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Chapter 7
Accounting Policies
Slide 2 notes reference - page 65
Accounting Standards
• Aim to narrow areas of choice and improve comparability.
• Apply to all accounts intended to give a truthful presentation (true and fair view).
notes reference - page 65
The objective of financial statements
To provide information about the financial position, performance and changes in
financial position of an enterprise that is useful to a wide range of users in making economic
decisions
Slide 4 notes reference - page 65
Underlying assumptions
• Going concern
The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future.
Hence, it is assumed that the enterprise has neither the intention nor the need to liquidate or curtail
materially the scale of its operations; if such an intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the
basis used is disclosed.
Slide 5 notes reference - page 65
Underlying assumptions
• Accruals
The effects of transactions and other events are recognised when they occur (and not as cash or its
equivalent is received or paid) and they are recorded in the accounting records and reported in the financial
statements of the period to which they relate
Slide 6 notes reference - page 65
Other concepts, conventions and qualities
• Prudence
• Consistency
• Entity concept
• Separate valuation principle
• Materiality
• Historical cost convention
Chapter 8
Accruals and prepayments
Slide 8 notes reference - page 71
Accruals
Accruals are expenses incurred by the business during theaccounting period but not yet paid for.
Shown in the balance sheet under “Current liabilities”
Slide 9 notes reference - page 71
Accruals example
Accounting period
1.1.X4 31.12.X41.10.X4
Period to which bill relates
Accrue bill at 31.12.X4
Pay telephone bill$60 on 1.1.X5
Slide 10 notes reference - page 71
Prepayments
Prepayments arise when expenses are paid for before theyhave been used.
Shown in the balance sheet under “Current assets”
Slide 11 notes reference - page 72
Prepayments example
Accounting period
Period to which bill relates
1.1.X4 31.12.X4 31.12.X5
Pay insurance billon 20.12.X4
Prepayment at 31.12.X4
Slide 12 notes reference - page 72
Lecture example 1ElectricityDate paid10.3.X412.6.X414.9.X410.12.X4
96Amount
120104145
Period2 months to 28 Feb 20X4Quarter to 31 May 20X4Quarter to 31 August 20X4Quarter to 30 Nov 20X4
Rates1.2.X46.4.X4
3751,584
3 months to 31 March 20X412 months to 31 March 20X5
1 July 20X4 employed assistant. Paid assistant $150 permonth on 28th of each month.
6 March 20X5 received electricity bill for $168 forquarter to 28 Feb 20X5.
Slide 13 notes reference - page 73
Lecture example 1
Electricity
Expense for yearto 31.12.X4
Accrual Prepayment Total paid
Rates
Wages
465
1,959
900
521 (W1)
1,563 (W3)
900
56
396
-
-
--
(W1) 96 + 120 + 104 + 145 + (1/3 x 168)
(W3) 375 + (9/12 x 1,584)(W4) 3/12 x 1,584
(W4)
(W2)
(W2) 1/3 x 168
(W5) 6 x 150
(W5)
Slide 14 notes reference - page 73
Year-end adjustments
AccrualsDebit ExpenseCredit Accruals
PrepaymentsDebit PrepaymentsCredit Expense
Slide 15 notes reference - page 74
Lecture example 2
104Cash14.9.X4
521I/S31.12.X456Accruals31.12.X4
145Cash10.12.X4
120Cash12.6.X4
96Cash10.3.X4
56bal b/d1.1.X5
56Electricity31.12.X456bal c/d31.12.X4
Electricity
Accruals
521521
5656
Slide 16 notes reference - page 74
1,563I/S31.12.X41,584Cash6.4.X4
375Cash1.2.X4
Rates
1,9591,959
396bal b/d1.1.X5
396bal c/d31.12.X4396Rent31.12.X4
Prepayments
396396
Lecture example 2 part (c)
396Prepayments31.12.X4
Slide 17 notes reference - page 74
Lecture example 2
150Cash28.9.X4
900I/S31.12.X4
150Cash28.11.X4
150Cash28.10.X4
150Cash28.8.X4
150Cash28.7.X4
Wages
900900
150Cash28.12.X4
Slide 18 notes reference - page 75
Accruals and prepayments
Situation so far: Year end adjustmentcompleted
Revenues matched expenses
Accrual or Prepayment created
Slide 19 notes reference - page 75
Reversals illustration
Bal b/d on prepayments is $396Paid rates in X5 of $1,740 for 12 months
Prepayment from last year Cash paid that relates to this year
31.12.X51.4.X5
3/12 * $1,584($396)
9/12 * $1,740 = $1,701 ($1,305)
1.1.X5
The other 3/12 x $1,740
= $435 is a prepayment
Slide 20 notes reference - page 76
Reversals illustration (cont’d)
Cash 1,740 Prepayment 435 Bal b/d 396
Rent 435
Rates expense Prepayments
Slide 21 notes reference - page 76
Reversals illustration (cont’d)
Opening prepayments must therefore be reversed
Dr Rates expense (I/S)
Cr Prepayments (B/S)
Slide 22 notes reference - page 77
Summary - Reversals
Accruals Prepayments
Debit AccrualsCredit Expense
Debit ExpenseCredit Prepayments
Slide 23 notes reference - page 77
Steps
• Reverse the opening accrual/prepayment
• Post cash paid
• Post closing accrual/prepayment
Slide 24 notes reference - page 77
396Reverse prepayment1.1.X5
Rates
2,1362,136
(3/12 x 1,740)435Prepayments31.12.X5
435bal b/d1.1.X6
435bal c/d31.12.X5
396bal b/d1.1.X5
Prepayments
831831
Lecture example 3
1,701I/S31.12.X5
1,740Cash10.4.X5
396Reverse prepayment1.1.X543531.12.X5 Rates (3/12 x 1,740)
Slide 25 notes reference - page 78
Lecture Example 4
Date paid Amount Period $ quarter
12.3.X5 168 Feb 20X5
9.6.X5 134 May 20X5
12.9.X5 118 Aug 20X5
12.12.X5 158 Nov 20X5
During March 20X6 Fiona received bill for $189 for quarter to 28 February 20X6
Accounting
Opening accrual
Cash paid
Cash paid
Cash paid
Slide 26 notes reference - page 78
Lecture example 4
(a) The closing accrual is
(b) The electricity expense for the year is
$63
$585
118Cash12.9.X5
585I/S31.12.X5
158Cash12.12.X5
134Cash9.6.X5
168Cash12.3.X5
Electricity
641641
Working
63Accruals31.12.X5(1/3 x 189)
56Reverse accrual1.1.X5
Chapter 9
Non-current assets and depreciation
Slide 28 notes reference - page 83
Definitions
Intended for use on continuing basis
Non-current assets
Property, plant and equipmentTangible assets
– production/supply of goods/services– rental to others– admin purposes
AND
Expected use > 1 period
Slide 29 notes reference - page 83
Lecture example 1
• Land and buildings
• Plant and equipment
• Motor vehicles
• Furniture and fixtures
Slide 30 notes reference - page 83
Non-current asset register
A listing of all non-current assets owned by the organisation
Details likely to be kept:- serial number- description of asset- location of asset- purchase date- cost- depreciation method & estimated useful life- net book value
Slide 31 notes reference - page 84
Capital expenditureCapital expenditure
Results in NCA on B/S
Initial cost of NCA expenditure on NCA Subsequent
Purchase
price
Directly attributable costs
- acquisition costs- site preparation- delivery & handling- installation- professional fees
Improves earningcapacity of NCA
more
output
better
quality
output
longer
life of
NCA
Slide 32 notes reference - page 85
Revenue expenditureRevenue expenditure
Expense in IS
expenditure on NCA Subsequent To carry on trade of
business
e.g. rent
electricity
Maintains existingearning capacity
repairs routine
maintenance
of NCA
Slide 33 notes reference - page 85
Lecture example 2Frodo Ltd buys a car for a sales representative.
The invoice contained the following information:
List price of the car 15,000Road tax 165Burglar alarm system 200Petrol 30Delivery charge 100
The car will be shown in the B/S at a cost of 15,300
List price 15,000
Burglar alarm system 200Delivery charge 100
15,300
Working
Slide 34 notes reference - page 86
Depreciation
“…the systematic allocation of the depreciable amount of an asset over its useful life.”
All non-current assets apart from land should be
depreciated
Slide 35 notes reference - page 86
Depreciation
There are 3 methods of calculating depreciation:
(a) Straight line(b) Reducing balance(c) Machine hour
Slide 36 notes reference - page 86
Depreciation = cost – residual value
useful economic life (years)
Residual value = expected proceeds at end of UEL
or
Depreciation = % x (cost – residual value)
Straight line method
Slide 37 notes reference - page 87
Lecture example 3
(a) The annual depreciation charge is $400
2,500 - 500
5 years= 400
Slide 38 notes reference - page 87
2,5005
2,5004
2,5003
2,5002
2,5001
NBVAcc depnCostYear
400
800
1,600
2,100
1,700
1,300
900
500
Lecture example 3 part (b)
1,200
2,000
notes reference - page 87
Lecture example 2 (cont’d)
Graphical representation
$2,500
500
0 5Year
NBV
Slide 40 notes reference - page 87
Depreciation = depreciation rate (%) x NBV
Cost – accumulated depn to date
Reducing balance method
Slide 41 notes reference - page 88
NBVYear
rate expense depn
5184
8643
1,4402
2,4001
AccDepn
2,400 3,600
2,160
1296
778
Lecture example 4 part (a)
Depn
3,840
4,704
5,222
40%
40%
40%
40%
notes reference - page 88
Lecture example 4 (cont’d)
Graphical representation
778
$6,000
1 2 3 4 5Year
NBV
3,600
2,160
1,296
Slide 43 notes reference - page 89
Machine hour method
Depreciation = cost – residual value
useful economic life (hours)x actual
use p.a.
Slide 44 notes reference - page 89
Lecture example 5
(a) The depreciation rate per HOUR is £6
125,000 – 5,000
20,000 hours= £6
Slide 45 notes reference - page 89
NBVYear
expense depnuse
30,0003
42,0002
48,0001
AccActual
48,000 77,000
35,000
5,000
Lecture example 5 part (b)
hoursDepn
90,000
120,000
8,000
7,000
5,000
Slide 46 notes reference - page 90
Accounting for depreciation
Dr Depreciation expense (I/S)
Cr Accumulated depreciation (B/S)
Slide 47 notes reference - page 90
Lecture example 6 part (a)Machine
2,5002,500
Cash 2,500
bal b/d
bal c/d 2,500
2,500
Depreciation expense
Year 1 Acc depn 400
Year 2 Acc depn 400
Year 3 Acc depn 400
Year 4 Acc depn 400
Year 5 Acc depn 400
Year 1 IS 400
Year 2 IS 400
Year 3 IS 400
Year 4 IS 400
Year 5 IS 400
Slide 48 notes reference - page 91
Lecture example 6 part (a)
400Depn exp2000bal c/d
1600bal b/dYear 5
400Depn exp1600bal c/d
1200bal b/dYear 4
400Depn exp1200bal c/d
800bal b/dYear 3
400Depn exp800bal c/d
400bal b/dYear 2
400Depn expYear 1400bal c/d
400400
800800
12001200
16001600
20002000
Accumulated depreciation
Slide 49 notes reference - page 91
Lecture example 6 part (b)
Income Statement (extract)
ExpensesYear 1 Year 2 Year 3 Year 4 Year 5
Depreciation 400 400 400 400 400
Slide 50 notes reference - page 91
Lecture example 6 part (b)
Balance Sheet (extract)
Cost Acc depn NBV
Year 1
Year 2
Year 3
Year 4
Year 5
2,500 (400) 2,100
2,500 (800) 1,700
2,500 (1,200) 1,300
2,500 (1,600) 900
2,500 (2,000) 500
Slide 51 notes reference - page 92
Lecture example 6 part (c)
Journal entry
Debit Credit
Depreciation expense 400
Accumulated depreciation 400
Being annual depreciation charged on machine
Slide 52 notes reference - page 92
Disposal of non current assetsProfit/loss on disposal
NBV < sales proceeds = profitNBV > sales proceeds = loss
Accounting treatment
Everything to do with disposal is transferred to a Disposal a/c
(a) Transfer original cost of asset to disposal a/c
(b) Transfer accumulated depreciation to disposal a/c
(c) Post sales proceeds
(d) Balance off disposal a/c to find profit/loss on disposal
(e) Profit on disposal = sundry income in I/S Loss on disposal = expense in I/S
Slide 53 notes reference - page 93
Lecture example 7The profit/loss on disposal is
Machine
bal b/d Disposal 6,0006,000
Accumulated depreciation
bal b/d 3,840Disposal 3,840
Disposal
6,8406,840
Accum depn 3,840Machine cost 6,000
Cash 3,000Profit on disposal
(I/S) 840
$840
Slide 54 notes reference - page 94
Lecture example 8The profit/loss on disposal is
Machine
bal b/d Disposal 6,0006,000
Accumulated depreciation
bal b/d 3,840Disposal 3,840
Disposal
6,8406,840
Accum depn 3,840Machine cost 6,000
Profit on disposal (IS) 840
$840Cash paid for the new machine is $7,000
New machine 3,000(part exchange)
Slide 55 notes reference - page 94
Lecture example 8 (cont)
New machine
10,00010,000
bal b/d 10,000
Disposal (part ex) 3,000
bal c/d 10,000Cash 7,000
Slide 56 notes reference - page 94
Land and Buildings
Non-current assets are depreciated over their useful life
Property is split into land and building elements for depreciation
Land is not normally depreciated as it has an unlimited useful life
Slide 57 notes reference - page 95
If an item of property has increased in value, IAS 16 allows the asset to be revalued to show the increase in value on the balance sheet.
All items in the same class must be revalued at the same time.
Revaluations
Slide 58 notes reference - page 95
Land and Buildings – accounting treatment
REVALUED
Dr NCA costDr Accumulated depreciationCr Revaluation reserve/Capital
Slide 59 notes reference - page 96
Lecture example 9The balance on the capital a/c / revaluation surplus is $70,000
Accumulated depreciationbal b/d 20,000
Building
150,000150,000
Revaluation 20,000
bal b/d 100,000Revaluation 50,000
Capital/Revaluation Surplus
Building 50,000Accum depn 20,000bal c/d 70,000
bal c/d 150,000
70,00070,000
Slide 60 notes reference - page 97
Lecture example 10
Date Depn charge Acc Depn NBV
31.12.X5 200,000/5 = 40,000 40,000 160,000
31.12.X6 40,000 80,000 120,000
31.12.X7 40,000 120,000 80,000
Working
Slide 61 notes reference - page 97
Lecture example 10 (cont.)
(a) Asset revalued on 1.1.X8 to 250,000. The double entry
to reflect the revaluation is:
Dr NC asset (250,000 – 200,000) 50,000
Dr Accumulated depn (Working) 120,000
Cr Revaluation surplus 170,000
Slide 62 notes reference - page 97
Lecture example 10 (cont.)
(b) Asset revalued on 1.1.X8 to 180,000. The double entry
to reflect the revaluation is:
Dr Accumulated depn (Working) 120,000
Cr NC Asset (200,000 – 180,000) 20,000
Cr Revaluation surplus 100,000
Slide 63
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