERAL JOURNAL
  Date                          Particulars                              Debit         Credit
 30/6/08   Depreciation – motor vehicles                                   8,000
             Accumulated depreciation – motor vehicles                                    8,000
           Depreciation at 20% on cost.
           Depreciation – office equipment                                  5,000
             Accumulated depreciation – office equipment                                  5,000
           Depreciation at 25% on cost.

                                 GENERAL LEDGER (Extract)

                                   Depreciation – Motor Vehicles
  Date                 Details                 Jrn. Ref.  Debit ($)     Credit ($)   Balance ($)
 30/6/08   Accum. dep’n. – motor vehicles         GJ           8,000                    8,000 dr


                        Accumulated Depreciation – Motor Vehicles
  Date                 Details           Jrn. Ref.   Debit ($) Credit ($)            Balance ($)
 30/6/08   Balance                                                                     16,000 cr
           Depreciation – motor vehicles         GJ                         8,000      24,000 cr

                                  Depreciation – Office Equipment
  Date                 Details                 Jrn. Ref.    Debit ($)   Credit ($)   Balance ($)
 30/6/08   Accum. Dep’n – office equipment        GJ           5,000                    5,000 dr


                        Accumulated Depreciation – Office Equipment
  Date                 Details            Jrn. Ref.    Debit ($) Credit ($)          Balance ($)
 30/6/08   Balance                                                                      5,000 cr
           Depreciation – office equip.          GJ                         5,000      10,000 cr

Notes:
   - As we shall see later in this unit, the balance in the depreciation accounts will be
       closed off to an account called the ‘profit and loss’ account, leaving a zero balance
       in the depreciation accounts.
   - The balance in the Accumulated Depreciation accounts will remain in the ledger and
       will be subtracted from the asset accounts in the Balance Sheet to show the ‘written-
       down value’ or ‘carrying amount’ of the asset.
   - For example, the motor vehicles would be shown in the balance sheet as follows:
                                                                    $
                Motor vehicles – cost                            40,000
                Less accumulated depreciation                    24,000
                = Written down value (Carrying amount)           16,000


Method 2 – ‘Reducing Balance’ Method

Under this method, a constant percentage rate of depreciation is allocated for each
accounting period against the reduced balanced of the assets. That is, the written down value
(or carrying amount) of the asset before this period’s adjustment is multiplied by a
predetermined percentage rate.

Once the amount has been calculated it is recorded in the general journal in exactly the same
way as the straight-line method.




NMIT OFFSHORE PROGRAMS                         24
Example:

An extract of a trial balance (before balance day adjustments) for the year ended 30/6/08
reveals the following:

                                                                    Debit ($)       Credit ($)
 Furniture – cost                                                      30,000
 Accumulated depreciation – furniture                                                     10,000

- Furniture is depreciated at 20% per annum using the reducing balance method.

The depreciation adjustment would be recorded in the general journal and posted to the
general ledger as follows:

                                    GENERAL JOURNAL
  Date                          Particulars                            Debit             Credit
 30/6/08   Depreciation – furniture                                      4,000
             Accumulated depreciation – furniture                                          4,000
           Depreciation at 20% on reduced balance.

The amount is calculated: ($30,000 less $10,000 = $20,000 x 20% = $4,000)


                                GENERAL LEDGER (Extract)

                                  Depreciation – Furniture
  Date               Details               Jrn. Ref.    Debit ($)     Credit ($)   Balance ($)
 30/6/08   Accum. dep’n. – furniture          GJ           4,000                      4,000 dr


                        Accumulated Depreciation – Motor Vehicles
  Date                 Details           Jrn. Ref.   Debit ($) Credit ($)          Balance ($)
 30/6/08   Balance                                                                   10,000 cr
           Depreciation – furniture             GJ                        4,000      14,000 cr

Note:
- Furniture would be shown in the Balance Sheet for the period ended 30/6/08 as follows:

Furniture – cost                                    30,000
Less accumulated depreciation                       14,000
= Written down value (Carrying amount)              16,000

- As the written down value is now $16,000, next period’s depreciation would be calculated as
  follows:
         $16,000 x 20% = $3,200

A business is not bound to choose a particular depreciation method. It could use the straight-
line method for one asset and the reducing balance method for another asset. However, once
it chooses a method for a particular asset it should continue to use that method for the life of
the asset.

If a business believes that a particular asset will lose more value in its early years and less
value in later years then the reducing balance method may give a more accurate estimation of
depreciation.

Once a business has depreciated the entire value of the asset, it cannot continue to
depreciate it even if the business retains and uses it past its estimated useful life.




NMIT OFFSHORE PROGRAMS                         25
Depreciation for parts of the year:

A non-current asset can be purchased at any time during an accounting period. Where an
asset is purchased partway through the year, a full year’s depreciation cannot be recorded at
the balance date.

Example:

An asset was purchased on 1/11/07 for $12,000. Depreciation is calculated at 15% on cost.
The depreciation amount to be recorded on 30/6/08 would be calculated as follows:

$12,000 x 15% = $1,800 x 8/12 = $1,200


Exercises:

2.13

Accounting records at the 30/6/08 (before balance day adjustments) reveal the following
ledger account balances:
                                                          $
- Equipment                                             14,000
- Accumulated depreciation – equipment                   4,000
- Vehicles                                              42,000
- Accumulated depreciation – vehicles                   10,000

Equipment is depreciated at 10% on cost and vehicles are depreciated at 20% using the
reducing balance method.

You are required to:
a) Complete the general journal entries to record the depreciation of each asset at 30/6/08.
b) Post the journal entries to the relevant ledger accounts.

2.14

A review of accounting records indicates the following balance day adjustments need to be
           th
made at 30 June 2008. You are required to prepare general journal entries for each of these
adjustments.

- Advertising owing but not yet paid is $400.
- Rent expense contains a prepayment of $700.

- Machinery at a cost of $20,000, with existing accumulated depreciation of $5,000, is to be
  depreciated at a rate of 16% per annum using the reducing balance method.
- Provision for long service leave is to be increased by $900.
- Provision for doubtful debts is to be created at 2.5% of the debtors’ balance. The current
  balance of debtors is $40,000, but an additional bad debt of $2,000 needs to be written off.

2.15
                                                                                     th
Prepare general journal entries for the following balance day adjustments as at 30 June
2008:

- Salaries owing $500.
- Interest on mortgage due, but not yet paid, $600.
- Commission earned, but not received, is $1,000.
- Insurance paid in advance $1,200.
- Provision for doubtful debts currently at $3,000 is to be adjusted to 3% of the debtors’
  balance of $150,000.



NMIT OFFSHORE PROGRAMS                         26
2.16
                                  th
An extract of a Trial Balance at 30 June 2008 discloses the following:

                                                                     Debit ($)      Credit ($)
Debtors control                                                         76,000
Advertising expense                                                       1,400
Bad debts                                                                   500
Commission revenue                                                                         2,000
Furniture                                                                 10,000
Accumulated depreciation – furniture                                                       2,000
Insurance expense                                                          1,780
Motor vehicles expenses                                                    2,300
Allowance for doubtful debts                                                                 800
Rent revenue                                                                               3,700
Wages expense                                                            120,000
Stationery expense                                                         1,000
Provision for annual leave                                                                 1,600
Provision for long service leave                                                           6,400
Motor vehicles                                                            24,000
Accumulated depreciation – motor vehicles                                                  8,000

Prepare general journal entries for each of the following adjustments that are required on
30/6/08:

- Expense due but not yet paid:
          - Advertising $300
          - Insurance $240
          - Wages $5,000.
- Additional bad debts to be written off $1,000.
- Allowance for doubtful debts to be 2% of debtors.
- Furniture to be depreciated at 12% on cost.
- Motor vehicles to be depreciated at 20%, reducing balance method.
- Commission due but not yet received $400.
- Insurance expense includes an amount of $150 that is applicable to the next accounting
  period.
- A stock-take reveals stock of stationery on hand $200.
- Provision for annual leave to be increased by $800.
- Provision for long service leave to be increased to $8,000.

2.17

Prepare general journal entries at 30/6/08 for the following balance day adjustment:

- Delivery expenses due but not yet paid are $200.
- 30% of the total insurance expense of $3,800 relate to the next accounting period.
- Rent revenue of $3,000 was received in May for the three-month period 15 May to 15
  August 2008.
- Interest earned but not yet received is $300.
- Depreciation of machinery is to be charged at 17.5% on a reduced balance of $12,200.
- An allowance for doubtful debts is to be created at 3.75% of the balance of debtors of
  $16,800.




NMIT OFFSHORE PROGRAMS                        27
2.18

The accountant discovers that the following balance day adjustments are required to adjust
ledger accounts on the balance date of 30/6/08:

- The balance in the insurance expense ledger of $8,800 includes a payment of $1,100 on
  1/5/08 for the four-month period ending 31/8/08.
- The balance in the rent revenue ledger of $11,700 includes rent for 13 months. The extra
  month is July 2008. (Assume that rent is the same amount each month)
- Interest revenue of $550 does not include $50 interest for June 2008, due to be received in
  July.

a) Prepare general journal entries for the above adjustments.
b) Post the journal entries to relevant ledger accounts in the general ledger.

2.19

The following Trial Balance and list of balance day adjustments relates to M. Miller, retailer,
                      th
for the year ended 30 June 2008.

You are required to:
a) Prepare general journal entries to record balance day adjustments at 30/6/08.
b) Post the journal entries to the general ledger.
c) Prepare an adjusted trial balance as at 30/6/08
                                  th
M. Miller – Trial Balance as at 30 June 2008
                                                                          Debit ($)    Credit ($)
Capital                                                                                   42,200
Drawings                                                                      4,000
Debtors control                                                              16,800
Creditors control                                                                           9,400
Stock (1/7/07)                                                                9,800
Purchases                                                                    60,000
Stationery expense                                                            2,000
Sales                                                                                    100,000
Sales returns                                                                 2,000
Purchase returns                                                                            1,600
Cartage inwards                                                               1,600
Cartage outwards                                                              2,000
Discount expense                                                              1,120
Discount revenue                                                                              400
Motor vehicles – at cost                                                     27,800
Accumulated depreciation – motor vehicles                                                   2,400
Insurance                                                                     2,000
Wages                                                                        26,400
Furniture - at cost                                                           4,000
Duty and wharfage                                                               800
Bad debts                                                                     1,000
Loan from T. Thomas (Due 30/9/09)                                                         20,000
Cash at bank                                                                 12,000
Rent                                                                          2,080
Interest income                                                                               200
Allowance for doubtful debts                                                                  200
Interest on loan                                                              1,000
                                                                            176,400      176,400

* Closing stock at 30/6/08 $10,000 (The adjustment for this will not be covered until later in
                                    the unit so you can ignore it for the moment)




NMIT OFFSHORE PROGRAMS                         28
Balance day adjustments at 30/6/08:
- Insurance due but not yet paid $200.
- Stock of stationery on hand $280.
- Depreciate motor vehicles at the rate of 20% per annum using the reducing balance method.
- Depreciate furniture at 10% per annum using the straight-line method.
- Additional bad debts $1,800.
- Create a provision for annual leave of $1,400.
- Create a provision for long service leave of $5,400.
- Bank interest earned but not yet received $180.
- Allowance for doubtful debts to be 2% of debtors.

2.20

The following Trial Balance and list of balance day adjustments relates to a business owned
                                                 th
and operated by C. Chan for the year ended 30 June 2008.

You are required to:
a) Prepare general journal entries to record balance day adjustments at 30/6/08.
b) Prepare an adjusted trial balance at 30/6/08.

                                                                          Debit ($)    Credit ($)
Advertising                                                                  5,200
Bad debts                                                                       600
Buying expenses                                                              2,200
Capital                                                                                   44,400
Cash at bank                                                                 48,400
Cash on hand                                                                  1,600
Commission revenue                                                                         1,200
Creditors control                                                                         12,000
Drawings                                                                     22,000
Freight outwards                                                             24,800
Office furniture – at cost                                                   12,000
Accumulated depreciation – office furniture                                                3,000
Interest on loan                                                              2,400
                             st
Loan from D. Drake (Due 1 Feb. 2010)                                                      40,000
Delivery vehicles – at cost                                                  61,600
Accumulated depreciation – delivery vehicles                                               8,640
Purchases                                                                    80,000
Investments                                                                  50,000
Purchase returns                                                                           1,600
Rent                                                                          5,600
Insurance                                                                     2,600
Sales                                                                                    266,000
Sales returns                                                                 1,200
Sales staff salaries                                                         28,640
Office staff salaries                                                        20,000
Delivery vehicle expenses                                                     2,000
Stock (1/7/07)                                                               24,000
Provision for annual leave                                                                 4,000
Provision for long service leave                                                          14,000
                                                                           394,840       394,840

* Closing stock at 30/6/08 $20,000 (The adjustment for this will not be covered until later in
                                    the unit so you can ignore it at the moment)

Balance day adjustments at 30/6/08:
- Depreciate motor vehicles at 20% per annum using the straight-line method.
- Depreciate furniture at 20% per annum using the reducing balance method.
- Chan owes $900 interest on the loan from D. Drake.



NMIT OFFSHORE PROGRAMS                         29
- Rent paid in advance $440.
- Increase provision for annual leave by $2,000.
- Increase provision for long service leave to $20,000.
- Advertising owing $800.
- Commission revenue earned but not yet received $300.

2.21

The following Trial Balance and list of balance day adjustments relates to a business owned
                                                th
and operated by P. King for the year ended 30 June 2008.

You are required to:
a) Prepare general journal entries to record balance day adjustments at 30/6/08.
b) Prepare an adjusted trial balance at 30/6/08.

                                                                          Debit ($)    Credit ($)
Cash at bank                                                                 4,200
Capital                                                                                  142,000
Sales                                                                                    500,000
Purchases                                                                  200,000
Shares in ABX Ltd                                                           50,000
Drawings                                                                    42,000
Discount revenue                                                                           2,000
Discount expense                                                              1,200
Debtors control                                                              30,800
Creditors control                                                                         28,000
Cartage inwards                                                               3,500
Purchase returns                                                                             800
Cartage outwards                                                              5,200
Sales returns                                                                   600
Dividend revenue                                                                           1,200
Land and buildings – at cost                                               168,000
Mortgage on land and buildings                                                            80,000
Advertising                                                                   4,000
Sales vehicle expenses                                                        8,200
Rates                                                                         2,600
Insurance                                                                     2,450
Bad debts                                                                       900
Sales vehicles – at cost                                                     52,000
Accumulated depreciation – sales vehicles                                                 10,400
Office staff salaries                                                        62,000
Sales staff salaries                                                         40,000
Repairs - office equipment                                                      900
Office equipment – at cost                                                   30,000
Accumulated depreciation – office equipment                                                6,000
Allowance for doubtful debts                                                                 400
Stock (1/7/07)                                                              52,000
Interest on mortgage loan                                                    5,400
Stationery expense                                                           4,850
                                                                           770,800       770,800

* Closing stock at 30/6/08 $50,000 (The adjustment for this will not be covered until later in
                                    the unit so you can ignore it at the moment)

Balance day adjustments at 30/6/08:
                                                                                       st
- The quarterly expense for rates is $300. King has paid rates for the quarter ended 31 July
  2008.
- The balance in the insurance expense ledger includes an amount of $2,100 that was paid
  on 1/9/07 for the 12-month period ending 31/8/08.


NMIT OFFSHORE PROGRAMS                         30
- An analysis of debtors reveals that an additional bad debt of $800 should be written off.
- Depreciate sales vehicles at 20% per annum using the reducing balance method.
- Depreciate office equipment at 10% per annum using the straight-line method.
- Create a provision for long service leave of $5,000.
- Create a provision for annual leave of $800.
- Dividends earned but not yet received $1,200.
- Allowance for doubtful debts to be 2% of debtors.
- Office salaries owing $1,000.
- Stock of stationery on hand $500.

2.22

The following Trial Balance and list of balance day adjustments relates to a business owned
                                                  th
and operated by M. Chong for the year ended 30 June 2008.

You are required to:
a) Prepare general journal entries to record balance day adjustments at 30/6/08.
b) Prepare an adjusted trial balance at 30/6/08.

                                                                          Debit ($)    Credit ($)
Capital                                                                                   95,800
Sales                                                                                   400,000
Cash at bank                                                                 10,500
Purchases                                                                   180,000
Stock (1/7/07)                                                               20,000
Sales returns                                                                 1,800
Purchase returns                                                                            2,000
Drawings                                                                     49,900
Debtors control                                                              50,000
Creditors control                                                                          10,400
Cartage inwards                                                               2,200
Rent                                                                         24,000
Loan – Easy Finance                                                                        40,000
Office furniture – at cost                                                   20,000
Accumulated depreciation – office furniture                                                 4,600
Delivery vehicles – at cost                                                 140,000
Accumulated depreciation – delivery vehicles                                               42,000
Office equipment – at cost                                                   36,000
Accumulated depreciation – office equipment                                                10,800
Discount expense                                                              1,000
Bad debts                                                                    20,000
Discount revenue                                                                            1,400
Buying expenses                                                               2,400
Provision for annual leave                                                                  1,500
Sales wages                                                                  26,000
Office wages                                                                 20,000
Cash on hand                                                                    100
Interest on loan                                                              3,300
Advertising                                                                   2,500
Insurance                                                                     1,800
Gas and electricity                                                           2,400
Commission income                                                                          11,000
Delivery vehicle expenses                                                     2,700
Allowance for doubtful debts                                                                  500
Stationery expense                                                            3,400
                                                                            620,000      620,000

* Closing stock $18,000 (The adjustment for this will not be covered until later in the unit so
                        you can ignore it at the moment)


NMIT OFFSHORE PROGRAMS                         31
Balance day adjustments at 30/6/08:
- Advertising includes an amount of $800 that has been prepaid.
- Stock of unused stationery on hand $400.
- Sales wages owing 500.
- Depreciate office furniture at 10% per annum on cost.
- Depreciate delivery vehicles at 20% on the reduced balance.
- Depreciate office equipment at 15% on cost.
- A provision for annual leave is to be increased to $2,000.
- Allowance for doubtful debts to be adjusted to $900.
- Commission revenue received in advance is $3,000.




NMIT OFFSHORE PROGRAMS                      32
3. PREPARATION OF FINAL REPORTS
Once the balance day adjustments have been completed and the trial balance has been
adjusted the financial reports can be prepared at the end of the accounting period.

The two main financial reports for most businesses are the Income Statement and the
Balance Sheet.

Reporting entities (defined in the introduction to this unit) are required by Corporations Law to
prepare financial reports in accordance with accounting standards. These reports are referred
to as General Purpose Financial Reports and are generally prepared by companies.

The financial reports covered in this unit, however, are restricted to non-reporting entities (e.g.
sole traders). Although non-reporting entities are not required by law to prepare their reports
in accordance with accounting standards, the accounting profession expects non-reporting
entities to apply the standards, where applicable, to achieve some sort consistency in report
preparation.

Financial reports prepared by non-reporting entities are usually for the following purposes:
    - Control
    - Management information
    - Support for loan applications
    - Taxation

These financial reports are referred to as Special Purpose Financial Reports. The format of
these reports will depend on the accounting standards as well as the purpose for which the
reports will be used by a particular business.

The bulk of this unit will concentrate on the preparation of financial reports for sole traders
involved in retail or wholesale businesses. However, because sole traders also operate widely
in the service industry we will also look briefly at the preparation of financial reports for service
businesses.


The Income Statement (Retail or Wholesale Businesses)
The Income Statement, as mentioned earlier, is a statement showing the profit or loss for a
given accounting period and how it was earned. It shows the result of transactions over a
period of time.

It contains information about revenue and expenses and shows both gross and net profits.

The format of the income statement depends on the accounting standards and the needs of
the particular business. Some businesses prefer a basic format where expenses are not
classified to any great extent while others prefer the report to be classified, showing expenses
related to specific departments or operations and highlighting revenue and expenses that are
‘material’ in their nature and/or amount.

Whether the income statement is in a basic format or in a classified format, the report should
clearly show all revenue earned for a particular period and all expenses incurred in earning
that revenue. The income statement should also show both gross profit (or loss) and net
profit (or loss) figures.

Gross profit (or loss) refers to the difference between the revenue earned from the sale of
stock for a period and the cost of goods sold.

Cost of goods sold represents the cost to the business of stock sold during an accounting
period. These costs include all costs incurred in getting goods to their present location and
condition for sale.


NMIT OFFSHORE PROGRAMS                           33
‘Cost of goods sold’ is not simply the invoiced cost of purchasing stock for a particular period.
Because some of the stock sold during the current period may have been purchased during
the previous period the cost of opening stock should be included in the calculation of cost of
goods sold. On the other hand, some of the stock purchased during the current period may
not be sold until the next period and therefore should be excluded from the calculation of this
period’s cost of goods sold. Also, the cost of purchasing stock is not just the invoiced cost, but
also other costs directly associated with the purchase such as:
    - Buying expenses
    - Cartage or freight inwards (cartage out is not included here as this is a cost of selling
                                     the stock, not purchasing it)
    - Import duties and wharfage.

The gross profit earned by a retailer (or wholesaler) is a most important figure for the
business to know and analyse. That is, a trading business earns the majority of its profit by
buying stock from a supplier at one price and then selling that stock to the customer at a
higher price. The size of the overall profit will largely depend on the ability of the business to
maximise the difference between the selling price and the purchase price of its stock while
maintaining sales levels.

The larger the gross profit figure the better as it also represents what is left to fund the
remaining costs of the business (such as rent, advertising, power, insurance etc) and leave
an overall profit. This overall profit (or loss) is referred to as net profit (or loss).

The ‘cost of goods sold’ for a trading business is usually calculated and shown in the Income
Statement as follows:

Note: The figures in the following examples have been assumed. In actual practice, they would be obtained
from the adjusted trial balance. It is also assumed that the business is a retail business owned and operated
by P. Slater and that the accounting period is the year ended 30th June 2008.

                                                                               $           $            $
Opening stock (1/7/07)                                                                   10,000
Plus Purchases                                                             240,000
     Less purchase returns                                                   2,000     238,000
     Buying expenses                                                                     1,400
     Freight/cartage inwards                                                             2,600
     Import duty/wharfage                                                                2,000
                                                                                       254,000
Less closing stock (30/6/08)                                                            14,000      240,000

The ‘gross profit’ for a trading business would be calculated and shown in the Income
Statement as follows:

                                                                               $           $            $
Sales                                                                                  520,000
less sales returns                                                                       4,000      516,000
Less Cost of Goods Sold:
Opening stock (1/7/07)                                                                   10,000
Plus Purchases                                                             240,000
     less purchase returns                                                   2,000     238,000
     Buying expenses                                                                     1,400
     Freight/Cartage inwards                                                             2,600
     Import duty/Wharfage                                                                2,000
                                                                                       254,000
Less closing stock (30/6/08)                                                            14,000      240,000
Gross Profit                                                                                        276,000

Once the gross profit (or loss) has been ascertained, other operating income is then added
to the gross profit and a sub-total is ascertained. Continuing the above example, this sub-total
could be calculated as follows:


NMIT OFFSHORE PROGRAMS                               34
Note: ‘Other Operating Income’ refers to revenue (other than sales which has already
      been accounted for in the statement) earned in the normal operations of the
      business.
                                                                     $          $            $
Sales                                                                       520,000
less sales returns                                                            4,000    516,000
Less Cost of Goods Sold:
Opening stock (1/7/07)                                                        10,000
Plus Purchases                                                   240,000
     less purchase returns                                         2,000    238,000
     Buying expenses                                                          1,400
     Freight/cartage inwards                                                  2,600
     Import duty/wharfage                                                     2,000
                                                                            254,000
Less closing stock (30/6/08)                                                 14,000    240,000
Gross Profit                                                                           276,000
Add Other Operating Income:
   Discount revenue                                                            1,200
   Interest revenue                                                              600
   Commission revenue                                                          1,400
   Dividend revenue                                                              800     4,000
                                                                                       280,000

The next step in the preparation of the Income Statement is to subtract other operating
expenses from the previous sub-total to ascertain net profit (or loss). This step, and the
completed Income Statement, is illustrated as follows:

Note: ‘Other Operating Expenses’ refers to expenses (other than cost of goods sold
      which has already been accounted for in the statement) incurred in the normal
      course of business.
                                                       th
P. Slater - Income Statement for the year ended 30 June 2008.
                                                                     $          $            $
Sales                                                                       520,000
less sales returns                                                            4,000    516,000
Less Cost of Goods Sold:
Opening stock                                                                 10,000
Plus Purchases                                                   240,000
     less purchase returns                                         2,000    238,000
     Buying expenses                                                          1,400
     Freight/cartage inwards                                                  2,600
     Import duty/wharfage                                                     2,000
                                                                            254,000
Less closing stock                                                           14,000    240,000
Gross Profit                                                                           276,000
Add Other Operating Income:
   Discount revenue                                                            1,200
   Interest revenue                                                              600
   Commission revenue                                                          1,400
   Dividend revenue                                                              800     4,000
Less Other Operating Expenses:                                                         280,000
   Advertising                                                                 2,000
   Salespersons’ salaries                                                     30,000
   Cartage/Freight outwards                                                    1,200
   Depreciation – delivery vehicles                                           10,000
   Delivery vehicle expenses                                                   1,600
   Office staff salaries                                                      40,000
   Stationery expense                                                          3,000
   Depreciation – office equipment                                             4,500


NMIT OFFSHORE PROGRAMS                        35
   Telephone                                                                    3,800
   Postage                                                                      1,000
   Insurance                                                                    2,600
   Rates                                                                        2,800
   Light and power                                                              4,000
   Rent                                                                        16,000
   Discount allowed                                                               800
   Interest expense                                                             1,500
   Bad debts                                                                      600
   Doubtful debts                                                                 400
   Bank charges                                                                   200    126,000
Net Profit                                                                               154,000

Note that the Income Statement is the result of business transactions over a period of
time. The heading of this statement should therefore include the name of the business
                                                                                   th
or owner and the period for which it has been prepared (e.g. for the year ended 30
June 2008).


Exercise

3.1

Using the adjusted trial balance that you prepared in part c) of exercise 2.19, you are required
to prepare an Income Statement for the business owned and operated by M. Miller for the
               th
year ended 30 June 2008.


Classification of operating expenses

If a business wishes to follow accounting standards more closely or prepare an Income
Statement that may enable greater cost analysis and control, it could classify its ‘operating
expenses’ according to their nature or function.

The accounting standards suggest the choice of classification depends on the nature of the
business. For example, trading and service businesses are quite different in nature and thus
the classifications chosen would be different. That is, service businesses do not sell stock and
therefore would not include a classification for ‘cost of goods sold’ or ‘selling and distribution
expenses’.

The following classifications refer to those commonly used by trading (retail / wholesale)
businesses.

Although the choice of classification is up to the individual business, many businesses classify
their ‘other operating expenses’ according to the following functions:

         Selling and distribution expenses:

      These expenses include those related to promoting, selling and distributing the product
      and may include the following:
      - Advertising
      - Cartage outwards / freight outwards
      - Sales commission expense
      - Salespersons’ salaries
      - Delivery or sales vehicle expenses
      - Depreciation of delivery or sales vehicles.




NMIT OFFSHORE PROGRAMS                         36
       Administrative and general expenses:

    These expenses are those that relate to the administration of the business. They usually
    refer to office related expenses or those that relate to the business overall rather than
    being identified specifically with the selling and distribution or finance functions. Examples
    include the following:
    - Office staff salaries
    - General office expenses
    - Stationery expense
    - General manager’s salary
    - General manager’s vehicle expenses
    - Depreciation of office equipment
    - Depreciation of office furniture
    - Repairs – office equipment
    - Postage
    - Insurance
    - Light and power
    - Telephone
    - Rates
    - Rent
    - Cleaning

    A part of many of the above expenses such as telephone, rent, light and power etc would
    have also been incurred by the ‘selling and distribution’ function. However, if you are not
    told how to allocate these costs between different functions, you should treat them as
    ‘overall business costs’ and allocate them to the ‘administrative and general expense’
    function.

       Financial expenses:

    These expenses relate to costs associated with collecting amounts from customers and
    raising funds to finance the operations of the business. Examples include the following:
    - Interest on loans
    - Discount expense
    - Bad debts
    - Doubtful debts
    - Bank charges

    From the examples of financial expenses above, you should be able to see that they
    usually relate to either collecting amounts from debtors (bad debts, doubtful debts and
    discount expense) or obtaining funds from banks and other lending institutions (interest
    expense and bank charges).
The Income Statement prepared for the business owned and operated by P. Slater in the
previous section could now be prepared classifying ‘other operating expenses’ according to
the above functions.
                                                        th
P. Slater - Income Statement for the year ended 30 June 2008.
                                                                      $           $          $
Sales                                                                         520,000
less sales returns                                                              4,000    516,000
Less Cost of Goods Sold:
Opening stock                                                                  10,000
Plus Purchases                                                     240,000
     less purchase returns                                           2,000    238,000
     Buying expenses                                                            1,400
     Freight/cartage inwards                                                    2,600
     Import duty/wharfage                                                       2,000
                                                                              254,000
Less closing stock                                                             14,000    240,000
Gross Profit                                                                             276,000



NMIT OFFSHORE PROGRAMS                         37
Add Other Operating Income:
    Discount revenue                                                           1,200
    Interest revenue                                                             600
    Commission revenue                                                         1,400
    Dividend revenue                                                             800     4,000
Less Other Operating Expenses:                                                         280,000
Selling and distribution:
    Advertising                                                    2,000
    Salespersons’ salaries                                        30,000
    Cartage/Freight outwards                                       1,200
    Depreciation – delivery vehicles                              10,000
    Delivery vehicle expenses                                      1,600      44,800
Administrative and general:
    Office staff salaries                                         40,000
    Stationery expense                                             3,000
    Depreciation – office equipment                                4,500
    Telephone                                                      3,800
    Postage                                                        1,000
    Insurance                                                      2,600
    Rates                                                          2,800
    Light and power                                                4,000
    Rent                                                          16,000      77,700
Financial:
    Discount allowed                                                  800
    Interest expense                                                1,500
    Bad debts                                                         600
    Doubtful debts                                                    400
    Bank charges                                                      200      3,500   126,000
Net Profit                                                                             154,000

For all exercises from this point, Income Statements should be prepared using the
above classifications.


Exercises

3.2

Using the adjusted trial balance that you prepared in part b) of exercise 2.20, you are required
to prepare a classified Income Statement for the business owned and operated by C. Chan
                       th
for the year ended 30 June 2008.

Note: Assume that 50% of both the annual leave and long service leave expenses relate to
     the sales stag and 50% to office staff.

3.3

Using the adjusted trial balance that you prepared in part b) of exercise 2.21, you are required
to prepare a classified Income Statement for the business owned and operated by P. King for
                   th
the year ended 30 June 2008.

Note: Assume that 40% of both the annual leave and long service leave expenses relate to
     the sales staff and 60% to office staff.




NMIT OFFSHORE PROGRAMS                        38
3.4

Using the adjusted trial balance that you prepared in part b) of exercise 2.22, you are required
to prepare a classified Income Statement for the business owned and operated by M. Chong
                       th
for the year ended 30 June 2008.

Note: Assume that the annual leave expense relates to the sales staff.


Disclosure of ‘material’ items in the Income Statement

The accounting standards state that when items of revenue or expense are ‘material’, their
nature and amount must be disclosed separately either in the Income Statement itself or in
notes accompanying the statement.

 ‘Material’ revenue and expenses are those that are significant and which could influence any
decision that is made based on the Income Statement; for example a decision to lend money
to the business or a decision to purchase the business. It is the relative importance and the
affect it has on the profit or loss of the business that makes an item ‘material’.

Examples of items that may fall within this category are:
   - Write downs of inventory or property, plant and equipment
   - Profit or loss on the disposal of property, plant and equipment
   - Profit or loss on the disposal of investments
   - Legal settlements
   - Storm / flood losses.

Continuing the example of P. Slater, ‘material’ items of revenue or expense could be included
separately in the Income Statement as follows:

Note that where there are ‘material’ items, the profit (or loss) figure after subtracting
‘other operating expenses’ is referred to as ‘profit (or loss) from ordinary operations’
rather than net profit (or loss). The net profit (or loss) is the final figure calculated after
including the ‘material’ items.
                                                       th
P. Slater - Income Statement for the year ended 30 June 2008.
                                                                     $          $          $
Sales                                                                       520,000
less sales returns                                                            4,000    516,000
Less Cost of Goods Sold:
Opening stock                                                                10,000
Plus Purchases                                                   240,000
     less purchase returns                                         2,000    238,000
     Buying expenses                                                          1,400
     Freight/cartage inwards                                                  2,600
     Import duty/wharfage                                                     2,000
                                                                            254,000
Less closing stock                                                           14,000    240,000
Gross Profit                                                                           276,000
Add Other Operating Income:
    Discount revenue                                                           1,200
    Interest revenue                                                             600
    Commission revenue                                                         1,400
    Dividend revenue                                                             800     4,000
Less Other Operating Expenses:                                                         280,000
Selling and distribution:
    Advertising                                                    2,000
    Salespersons’ salaries                                        30,000
    Cartage/Freight outwards                                       1,200



NMIT OFFSHORE PROGRAMS                        39
    Depreciation – delivery vehicles                                10,000
    Delivery vehicle expenses                                        1,600     44,800
Administrative and general:
    Office staff salaries                                           40,000
    Stationery expense                                               3,000
    Depreciation – office equipment                                  4,500
    Telephone                                                        3,800
    Postage                                                          1,000
    Insurance                                                        2,600
    Rates                                                            2,800
    Light and power                                                  4,000
    Rent                                                            16,000     77,700
Financial:
    Discount allowed                                                   800
    Interest expense                                                 1,500
    Bad debts                                                          600
    Doubtful debts                                                     400
    Bank charges                                                       200      3,500    126,000
Profit from Ordinary Operations                                                          154,000
Add Material items of revenue:
    Profit on sale of segment of the business                                  20,000
Less Material items of expense:
    Legal damages                                                              10,000     10,000
Net Profit                                                                               164,000



The Balance Sheet
As mentioned earlier, the Balance Sheet is a statement showing what the business owns
(assets), what the business owes (liabilities) and the owner’s investment in the business
(owner’s equity) at the particular balance date. It indicates the financial position of the
business and also ensures that the accounting equation (i.e. A = L + OE) balances.

It is a statement at a particular point in time rather than a statement over time like the Income
Statement. For example, if a business was owned and operated by P. Slater and the balance
              th
date was 30 June 2008, the Balance Sheet title would be as follows:
                                    th
P. Slater – Balance Sheet as at 30 June 2008.


Classification in the Balance Sheet

Before looking at the format of the Balance Sheet, it should be noted that both ‘assets’ and
‘liabilities’ are classified into ‘current’ items and ‘non-current’ items.

Current assets are items of value that are expected to be turned over or converted to cash
within a twelve month period. Examples include the following:
    - Cash at bank
    - Inventory (stock)
    - Debtors control (accounts receivable) less allowance for doubtful debts
    - Cash on hand
    - Petty cash
    - Deposits at call
    - Stock of stationery
    - Prepaid expenses
    - Accrued revenue




NMIT OFFSHORE PROGRAMS                          40
Non-current assets are items of value that will be held over a period of time in excess of 12
months. Basically, they are all assets that are not current assets. Examples include the
following:

Property, Plant and Equipment:
   - Land and buildings
   - Equipment (less accumulated depreciation)
   - Furniture (less accumulated depreciation)
   - Fixtures & fittings (less accumulated depreciation)
   - Motor vehicles (less accumulated depreciation)
   - Plant & machinery (less accumulated depreciation)

Investments:
    - Shares in companies
    - Term deposits (for periods greater than 12 months)
    - Other long-term investments

Intangibles (Assets that are of value but that have no physical presence)
    - Goodwill
    - Patents
    - Trade marks
    - Copyright

Current liabilities are amounts owed by the business that are expected to be cleared within
a 12-month period. Examples include the following:
    - Bank overdraft
    - Creditors control (Accounts payable)
    - Short-term loans
    - Provision for annual leave
    - Accrued expenses
    - Prepaid revenue (Revenue received in advance)

Non-current liabilities are amounts owed by the business for a period in excess of 12
months. Examples include the following:
     - Mortgage loans
     - Long-term loans
     - Provision for annual leave
It should be noted that if any portion of a mortgage loan, other long-term loan or provision for
long service leave is to be paid during the next 12 months then this portion of the loan or
provision should be classified as a ‘current’ liability.

The Balance Sheet also has a section showing Owner’s Equity. Owner’s equity is the
owner’s investment in the business and is calculated as follows:

Capital
Plus Net Profit (or less net loss)
Less Drawings

Format of the Balance Sheet

There are basically two formats that are used to prepare a Balance Sheet – the ‘T’ format
and the ‘narrative’ format. There can also be different variations of the ‘narrative’ format.
Although a ‘non-reporting entity’ is free to choose between these formats, it should ensure
that whatever format is chosen, current assets are shown separately from non-current assets
and current liabilities are shown separately from non-current liabilities.




NMIT OFFSHORE PROGRAMS                         41
   ‘T’ Format

   A Balance Sheet prepared in this format displays the accounting equation as A = L + OE. An
   example of this format is shown as follows:

   Note: The figures in the following examples have been assumed. In actual practice, they would be obtained
   from the adjusted trial balance. It is also assumed that the business is a retail business owned and operated
   by P. Slater and that the accounting period is the year ended 30th June 2008.

                                                                        th
                              P. Slater – Balance Sheet as at 30 June 2008.
                               $          $           $                                       $          $           $
Current Assets:                                                Current Liabilities:
Cash at bank                             12,000                Creditors control             10,400
Debtors control               20,000                           Short-term loan               12,000
Less allowance for D. D.         500     19,500                Provision for annual leave     1,200
Inventory                                 8,000                Accrued expenses                 400
Prepaid expenses                            500                Prepaid revenue                1,000    25,000
Accrued revenue                           1,800                Non-Current Liabilities:
Stock of stationery                         200     42,000     Mortgage loan                 80,000
Non-Current Assets:                                            Long-term loan                26,000
Land and buildings                      200,000                Provision for LSL              4,000   110,000      135,000
Equipment                     15,000
Less accum. depreciation       5,000     10,000                Owner’s Equity:
Vehicles                      20,000                           Capital                      100,000
Less accum. depreciation       8,000     12,000                Plus net profit              120,000
Shares in AVG Ltd                        16,000                                             220,000
Goodwill                                 20,000    258,000     Less drawings                 55,000                165,000
Total Assets                                       300,000     Total Equities                                      300,000



   The above Balance Sheet not only shows the financial position (what it owns and what it
   owes) of the business, it also ensures that the accounting equation balances. If the figure for
   total assets is not equal to the figure for total equities (i.e. liabilities plus owner’s equity) one
   or more errors have been made in the preparation of the Income Statement and/or the
   Balance Sheet.




   NMIT OFFSHORE PROGRAMS                                 42
‘Narrative’ Format

A Balance Sheet prepared in this format displays the accounting equation as OE = A - L.
Using the same figures as above, A Balance Sheet in the ‘narrative’ format is shown as
follows:
                                      th
P. Slater – Balance Sheet as at 30 June 2008.
                                                                           $           $           $
OWNER’S EQUITY:
Capital                                                                            100,000
Plus net profit                                                                    120,000
                                                                                   220,000
Less drawings                                                                       55,000     165,000

This is represented by:
ASSETS:
Current Assets:
Cash at bank                                                                         12,000
Debtors control                                                          20,000
Less allowance for doubtful debts                                           500      19,500
Inventory                                                                             8,000
Prepaid expenses                                                                        500
Accrued revenue                                                                       1,800
Stock of stationery                                                                     200     42,000
Non-Current Assets:
Land and buildings                                                                 200,000
Equipment                                                                15,000
Less accumulated depreciation                                             5,000      10,000
Vehicles                                                                 20,000
Less accumulated depreciation                                             8,000      12,000
Shares in AVG Ltd                                                                    16,000
Goodwill                                                                             20,000    258,000
Total Assets                                                                                   300,000
Less LIABILITIES:
Current Liabilities:
Creditors control                                                        10,400
Short-term loan                                                          12,000
Provision for annual leave                                                1,200
Accrued expenses                                                            400
Prepaid revenue                                                           1,000      25,000
Non-Current Liabilities:
Mortgage loan                                                            80,000
Long-term loan                                                           26,000
Provision for long service leave                                          4,000    110,000
Total Liabilities                                                                              135,000
Net Assets                                                                                     165,000

If the figure for total assets is not equal to the figure for net assets (i.e. total assets less total
liabilities) one or more errors have been made in the preparation of the Income Statement
and/or the Balance Sheet.

To keep things simple and consistent, Balance Sheets should be prepared using the
‘narrative’ format in all the following exercises.




NMIT OFFSHORE PROGRAMS                            43
Exercises

3.5

Using the adjusted trial balance that you prepared in part c) of exercise 2.19 and the Income
Statement from exercise 3.1, you are required to prepare a classified Balance Sheet for the
                                                    th
business owned and operated by M. Miller as at 30 June 2008.

Note: Assume that none of the provision for long service leave is to be paid during the next 12
months.

3.6

Using the adjusted trial balance that you prepared in part b) of exercise 2.20 and the Income
Statement from exercise 3.2, you are required to prepare a classified Balance Sheet for the
                                                    th
business owned and operated by C. Chan as at 30 June 2008.

Note: Assume that none of the provision for long service leave will be paid during the next 12
months.

3.7

Using the adjusted trial balance that you prepared in part b) of exercise 2.21 and the Income
Statement from exercise 3.3, you are required to prepare a classified Balance Sheet for the
                                                  th
business owned and operated by P. King as at 30 June 2008.

Note: Assume that none of the provision for long service leave is to be paid during the next 12
months.

3.8

Using the adjusted trial balance that you prepared in part b) of exercise 2.22 and the Income
Statement from exercise 3.4, you are required to prepare a classified Balance Sheet for the
                                                     th
business owned and operated by M. Chong as at 30 June 2008.




NMIT OFFSHORE PROGRAMS                        44
3.9

Using the Adjusted Trial Balance for Sam Grover you are required to prepare:
                                                           th
    a) A classified Income Statement for the year ended 30 June 2008.
                                          th
    b) A classified Balance Sheet as at 30 June 2008.
                                   th
Sam Grover – Trial Balance as at 30 June 2008
Account                                                                $          $
Debtors control                                                        12,000
Creditors control                                                                  4,000
Vehicles – at cost                                                     41,100
Accumulated depreciation – vehicles                                                5,500
Equipment – at cost                                                    14,200
Accumulated depreciation – equipment                                               9,000
Advertising                                                              1,500
Bad debts                                                                  400
Bank loan (due 1/7/10)                                                            45,000
Premises                                                              240,000
Capital                                                                          200,000
Cash at bank (overdrawn)                                                           1,600
Commission revenue                                                                 3,500
Drawings                                                               40,000
Discount expense                                                          200
Discount revenue                                                                      150
Electricity                                                             3,800
Freight inwards                                                         1,800
Freight outwards                                                          700
Interest expense                                                          650
Vehicle expenses                                                        1,300
General manager’s salary                                               50,000
Office wages                                                           24,000
Stock (1/7/07)                                                          8,000
Purchases                                                              98,000
Purchase returns                                                                   1,000
Allowance for doubtful debts                                                         400
Rent revenue                                                                       4,000
Sales                                                                            315,400
Sales returns                                                             400
Telephone                                                               1,200
Sales wages                                                            44,000
Depreciation – vehicles                                                 2,400
Depreciation – equipment                                                3,000
Prepaid expenses                                                          100
Accrued expenses                                                                      300
Accrued revenue                                                           900
Doubtful debts                                                            200
                                                                      589,850    589,850

Additional information:
                        th
   - A stock-take at 30 June 2008 revealed closing stock of $10,000.
   - Vehicles are used exclusively by the sales staff.
   - All equipment is maintained in the office.




NMIT OFFSHORE PROGRAMS                      45
3.10

Using the Adjusted Trial Balance for Lucy Chan you are required to prepare:
                                                           th
    a) A classified Income Statement for the year ended 30 June 2008.
                                           th
    b) A classified Balance Sheet as at 30 June 2008.
                                  th
Lucy Chan – Trial Balance as at 30 June 2008
Account                                                                 $         $
Creditors control                                                                 2,100
Debtors control                                                          5,400
Accrued expenses                                                                     120
Accumulated depreciation – delivery vehicles                                      22,000
Advertising                                                              2,000
Bank charges                                                               650
Cash at bank                                                            15,000
Capital                                                                          162,000
Commission revenue                                                                   800
Office equipment – at cost                                              30,000
Accumulated depreciation – office equipment                                       10,000
Customs duty                                                             1,000
Depreciation – delivery vehicles                                         3,600
Depreciation – office equipment                                          5,000
Discount expense                                                           300
Discount revenue                                                                    630
Doubtful debts                                                             400
Drawings                                                                40,000
Buying expenses                                                          3,800
Cartage outwards                                                         3,900
Long-term loan                                                                    45,300
Insurance                                                                1,000
Interest on loan                                                         2,100
Land                                                                   190,000
Manager’s salary                                                        30,000
Delivery vehicle – at cost                                              30,000
Delivery vehicle expenses                                                4,200
Sundry office expenses                                                  12,200
Stock (1/7/07)                                                          12,500
Prepaid expenses                                                         2,000
Purchases                                                              200,000
Purchase returns                                                                   2,600
Rent expense                                                            30,000
Sales                                                                            480,000
Sales returns                                                            3,400
Sales staff salaries                                                    70,000
Stationery expense                                                       3,500
Telephone expense                                                        4,000
Allowance for doubtful debts                                                        400
Fire losses                                                             20,000
                                                                       725,950   725,950

Additional information:
                        th
   - A stock-take at 30 June 2008 revealed closing stock of $16,000.
   - Fire losses are deemed to be of a ‘material’ nature.




NMIT OFFSHORE PROGRAMS                       46
3.11

Using the Adjusted Trial Balance for Tom Tate you are required to prepare:
                                                            th
    a) A classified Income Statement for the year ended 30 June 2008.
                                          th
    b) A classified Balance Sheet as at 30 June 2008.
                                 th
Tom Tate – Trial Balance as at 30 June 2008
Account                                                                 $            $
Sales                                                                              250,000
Sales returns                                                           10,500
Interest revenue                                                                        700
Purchases                                                               90,700
Purchase returns                                                                       4,100
Advertising                                                              3,900
Bank charges                                                               210
Buying expenses                                                            450
Insurance                                                                  800
Motor vehicle expenses                                                   8,400
Rent                                                                    14,500
Stationery expense                                                         940
Telephone                                                                  860
Freight outwards                                                           540
Wages – sales staff                                                     15,600
Wages – office staff                                                    12,300
Cash at bank                                                            30,900
Mortgage on buildings                                                                 30,000
Cash on hand                                                                50
Debtor’s control                                                         4,300
Allowance for doubtful debts                                                            200
Stock on hand (1/7/07)                                                  28,000
Shares in PNG Ltd                                                        7,000
Motor vehicles – at cost                                                38,500
Accumulated depreciation – motor vehicles                                             15,700
Buildings                                                              100,000
Office furniture – at cost                                              20,000
Accumulated depreciation – office furniture                                            4,100
Creditors control                                                                     11,200
Legal expenses                                                          10,000
Capital                                                                            104,300
Dividend revenue                                                                       500
Prepaid expenses                                                             680
Accrued expenses                                                                       1,900
Postage                                                                    490
Stock of stationery                                                         80
Doubtful debts                                                             100
Depreciation – motor vehicles                                            7,700
Depreciation – office furniture                                          2,000
Drawings                                                                10,500
Interest on mortgage                                                     2,700
                                                                       422,700     422,700

Additional information:
                        th
   - A stock-take at 30 June 2008 revealed closing stock of $30,000.
   - Legal expenses are deemed to be of a ‘material’ nature.
   - Motor vehicles are used exclusively by the office staff.
   - $5,000 of the mortgage on buildings will be re-paid during the next 12 months.




NMIT OFFSHORE PROGRAMS                       47
3.12

Using the Adjusted Trial Balance for Charlie Chaplin you are required to prepare:
                                                             th
    a) A classified Income Statement for the year ended 30 June 2008.
                                            th
    b) A classified Balance Sheet as at 30 June 2008.
                                       th
Charlie Chaplin – Trial Balance as at 30 June 2008
Account                                                                  $            $
Shop premises                                                           240,000
Mortgage on shop premises                                                            160,000
Goodwill                                                                 20,000
Office Furniture                                                          8,000
Accumulated depreciation – office furniture                                            3,000
Loan from AG Finance (due 30/11/08)                                                   10,000
Investments – KPL shares                                                 25,000
Purchases                                                                42,000
Advertising                                                                 900
Office equipment                                                          4,000
Accumulated depreciation – office equipment                                            1,200
Shop equipment                                                            6,400
Accumulated depreciation – shop equipment                                              1,600
Stock (1/7/07)                                                            7,000
Sales                                                                                136,000
Sales returns                                                             1,400
Bad debts                                                                   400
Discount revenue                                                                          400
Discount expense                                                            600
Cash at bank                                                                           3,000
Capital                                                                              100,000
Drawings                                                                 10,000
Rates                                                                       920
Debtors control                                                           5,400
Allowance for doubtful debts                                                             100
Purchase returns                                                                         600
Creditors control                                                                      3,500
Gas and electricity                                                       3,200
Insurance                                                                 1,400
Wages – sales staff                                                      18,000
Wages – office staff                                                     15,000
Repairs – shop                                                            2,000
Profit on sale of investments                                                          8,000
Accrued expenses                                                                         600
Revenue received in advance (prepaid revenue)                                            200
Doubtful debts                                                               50
Interest expense                                                          9,050
Depreciation – office furniture                                             800
Depreciation – office equipment                                             460
Depreciation – shop equipment                                               620
Flood losses                                                              5,600
                                                                        428,200      428,200

Additional information:
                         th
   - A stock-take at 30 June 2008 revealed closing stock of $6,000.
   - Flood losses are deemed to be of a ‘material’ nature.
   - Profit on sale of investments is deemed to be revenue of a ‘material’ nature.




NMIT OFFSHORE PROGRAMS                       48
Final Reports for Service Businesses
The Balance Sheet for a service business is prepared in the same way as that of a trading
(retail/wholesale) business.

Service businesses, however, have different requirements for the format of the Income
Statement. Generally, a service business does not sell a product and therefore there is no
section for ‘Cost of Goods Sold’ or ‘Gross Profit’. Instead of sales, the major item of revenue
will be service fees earned.

There are many ways to present an Income Statement for a service business depending on
the type of service it provides and the requirements of the user. The following is an example
of Income Statement that might be prepared by a service provider.

                               Bill Durr – Home Maintenance
                                                          th
                    Income Statement for the year ended 30 June 2008
                                                             $       $                     $
Direct operating Revenue
Service fees                                                                            210,000
less Direct operating expenses
     Materials used                                                110,000
     Repairs to tools and equipment                                  2,500
     Depreciation – tools and equipment                              1,600
     Vehicle expenses                                                2,100
     Depreciation – vehicles                                         4,800              121,000
Service Margin                                                                           89,000
add Other operating revenue
     Interest received                                                                       200
                                                                                          89,200
Less Other operating expenses
Office expenses:
     Electricity                                                  1,700
     Wages                                                       15,000
     Stationery                                                   2,200
     Depreciation – office equipment                              2,800      21,700
Financial expenses:
     Interest on loan                                               400
     Bank charges                                                   100         500       22,200
Net Profit                                                                                67,000




NMIT OFFSHORE PROGRAMS                         49
4. CLOSING THE LEDGER
Because the profit or loss for an accounting period is calculated at the end of each period we
only need to know the revenue earned and expenses incurred for that particular period. Once
the profit or loss has been calculated for a particular period, the balances in the revenue and
expense ledgers have served their purpose for that period.

Therefore, at the end of each accounting period, the revenue and expense ledgers are closed
to a nil balance so that the ledgers are then ready to record only the revenue and expenses
for the next period. This involves transferring the balance in each revenue and expense
ledger to two new ledger accounts. For a trading business, these two new accounts are the:

       Trading account
       Profit and loss account

At the conclusion of this procedure, the balances in each revenue and expense ledger will
have been transferred to either the ‘Trading Account’ or the ‘Profit and Loss Account’
depending on the type of revenue or expense. The only ledgers left with balances in them
should be assets, liabilities and capital. The balances in these ledgers are carried over into
the next period.

Note: Assets and liabilities are not closed off at the end of an accounting period. The
balances in these ledger accounts represent what the business owns and owes and must
remain in the ledgers until the asset is no longer owned or the liability is cleared.


The Trading Account
The ‘Trading Account’ is used to calculate the profit (loss) generated by the business from its
main trading activity – that is, gross profit (loss). Therefore, all revenue and expenses that
are used in the calculation of gross profit (loss) – i.e. sales and cost of goods sold – are
closed (transferred) to the ‘Trading Account’.

If we refer back to the previous section on the Income Statement, gross profit (loss) is
calculated as follows:

             Sales
             less sales returns
             Less Cost of Goods Sold:
             Opening stock
             Plus Purchases
                  less purchase returns
                  Buying expenses
                  Freight/cartage inwards
                  Import duty/wharfage

             Less closing stock
             Gross Profit / Loss

The final balances in the above revenue and expense ledgers are therefore closed to the
‘Trading Account’. The balances in these revenue and expense ledgers will then be zero and
the balance in the ‘Trading Account’ should be ‘Gross Profit (Loss)’ for the period. This gross
profit (loss) will now have been calculated twice - Once in the Income Statement (covered in
the previous section), which may be used by external users, and again in the ledgers for our
own internal use.

Note: Opening and closing stock must go into the ‘Trading Account’ as they affect the
calculation of ‘cost of goods sold’. Closing stock represents some of the current period’s
purchases that have not been sold and therefore it decreases ‘cost of goods sold’. Opening


NMIT OFFSHORE PROGRAMS                         50
stock represents some of the previous period’s purchases, which have been sold in the
current period, and therefore it increases ‘cost of goods sold’.


The Profit and Loss Account
The ‘Profit and Loss Account’ is used to calculate the net profit generated by the business.
Therefore, all remaining revenue and expenses that have not been closed to the ‘Trading
Account’ are closed to the ‘Profit and Loss Account’. If the balance in this account is to
represent net profit (loss), the balance in the ‘Trading Account’ (gross profit/loss) must also be
transferred to the ‘Profit and Loss Account’.


The Closing Procedure
The steps in the closing procedure involve a series of general journal entries to:
   1. Close opening stock to the trading account.
   2. Record closing stock in the trading account.
   3. Close items that increase gross profit to the trading account. That is:
            o Sales
            o Purchase returns
   4. Close items that decrease gross profit to the trading account. That is:
            o Purchases
            o Sales returns
            o Buying expenses
            o Cartage/freight inwards
            o Import/customs duty
            o Wharfage
   5. Transfer the balance in the trading account (i.e. gross profit or loss) to the profit and
       loss account.
   6. Close remaining revenue items to the profit and loss account.
   7. Close remaining expense items to the profit and loss account.

    At this stage, all revenue and expense items will have been summarised into one figure –
    net profit (loss). Remember, revenue and expense ledgers were kept during an
    accounting period to enable the calculation of this net profit or loss for the particular
    period. This has now been done and the balances in the revenue and expense ledgers
    will have been cleared and the ledgers will be ready to record revenue and expenses for
    the next period.

    8. Transfer the final balance in the profit and loss account (i.e. net profit or loss) to the
       ‘Capital’ ledger.

    The net profit (loss) is transferred from the profit and loss ledger to the capital ledger
    because the net profit (loss) represents a change to the ‘owner’s equity’ and the owner’s
    equity in the business is represented by the balance the capital account.

    9. Transfer any balance in the ‘drawings’ ledger to the ‘capital’ ledger.

    The drawings is transferred to the capital ledger as it also represents a change to the
    ‘owner’s equity’.

    Example

    The adjusted trial balance for a business operating under the name ‘Basic Trading’ is set
    out below. The figures from this trial balance and the additional information will be used to
    demonstrate the general journal entries for each of the above 9 steps. The journal entries
    will then be posted to the general ledger to show the affect on the individual ledger
    accounts.



NMIT OFFSHORE PROGRAMS                          51
                                      Basic Trading
                                                         th
                          Adjusted Trial Balance as at 30 June 2008
                                                                         Debit ($)   Credit ($)
Bank                                                                       1,400
Advertising                                                                   300
Loan – G. Grant                                                            2,000
Capital                                                                               100,000
Rent revenue                                                                            4,500
Debtors control                                                            20,000
Allowance for doubtful debts                                                             1,000
Creditors control                                                                       15,000
Land and buildings                                                        150,000
Mortgage on land and buildings                                                          90,000
Discount revenue                                                                         1,200
Discount expense                                                            1,600
Office salaries                                                             4,600
Shop fittings                                                              80,000
Accumulated depreciation – shop fittings                                                15,480
Office equipment                                                             5,000
Accumulated depreciation – office equipment                                              2,500
Interest on mortgage                                                        3,000
Insurance                                                                   1,400
Freight inwards                                                               600
Stock (1/7/07)                                                              5,000
Stationery expense                                                          1,250
Purchases                                                                  98,000
Purchase returns                                                                         2,000
Customs duty                                                                   650
Sales                                                                                 160,000
Sales returns                                                                1,600
Power and lighting                                                           2,700
Postage                                                                        560
Telephone expense                                                            1,840
Doubtful debts                                                                 400
Drawings                                                                     2,400
Interest revenue                                                                         1,000
Accrued revenue                                                                100
Accrued expenses                                                                           240
Prepaid revenue                                                                             80
Prepaid expenses                                                              300
Stock of stationery                                                           200
Depreciation – shop fittings                                                7,000
Depreciation – office equipment                                               800
Bad debts                                                                     300
                                                                          393,000     393,000

Additional Information:
                                th
   - A physical stock-take at 30 June 2008 revealed closing stock $6,500


The general journal entries for each step in the closing procedure are shown as follows. To
make it easier to understand, each journal entry is shown separately with a brief explanation
of the debit and credit entries.




NMIT OFFSHORE PROGRAMS                        52
Step 1.

                                Basic Trading – General Journal
  Date                               Details                                Debit        Credit
30/6/08    Trading                                                           5,000
              Stock (1/7/07)                                                                5,000
           Closing entry

The Adjusted Trial Balance indicates that the stock ledger has a debit balance representing
the opening stock value. Because this is no longer the current value of stock on hand and
because it affects the calculation of gross profit, it must be closed to the trading account. To
transfer the opening stock balance out of the stock ledger and leave a ‘nil’ balance, the stock
ledger needs to be credited. Because the other ledger account affected is the trading account,
it must be debited so that debits equal credits.

Step 2.

                                Basic Trading – General Journal
  Date                               Details                                Debit        Credit
30/6/08    Stock (30/6/08)                                                   6,500
              Trading                                                                       6,500
           To record the value of closing stock

A physical stock-take indicated that the current value of stock is $6,500. This is a current
asset and must therefore be debited to the stock ledger. Because it affects the calculated of
gross profit, it must also be credited to the trading ledger.

Step 3.

                                Basic Trading – General Journal
  Date                               Details                                Debit        Credit
30/6/08    Sales                                                            160,000
           Purchase returns                                                   2,000
              Trading                                                                    162,000
           Closing entry

Before the closing procedure, both the sales and purchase returns ledgers have credit
balances. To close them to ‘nil’ balances they must therefore be debited. Because they both
increase the value gross profit, they can be recorded together in the one journal entry. The
other account affected is the trading ledger that must be credited with the total so that debits
equal credits.

Step 4.

                                Basic Trading – General Journal
  Date                               Details                                Debit        Credit
30/6/08    Trading                                                          100,850
              Purchases                                                                   98,000
              Sales returns                                                                1,600
              Freight inwards                                                                600
              Customs duty                                                                   650
           Closing entry

Before the closing procedure, the purchases, sales returns, freight inwards and customs duty
ledgers all have debit balances. To close them to ‘nil’ balances they must therefore be
credited. Because they all decrease the value of gross profit, they can be recorded together in
one journal entry. The other account affected is the trading ledger that must be debited with
the total so that debits equal credits.




NMIT OFFSHORE PROGRAMS                         53
The next step in the procedure is to transfer the final balance in the ‘Trading Account’ (i.e. the
gross profit or loss) to the ‘Profit and Loss Account’. Before completing this step however, it
will be useful to post the previous journal entries to the general ledger to see the affect on the
individual ledger accounts and to calculate the final balance in the ‘Trading Account’. This is
shown as follows:

Note: A number in brackets has been inserted next to each entry in the ledgers to
indicate which step in the process the entry relates to. This does not need to be done
in actual practice.

                                        Basic Trading
                                    General Ledger (extract)

                                              Stock
  Date                        Details                         Debit        Credit       Balance
1/7/07     Balance                                                                       5,000 dr
30/6/08    Trading (1)                                                        5,000        nil
           Trading (2)                                          6,500                    6,500 dr

                                              Sales
  Date                        Details                         Debit        Credit       Balance
30/6/08    Balance                                                                     160,000 cr
           Trading (3)                                        160,000                      nil


                                        Purchase Returns
  Date                        Details                         Debit        Credit       Balance
30/6/08    Balance                                                                       2,000 cr
           Trading (3)                                          2,000                     nil


                                           Purchases
  Date                        Details                         Debit        Credit       Balance
30/6/08    Balance                                                                      98,000 dr
           Trading (4)                                                       98,000        nil


                                         Sales Returns
  Date                        Details                         Debit        Credit       Balance
30/6/08    Balance                                                                       1,600 dr
           Trading (4)                                                        1,600        nil


                                         Freight Inwards
  Date                        Details                         Debit        Credit       Balance
30/6/08    Balance                                                                         600 dr
           Trading (4)                                                          600         nil


                                         Customs Duty
  Date                        Details                         Debit        Credit       Balance
30/6/08    Balance                                                                         650 dr
           Trading (4)                                                          650         nil




NMIT OFFSHORE PROGRAMS                          54
                                              Trading
  Date                           Details                     Debit         Credit       Balance
30/6/08    Stock (1/7/07) (1)                                  5,000                     5,000 dr
           Stock (30/6/08) (2)                                               6,500       1,500 cr
           Sales (3)                                                       160,000     161,500 cr
           Purchase returns (3)                                              2,000     163,500 cr
           Purchases (4)                                         98,000                 65,500 cr
           Sales returns (4)                                      1,600                 63,900 cr
           Freight inwards (4)                                      600                 63,300 cr
           Customs duty (4)                                         650                 62,650 cr


Notes:
    Because the balance in the Trading Account is a credit balance it represents the
       ‘gross profit’ of the business for the period. That is, the items that were credited to the
       account were items that increase gross profit and the items that were debited to the
       account were items that decrease gross profit. A debit balance in the trading account
       would therefore indicate a ‘gross loss’.
    Although the general journal entry in step 3 credited the trading account with the total
       amount for sales and purchase returns, the individual amounts must be recorded in
       the ledger.
    Although the general journal entry in step 4 debited the trading account with the total
       amount for purchases, sales returns, freight inwards and customs duty, the individual
       amounts must be recorded in the ledger.

Once the balance in the trading account is known, the next step is to complete a general
journal entry to transfer this balance to the ‘profit and loss account’.

Step 5.

                                  Basic Trading – General Journal
  Date                                 Details                              Debit        Credit
30/6/08    Trading                                                           62,650
              Profit and Loss                                                               62,650
           To transfer gross profit

When the above entry is posted to the ledger it has the affect of closing the ‘Trading Account’
to a ‘nil’ balance.

The ‘Trading’ and ‘Profit and Loss’ accounts, after the above journal entry is posted the
ledgers, are shown as follows:

                                          Basic Trading
                                      General Ledger (extract)

                                              Trading
  Date                           Details                     Debit         Credit       Balance
30/6/08    Stock (1/7/07)                                      5,000                     5,000 dr
           Stock (30/6/08)                                                   6,500       1,500 cr
           Sales                                                           160,000     161,500 cr
           Purchase returns                                                  2,000     163,500 cr
           Purchases                                             98,000                 65,500 cr
           Sales returns                                          1,600                 63,900 cr
           Freight inwards                                          600                 63,300 cr
           Customs duty                                             650                 62,650 cr
           Profit and loss (5)                                   62,650                    nil




NMIT OFFSHORE PROGRAMS                          55
                                           Profit and loss
  Date                           Details                       Debit         Credit        Balance
30/6/08     Trading (5)                                                       62,650       62,650 cr


The following steps in the procedure show the general journal entries to close the remaining
revenue and expenses to the ‘profit and loss account’. When these journal entries are then
posted to the ledger, it has the affect of adding other revenue items to gross profit and
subtracting other expenses. The final balance in the ‘profit and loss account’ should therefore
represent net profit or loss.

Step 6.

                                  Basic Trading – General Journal
  Date                                 Details                                Debit         Credit
30/6/08     Rent revenue                                                       4,500
            Discount revenue                                                   1,200
            Interest revenue                                                   1,000
               Profit and loss                                                                 6,700
            Closing entry

Before the closing procedure, the rent revenue, discount revenue and interest revenue
ledgers have credit balances. To close them to ‘nil’ balances they must therefore be debited.
Because they are all then credited to the ‘profit and loss’ ledger, they can be recorded
together in the one journal entry.

Step 7.

                                  Basic Trading – General Journal
  Date                                 Details                                Debit         Credit
30/6/08     Profit and loss                                                    25,750
               Advertising                                                                       300
               Discount expense                                                                1,600
               Office salaries                                                                 4,600
               Interest on mortgage                                                            3,000
               Insurance                                                                       1,400
               Stationery expense                                                              1,250
               Power and lighting                                                              2,700
               Postage                                                                           560
               Telephone                                                                       1,840
               Doubtful debts                                                                    400
               Depreciation – shop fittings                                                    7,000
               Depreciation – office equipment                                                   800
               Bad debts                                                                         300
            Closing entry

Before the closing procedure, all the above expense ledgers have debit balances. To close
them to ‘nil’ balances they must therefore be credited. Because they are all then debited to
the ‘profit and loss’ ledger, they can be recorded together in the one journal entry.

The next step in the procedure is to transfer the final balance in the ‘Profit and Loss Account’
(i.e. the net profit or loss) to the ‘Capital Account’. Before completing this step however, it will
be useful to post the previous journal entries to the general ledger to see the affect on the
individual ledger accounts and to calculate the final balance in the ‘Profit and Loss Account’.
This is shown as follows:

Note: Once again, a number in brackets has been inserted next to each entry in the
ledgers to indicate which step in the process the entry relates to. This does not need to
be done in actual practice.



NMIT OFFSHORE PROGRAMS                           56
                                         Basic Trading
                                     General Ledger (extract)

                                             Rent Revenue
  Date                          Details                          Debit     Credit    Balance
30/6/08   Balance                                                                     4,500 cr
          Profit and loss (6)                                      4,500               nil


                                           Discount Revenue
  Date                          Details                          Debit     Credit    Balance
30/6/08   Balance                                                                     1,200 cr
          Profit and loss (6)                                      1,200               nil


                                           Interest Revenue
  Date                          Details                          Debit     Credit    Balance
30/6/08   Balance                                                                     1,000 cr
          Profit and loss (6)                                      1,000               nil


                                              Advertising
  Date                          Details                          Debit     Credit    Balance
30/6/08   Balance                                                                       300 dr
          Profit and loss (7)                                                  300     nil


                                           Discount Expense
  Date                          Details                          Debit     Credit    Balance
30/6/08   Balance                                                                     1,600 dr
          Profit and loss (7)                                                1,600      nil


                                            Office Salaries
  Date                          Details                          Debit     Credit    Balance
30/6/08   Balance                                                                     4,600 dr
          Profit and loss (7)                                                4,600      nil


                                          Interest on Mortgage
  Date                          Details                          Debit     Credit    Balance
30/6/08   Balance                                                                     3,000 dr
          Profit and loss (7)                                                3,000      nil


                                               Insurance
  Date                          Details                          Debit     Credit    Balance
30/6/08   Balance                                                                     1,400 dr
          Profit and loss (7)                                                1,400      nil


                                          Stationery Expense
  Date                          Details                          Debit     Credit    Balance
30/6/08   Balance                                                                     1,250 dr
          Profit and loss (7)                                                1,250      nil




NMIT OFFSHORE PROGRAMS                            57
                                          Power and Lighting
  Date                          Details                        Debit     Credit    Balance
30/6/08   Balance                                                                   2,700 dr
          Profit and loss (7)                                              2,700      nil

                                               Postage
  Date                          Details                        Debit     Credit    Balance
30/6/08   Balance                                                                     560 dr
          Profit and loss (7)                                                560     nil

                                          Telephone Expense
  Date                          Details                        Debit     Credit    Balance
30/6/08   Balance                                                                   1,840 dr
          Profit and loss (7)                                              1,840      nil

                                            Doubtful Debts
  Date                          Details                        Debit     Credit    Balance
30/6/08   Balance                                                                     400 dr
          Profit and loss (7)                                                400     nil

                                   Depreciation – Shop Fittings
  Date                          Details                      Debit       Credit    Balance
30/6/08   Balance                                                                   7,000 dr
          Profit and loss (7)                                              7,000      nil

                                 Depreciation – Office Equipment
  Date                          Details                     Debit        Credit    Balance
30/6/08   Balance                                                                     800 dr
          Profit and loss (7)                                                800     nil

                                              Bad Debts
  Date                          Details                        Debit     Credit    Balance
30/6/08   Balance                                                                     300 dr
          Profit and loss (7)                                                300     nil

                                            Profit and Loss
  Date                          Details                        Debit     Credit    Balance
30/6/08   Trading                                                         62,650   62,650 cr
          Rent revenue (6)                                                 4,500   67,150 cr
          Discount revenue (6)                                             1,200   68,350 cr
          Interest revenue (6)                                             1,000   69,350 cr
          Advertising (7)                                          300             69,050 cr
          Discount expense (7)                                   1,600             67,450 cr
          Office salaries (7)                                    4,600             62,850 cr
          Interest on mortgage (7)                               3,000             59,850 cr
          Insurance (7)                                          1,400             58,450 cr
          Stationery expense (7)                                 1,250             57,200 cr
          Power and lighting (7)                                 2,700             54,500 cr
          Postage (7)                                              560             53,940 cr
          Telephone expenses (7)                                 1,840             52,100 cr
          Doubtful debts (7)                                       400             51,700 cr
          Depreciation – shop fittings (7)                       7,000             44,700 cr
          Depreciation – office equipment (7)                      800             43,900 cr
          Bad debts (7)                                            300             43,600 cr




NMIT OFFSHORE PROGRAMS                            58
Notes:
    Because the balance in the Profit and Loss Account is a credit balance it represents
       the ‘net profit’ of the business for the period. That is, the items that were credited to
       the account were items that increase net profit and the items that were debited to the
       account were items that decrease net profit. A debit balance in the profit and loss
       account would therefore indicate a ‘net loss’.
    Although the general journal entry in step 6 credited the profit and loss account with
       the total amount for other revenue items, the individual amounts must be recorded in
       the ledger.
    Although the general journal entry in step 7 debited the profit and loss account with
       the total amount for all other expense items, the individual amounts must be recorded
       in the ledger.

Once the balance in the profit and loss account is known, the next step is to complete a
general journal entry to transfer this balance to the ‘capital account’.

Step 8.

                                  Basic Trading – General Journal
  Date                                 Details                             Debit        Credit
30/6/08    Profit and loss                                                  43,600
              Capital                                                                       43,600
           To transfer net profit

When the above entry is posted to the ledger it has the affect of closing the ‘Profit and Loss
Account’ to a ‘nil’ balance.

The ‘Profit and Loss’ and ‘Capital’ accounts, after the above journal entry is posted the
ledgers, are shown as follows:

                                          Basic Trading
                                      General Ledger (extract)

                                           Profit and Loss
  Date                           Details                     Debit        Credit       Balance
30/6/08    Trading                                                         62,650      62,650 cr
           Rent revenue (6)                                                 4,500      67,150 cr
           Discount revenue (6)                                             1,200      68,350 cr
           Interest revenue (6)                                             1,000      69,350 cr
           Advertising (7)                                          300                69,050 cr
           Discount expense (7)                                   1,600                67,450 cr
           Office salaries (7)                                    4,600                62,850 cr
           Interest on mortgage (7)                               3,000                59,850 cr
           Insurance (7)                                          1,400                58,450 cr
           Stationery expense (7)                                 1,250                57,200 cr
           Power and lighting (7)                                 2,700                54,500 cr
           Postage (7)                                              560                53,940 cr
           Telephone expenses (7)                                 1,840                52,100 cr
           Doubtful debts (7)                                       400                51,700 cr
           Depreciation – shop fittings (7)                       7,000                44,700 cr
           Depreciation – office equipment (7)                      800                43,900 cr
           Bad debts (7)                                            300                43,600 cr
           Capital (8)                                           43,600                  nil

                                               Capital
  Date                           Details                     Debit        Credit      Balance
30/6/08    Balance                                                                   100,000 cr
           Profit and loss (8)                                              43,600   143,600 cr




NMIT OFFSHORE PROGRAMS                           59
At this stage in the closing procedure, all revenue and expense ledgers have been closed to a
‘nil’ balance. They have all been summarised into one figure – net profit. This net profit is
transferred from the profit and loss account to the capital account because it represents an
increase in the owner’s equity in the business.

The final step in the procedure is to prepare a general journal entry to close the balance in the
‘drawings’ ledger to the ‘capital’ ledger and post the journal entry to the ledgers. This is done
because drawings represent a decrease in the owner’s equity in the business. The journal
and ledger entries for this step are shown as follows.

Step 9.

                                 Basic Trading – General Journal
  Date                                Details                              Debit        Credit
30/6/08      Capital                                                        2,400
                Drawings                                                                   2,400
             To close drawings


                                        Basic Trading
                                    General Ledger (extract)


                                             Capital
  Date                         Details                          Debit     Credit      Balance
30/6/08      Balance                                                                 100,000 cr
             Profit and loss                                                43,600   143,600 cr
             Drawings (9)                                         2,400              141,200 cr

                                            Drawings
  Date                         Details                          Debit     Credit       Balance
30/6/08      Balance                                                                    2,400 dr
             Capital (9)                                                     2,400        nil

The closing procedure is now complete. The balance in the ‘capital’ ledger should be
equal to the balance of ‘owner’s equity’ as shown in the Balance Sheet. The only
ledgers with balances remaining in them in the general ledger should be assets,
liabilities and capital. These balances are carried over into the next period.


Exercises

4.1

Using the Trial Balance from exercise 3.9 you are required to:

      a) Prepare general journal entries to close the ledger.
      b) Post journal entries to the general ledger.


4.2

Using the Trial Balance from exercise 3.10 you are required to:

      a) Prepare general journal entries to close the ledger.
      b) Post journal entries to the general ledger.




NMIT OFFSHORE PROGRAMS                         60
4.3

Using the Trial Balance from exercise 3.11 you are required to:

      a) Prepare general journal entries to close the ledger.
      b) Prepare the Trading, Profit and Loss, and Capital ledger accounts as they would
         appear in the general ledger.

4.4

Using the Trial Balance from exercise 3.12 you are required to:

      a) Prepare general journal entries to close the ledger.
      b) Prepare the trading, Profit and Loss, and Capital ledger accounts as they would
         appear in the general ledger.




NMIT OFFSHORE PROGRAMS                        61
5. REVERSING ENTRIES
As mentioned previously, in the section on Balance Day Adjustments, some of the
adjustments that are made on the balance date are only temporary adjustments and need to
be reversed on the first day of the next accounting period.

The balance day adjustments that need reversing are:

    -   Accrued expenses
    -   Accrued revenue
    -   Prepaid expenses
    -   Prepaid revenue (Revenue received in advance)
    -   Stock of stationery


Accrued expenses (expenses owed but not yet paid)
The balance day adjustment for accrued expenses is completed on the balance date to
include the relevant expense in the period it was incurred. It also allows us to create a liability
account (accrued expenses) for the amount owed which is shown in the current period’s
Balance Sheet.

When we move into the next period, however, the amount owed will actually be paid and the
cheque will be recorded in the cash payments journal and then posted to the relevant
expense ledger. This would mean that the same expense would have been recognised twice;
once in the previous period because of the balance day adjustment and again in the new
period when the cheque is issued.

To avoid this double-counting, the balance day adjustment for accrued expenses is reversed
on the first day of the new accounting period.


Accrued Revenue (revenue owing but not yet received)
The balance day adjustment for accrued revenue is completed on the balance date to include
the relevant revenue item in the period in which it is earned. It also creates an asset account
(accrued revenue) for the amount owing which is shown in the current period’s Balance
Sheet.

When we move into the next period, however, the amount owing will actually be received and
the amount will be recorded in the cash receipts journal and then posted to the relevant
revenue ledger. This would mean that the same revenue item would have been recognised
twice; once in the previous period because of the balance day adjustment and again in the
new period when the amount is received.

To avoid this double-counting, the balance day adjustment for accrued revenue is reversed
on the first day of the new accounting period


Prepaid Expenses (expenses paid but not yet incurred)
The balance day adjustment for prepaid expenses is completed on the balance date to
exclude the expense from the current period. That is, although the amount has been paid and
recorded in the relevant expense account in the current period, it should not be recognised as
an expense until the next period (i.e. the period in which it is incurred). The adjustment also
creates an asset account (prepaid expenses) for the amount prepaid which is shown in the
current period’s Balance Sheet.



NMIT OFFSHORE PROGRAMS                          62
When we move into the next period, however, the expense needs to be recorded back into
the relevant expense ledger. To do this, the balance day adjustment needs to be reversed on
the first day of the new accounting period. That is, the reversing entry transfers the expense
into the period in which it is incurred.


Prepaid Revenue (revenue received but not yet earned)
The balance day adjustment for prepaid revenue is completed on the balance date to exclude
the revenue item from the current period. That is, although the amount has been received and
recorded in the relevant revenue account in the current period, it should not be recognised as
revenue until the next period (i.e. the period in which it is earned). The adjustment also
creates a liability account (prepaid revenue) for the amount received in advance which is
shown in the current period’s Balance Sheet.

When we move into the next accounting period, however, the revenue needs to be recorded
back into the relevant revenue ledger. To do this, the balance day adjustment needs to be
reversed on the first day of the new accounting period. That is, the reversing entry transfers
the revenue item into the period in which it is earned.


Stock of Stationery
The balance day adjustment for stock of stationery on hand is completed on the balance date
to transfer stock of stationery on hand out of the stationery expense ledger and into the asset
account – stock of stationery. That is, the stationery expense for the current period should be
stationery ‘used’ during the period, not stationery purchased. When stationery is purchased it
is recorded in the stationery expense ledger assuming that it will all be used during the
current period. If, however, there is stock of stationery on hand at the balance date some of
the stationery purchased during the period has not been used and therefore should be
recognised as an asset (stock of stationery) rather than an expense.

When we move into the next accounting period, however, stationery on hand will actually
used and therefore the amount needs to be recorded back into the stationery expense ledger
for the this period. To do this, the balance day adjustment needs to be reversed on the first
day of the new period.

In summary, the reversing entries have the following affects:
     They ensure that revenue and expenses are recognised in the period in which they
       are earned or incurred and prevent double-counting of some revenue and expenses.
       And,
     They remove the temporary asset and liability accounts (i.e. accrued expenses,
       accrued revenue, prepaid expenses, prepaid revenue and stock of stationery) from
       the general ledger for the new period. That is, these are only assets and liabilities on
       the balance day of the current period. When we move into the next accounting period,
       accrued items will be paid or received and prepaid items will be incurred and earned
       and therefore these assets and liabilities do not relate to the new period.

It is only the above five balance day adjustments that need to be reversed on the first day of
the new accounting period.

Adjustments that create negative assets such as accumulated depreciation and allowance for
doubtful debts were completed to reflect the accounting value of non-current assets and
debtors and do not need to be reversed.

Adjustments to create liabilities such as provisions for annual and long service leave were
completed to reflect the amounts owing to employees. These items remain as liabilities until
they are paid and therefore do not need to be reversed.


NMIT OFFSHORE PROGRAMS                        63
An additional bad debt is a normal transaction that the business became aware of on the
balance date. This transaction can occur at any time during the accounting period and
therefore no reversal is required.

Reversing entries are so called because they do exactly the opposite of the original adjusting
entry. That is, if a ledger was debited in the original adjustment it is now credited in the
reversing entry and visa versa. The reversing entry therefore cancels out the original
adjustment.

Example

Given below are general journal entries for balance day adjustments prepared for the
                           th
accounting period ended 30 June 2008.

We will identify which adjustments need reversing on the first day of the next accounting
period (i.e. 1/7/08) and then complete the general journal entries to record these reversals.

We will then show the relevant ledger accounts in the general ledger and see how they were
affected by:
    - The balance day adjustment.
    - The closing entry.
    - The reversing entry

                                       General Journal
  Date                               Details                              Debit         Credit
30/6/08    Accrued revenue                                                   200
              Interest revenue                                                                 200
           Interest earned but not yet received
           Wages                                                            1,000
               Accrued wages                                                               1,000
           Wages owing but not yet paid
           Rent revenue                                                       500
               Prepaid revenue                                                                 500
           Rent received in advance
           Prepaid expenses                                                 1,200
               Insurance                                                                   1,200
           Insurance paid in advance
           Depreciation – equipment                                         4,000
               Accumulated depreciation – equipment                                        4,000
           Depreciation at 10% p.a. on cost
           Doubtful debts                                                     400
               Allowance for doubtful debts                                                    400
           2% of debtors estimated to be doubtful
           Stock of stationery                                                200
               Stationery expense                                                              200
           Stock of unused stationery

The reversing journal entries completed on the first day of the next accounting period (i.e.
1/7/07) would be completed as follows:




NMIT OFFSHORE PROGRAMS                         64
                                         General Journal
  Date                                 Details                        Debit       Credit
1/7/08    Interest revenue                                               200
             Accrued revenue                                                             200
          Reversing entry
          Accrued wages                                                 1,000
             Wages                                                                   1,000
          Reversing entry
          Prepaid revenue                                                 500
             Rent revenue                                                                500
          Reversing entry
          Insurance                                                     1,200
             Prepaid expenses                                                        1,200
          Reversing entry
          Stationery expense                                              200
             Stock of stationery                                                         200
          Reversing entry

The ledger accounts affected by the reversing entries are shown below. The revenue and
expense ledgers will have assumed balances at the 30/6/08 representing the amounts
received or paid during the accounting period. They will then show the affect of:
    - Balance day adjustment entries.
    - Closing entries
    - Reversing entries

                                   General Ledger (extract)

                                        Interest Revenue
  Date                       Details                       Debit      Credit     Balance
30/6/08   Balance                                                                 1,000 cr
          Accrued revenue                                                 200     1,200 cr
          Profit and loss                                     1,200                    Nil
1/7/08    Accrued revenue                                       200                 200 dr

                                        Accrued Revenue
  Date                       Details                       Debit      Credit     Balance
30/6/08   Interest revenue                                    200                   200 dr
1/7/08    Interest revenue                                                200          Nil

                                             Wages
  Date                       Details                       Debit      Credit     Balance
30/6/08   Balance                                                                20,000 dr
          Accrued expenses                                    1,000              21,000 dr
          Profit and loss                                              21,000          Nil
1/7/07    Accrued expenses                                              1,000     1,000 cr

                                        Accrued Expenses
  Date                       Details                       Debit      Credit     Balance
30/6/08   Wages                                                         1,000     1,000 cr
1/7/08    Wages                                               1,000                    Nil

                                          Rent Revenue
  Date                       Details                       Debit      Credit     Balance
30/6/08   Balance                                                                 6,500 cr
          Prepaid revenue                                       500               6,000 cr
          Profit and loss                                     6,000                    Nil
1/708     Prepaid revenue                                                 500       500 cr




NMIT OFFSHORE PROGRAMS                         65
                                       Prepaid Revenue
  Date                       Details                         Debit      Credit        Balance
30/6/08    Rent revenue                                                     500          500 cr
1/7/08     Rent revenue                                          500                        Nil

                                           Insurance
  Date                       Details                         Debit      Credit        Balance
30/6/08    Balance                                                                     2,400 dr
           Prepaid expenses                                               1,200        1,200 dr
           Profit and loss                                                1,200             Nil
1/7/08     Prepaid expenses                                    1,200                   1,200 dr

                                       Prepaid Expenses
  Date                       Details                         Debit      Credit        Balance
30/6/08    Insurance                                           1,200                   1,200 dr
1/7/08     insurance                                                      1,200             Nil

                                       Stationery Expense
  Date                       Details                         Debit      Credit        Balance
30/6/08    Balance                                                                     2,600 dr
           Stock of stationery                                              200        2,400 dr
           Profit and loss                                                2,400             Nil
1/7/08     Stock of stationery                                   200                     200 dr

                                       Stock of Stationery
  Date                      Details                          Debit      Credit        Balance
30/6/08    Stationery expense                                   200                      200 dr
1/7/08     Stationery expense                                               200             Nil


Exercises

5.1
                                                                                 th
From the following balance day adjustments prepared by Techno Trading on 30 June 2008,
identify the adjustments that need to be reversed and prepare the general journal reversing
             st
entries on 1 July 2008.
                                          General Journal
  Date                                 Details                          Debit        Credit
30/6/08      Electricity                                                     200
                Accrued expenses                                                           200
             Electricity owing but not yet paid
             Accrued revenue                                                 800
                Commission revenue                                                         800
             Commission earned but not yet received
             Doubtful debts                                                  100
                Allowance for doubtful debts                                               100
             Doubtful debts at 2% of debtors
             Depreciation – vehicles                                       2,500
                Accumulated depreciation – vehicles                                      2,500
             Depreciation at 20% p.a. – reducing balance
             Annual leave expense                                            700
                Provision for annual leave                                                 700
             Annual leave earned by employees but not yet taken
             Stock of stationery                                              50
                Stationery expense                                                          50
             Stock of unused stationery on hand



NMIT OFFSHORE PROGRAMS                         66
           Prepaid expenses                                                   600
              Advertising                                                                      600
           Advertising paid in advance
           Rent revenue                                                       450
              Prepaid revenue                                                                  450
           Rent received in advance

5.2

Using the trial balance from exercise 3.9, you are required to identify any adjustments that
need reversing and prepare the general journal entries for these reversals on 1/7/08.

5.3

Using the trial balance from exercise 3.10, you are required to identify any adjustments that
need reversing and prepare the general journal entries for these reversals on 1/7/08.

5.4

Using the trial balance from exercise 3.11, you are required to identify any adjustments that
need reversing and prepare the general journal entries for these reversals on 1/7/08.

5.5

Using the trial balance from exercise 3.12, you are required to identify any adjustments that
need reversing and prepare the general journal entries for these reversals on 1/7/08.




NMIT OFFSHORE PROGRAMS                        67

				
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