Accruals and Prepayments

• Accruals in the balance sheet are (current) liabilities, prepayments are (current) assets.

• They arise because of the accruals (or ‘matching’) concept - profit is not the same as cash and cash is not the same as profit!

• Expenses in the profit and loss account are recorded in the periods to which they relate - the balance sheet records the amounts over or under paid in cash

Accruals and Prepayments Example

Annual buildings insurance £4,000 paid in advance 1 July 2001. The insurance premium for the year to 30 June 2001 was £3,600. On 5th October 2001, received electricity bill for £560 for the quarter ended 30 September 2001. Other electricity costs for the year ended 30 September 2001 were £1,200. A/cing y/end is 30 September.

• P&L:

• B/Sheet:

Depreciation• Annual depreciation is charged to the profit

and loss account. It is an application of the accruals (‘matching’) concept, designed to spread the cost of fixed assets over their useful economic lives.

• Accumulated depreciation is deducted from the fixed asset cost in the balance sheet (to give net book value - NBV). This is the total depreciation charged to date.

• Depreciation is NOT a cash flow.

Main Methods

• Straight-Line – annual depreciation = (cost - scrap value)/UEL

• Reducing Balance– depreciation in year 1 = cost dep’n. rate– depreciation in year 2 = b/f NBV dep’n. rate– etc.

Example - straight-line

• Annual depreciation =

• NBV =

Example - reducing balance

• Depreciation in yr 1 =

• yr 2 =

• yr 3 =

• yr 4 =

Profit/Loss on Disposal

• When a fixed asset is sold, its NBV is no longer included in the balance sheet BUT the business may have made a profit or loss on disposal, which should be included in the P&L a/c for the year of disposal.

• Profit on disposal = sales proceeds - NBV

Example

• NBV after 2 years:

• Profit if sold for £50,000:

• Profit if sold for £80,000:

Fixed Assets and the Cash Flow Statement

• The purchase of a fixed asset is capital expenditure - the cash outflow is recorded under this heading in the CFS for the year in which it occurs.

• Remember that this initial outflow does NOT go into the profit and loss account.

• Depreciation is a non cash item and must be added back in the reconciliation of op. profit to net cash flow from op. activities.

• Disposals of fixed assets are a bit more complicated.

• Profits and losses on disposals of fixed assets must be adjusted in the reconciliation of op. profit to net cash flow from op. activities.

• Cash proceeds from the sale (an inflow) are shown in the body of the CFS for the year in which they are received.

Bad and Doubtful Debts• If you know you will never recover a specific

amount from a specific debtor, WRITE-OFF– expense in P&L a/c– deduct from debtors in B/S

• If you are unsure whether you will recover some of your debtors balance, PROVIDE– charge increase/credit decrease in provision to

P&L a/c– deduct total provision from debtors on face of

B/S

Example• Debtors currently £120,000.

• Bad debt £20,000 (customer in liquidation)

• Doubtful debts estimated at 2%. Brought forward provision for doubtful debts is £1,600.

• What will the B/S and P&L show?

• What if the b/f provision was £2,200 ?

Debtors and Creditors:Missing Numbers

• You will often be asked questions where there is a piece of information missing. You will have to find the missing number from the other numbers that you have.

• To do this, it is important that you understand how sales, cash receipts and debtors are related, and how purchases, cash payments and creditors are related.

Credit Sales/DebtorsWhat number is missing?

Opening debtors("already owed") x

+ Credit sales in period("extra sales") x

___ Total owed "T"

___

Amounts received in the period xin respect of credit sales (from debtors)

+ Amounts written off x

+ Still owed (closing debtors) x___

Total owed "T"

___

Example• Debtors in last year’s balance sheet £90,000.• Cash received from debtors this year £240,000.• Debtors in this year’s balance sheet £100,000.• What are credit sales for this year?

Credit Purchases/CreditorsOpening creditors

("already owed") x

+ Credit purchases in period("extra purchases") x

___ Total owed "T"

___

Amounts paid in the period xin respect of credit purchases

+ Still owed (closing creditors) x___

Total owed "T"

___

Cost of Sales

£Opening stock x from last year's balance

sheet (current assets)or cost of sales (P&L)

Add: Purchases x often needs to becalculated if creditpurchases are involved

______

xLess: Closing stock (x) from this year's balance

sheet (current assets)______

COST OF SALES x______

Cost of Sales: Missing Numbers

• Sometimes we need to use information about gross profit margins or mark-ups to work out the sales or purchases figure.

• Remember, gross profit = sales - cost of sales

• A ‘mark-up’ is a gross profit percentage calculated on cost of sales.

• A ‘margin’ is a gross profit percentage calculated on sales.

Examples

• Sales £1,000 made at mark-up of 25%. What is cost of sales?

• Cost of sales £500, profit margin on sales 20%. What is sales?

The Trial Balance• The trial balance is a list of balance sheet items,

separated into two columns. One column shows ‘debit’ balances, the other ‘credit’ balances.

• Debit balances are assets (or expenses), credit balances are liabilities (or income).

• If everything has been recorded correctly, it should balance (just like the balance sheet).

• Unfortunately, there could be a mistake and the TB could still balance - e.g. if you forget to record a transaction altogether

Example Trial BalanceDR CR

£ £Land and Buildings cost 50,000Buildings accumulated depreciation 4,000Machinery cost 12,000Machinery accumulated depreciation 3,000Stock 3,500Trade debtors 5,000Provision for doubtful debts 500Cash in hand 45Bank overdraft 2,000Trade creditors 3,600Mortgage 30,000Capital 10,000Reserves (incl. retained profit) 17,445

70,545 70,545

Double-Entry Book-keeping• Every transaction has two effects

• One effect is a ‘debit’ (DR) and one effect is a ‘credit’ (CR)

• Create ‘T’ accounts for each category in the balance sheet (and P&L)

• ‘Debit’ and ‘credit’ these as appropriate - must ‘debit’ one ‘T’ account and ‘credit’ another each time. Record as ‘journals’.

• At end, ‘close off’ all B/S ‘T’ accounts, and put c/f balances into the ‘trial balance’.

What do you debit or credit?Balance Sheet Accounts

DR CRAsset + Liability (Claim) +Liability – Asset –

Profit & Loss AccountsDR CR

Expenses + Income +Income – Expenses –

Simple Example - Joe Smith Revisited

‘Journal’ Entries:£

Start business – invest £1,000 cash

Dr cash 1,000 Cr capital 1,000

Purchase stock for cashDr purchases 100 Cr cash 100

Sell stock for cashDr cash 150 Cr sales 150

Purchase stock on creditDr purchases 50 Cr trade creditors 50

Cash at Bank Capital

Bal c/f_________________ _________________ ______________ _________________

_________________ _________________ ______________ _________________

Balance b/f

Trade Creditors Stock

Bal c/f Bal c/f_________________ ________________ ______________ _________________

_________________ ________________ ______________ _________________

Balance b/f Balance b/f

Sales Purchases

Trading Account Profit and Loss Account (Reserves)

Bal c/f______________ _________________

______________ _________________

Balance b/f

Joe Smith Trial Balance

£ £DR CR

Cash 1,050Stocks 50Creditors 50Capital 1,000Profit and Loss Account 50

_________________ _________________

1,100 1,100_________________ _________________

• Check that you could produce the balance sheet and P&L for the simple Joe Smith example.

• Lecture examples 5 and 6 are more complex.

• We will do example 5 in the lecture. You can work through example 6 yourselves (it is rather long and quite hard - contact me if you need extra help) as you have the completed ledger in the notes.

Example 5: The Ashton Company Revisited

• Journal entries:

Cash at Bank Trade CreditorsBal b/f 350 Bal b/f 18,000

Bal c/f______________ _________________

______________ _________________

Balance b/f || Stock - Raw Materials

Bal b/f 17,500

Bal c/f_________________ _________________ ______________ _________________

_________________ _________________ ______________ _________________

Balance b/f

Trade Debtors Stock - Finished GoodsBal b/f 30,000 Bal b/f 10,000

Bal c/f Bal c/f_________________ _________________ ______________ _________________

_________________ _________________ ______________ _________________

Balance b/f Balance b/f

Sales Purchases

Manufacturing Expenses Non-Manufacturing Expenses

Trading Account Profit and Loss Account (Reserves)Bal b/f 34,200

Bal c/f______________ _________________

______________ _________________

Balance b/f

The Ashton Company Trial Balance

DR CR£ £

Land (NBV) 20,000Buildings (NBV) 35,000Plant and machinery (NBV) 50,000Investments 2,500Stock - raw materialStock - finished goodsDebtorsCash in hand 50Trade creditorsBank overdraftMortgage 12,500Proprietor’s capital 100,000Retained profit (reserves)

Control Accounts

• Missing numbers questions involving debtors/sales/cash receipts or creditors/purchases/cash payments can be answered using ‘control accounts’.

• Control accounts are ‘T’ accounts for either debtors/receivables, or creditors/payables.

• The idea is the same as we saw before (incomplete records) - you can use either method for answering questions

Receivables/Sales/DebtorsBalance b/f (openingbalance) – last year'sBalance Sheet

X Cash received fromdebtors during the year –bank a/c

x

Credit sales for year (maybe a missing figure!)

X Bad debts written off inyear

x

Returns inwards x

Closing debtors(receivables) – currentasset in this year'sBalance Sheet

x

__________ __________

X x__________ __________

Payables/CreditorsPayments made during theyear (Bank a/c)

X Opening balance b/f atstart of year – last year'sBalance Sheet

x

Returns outwards XCredit purchases duringthe year (may be'missing figure')

x

Closing creditors – currentliability is this year'sBalance Sheet

X

__________ __________

X x__________ __________

Incomplete Records - Example

Receivables/Sales/DebtorsBalance b/f Cash received from

debtors during thequarter

Credit sales for quarter Bad debts written off inquarter

Returns inwards inquarter

Closing debtors(receivables)

__________ __________

__________ __________

• Cost of Sales for quarter:

£ %

Sales

Less: COS

Gross Profit

• Purchases for quarter:

£

Opening Stock

Purchases

Less: Closing Stock

Cost of Sales

Payables/CreditorsPayments made during thequarter

Balance b/f

Returns outwards inquarter

Credit purchases duringthe quarter

Closing creditors__________ __________

__________ __________

• Go through as much of Chippendale as there is time for