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Prior Lecture Slides: Adjustments
Prior Lecture Slides: Adjustments
ADJUSTMENTS
Textbook Chapter: 6
These slides have been developed using slides which accompany the textbook for
this course, Financial Accounting: an Introduction by Jacqui Kew and Alex Watson,
published by Oxford University Press.
Many thanks to the authors and publisher for graciously permitting their use.
Students are encouraged to refer to the textbook at all times. These slides are in
Weeks 6 and 7 no way intended as a complete guide to the course material. 1
Learning objectives
• Understand the need for adjustments
• Understand how adjustments fit into the accounting process
• Process adjustments for:
– Bookkeeping errors
– Prepaid expenses
– Income received in advance
– Accrued income
– Accrued expenses
– Inventory write-downs
– Bad debts expense
– Allowance for doubtful debts
– Depreciation
• Understand the effects of adjusting entries and reversals on
the financial statements
• Consolidate the students’ understanding of the accrual basis
(matching
Weeks 6 and 7 expenses against revenue). 2
The accounting process
Transaction (& related
source document)
Weeks 6 and 7 3
The accounting process
Prepared
whenever
Financial
Statements
need to be
prepared
Processed
whenever
Financial
Statements
need to be
prepared
Weeks 6 and 7 4
Recording/reporting process
Processed
whenever
financial
statements
need to be
prepared
Weeks 6 and 7 5
Recording and Reporting
Recording Reporting
Weeks 6 and 7 6
Adjusting entries
• What is the function of adjusting
entries?
• Why are adjusting entries needed?
– ...
– ...
– ...
Weeks 6 and 7 7
Why can’t recording always achieve
correct information?
OR
Financial statements
Stationery Stationery
used on hand
Weeks 6 and 7 9
Example
The financial statements need to
be prepared at 31 December:
•Assume stationery of R1 000 is on
hand
•How should the records be adjusted
so that the reports are accurate?
Weeks 6 and 7 10
Adjusting journal entries
Weeks 6 and 7 11
General ledger
Stationery (Asset)
Stationery (Expense)
Weeks 6 and 7 12
Alternative adjusting entries
If the bookkeeper initially recorded:
Dr Stationery asset R3 000
Cr Bank R3 000
Weeks 6 and 7 13
General ledger
Stationery (Asset)
Stationery (Expense)
Weeks 6 and 7 14
What types of adjustments need to be made?
Example 3 Example 5
Cash paid this year,
benefit from
expense used next
year
Benefit from
expense used this
year, cash paid next
year
Weeks 6 and 7 17
Adjustments: Income
Effect on profit Effect on SOFP
Cash received this
year, goods/service
provided this year
Example 7 Example 9
Cash received this
year, goods/service
provided next year
Goods/service
provided this year,
cash received next
year
Weeks 6 and 7 18
Reversals of adjustments
• For prepaid expenses, accrued expenses,
income received in advance and accrued
income...
• in cases where payments during the year are
expensed, and receipts recorded as income by
the bookkeeper...
• the adjustments are usually reversed at the start
of the next financial period.
• Why?
Weeks 6 and 7 19
Reversals: Prepaid expense
Year 1 Year 2
Weeks 6 and 7
Example 4 20
Reversals: Accrued expense
Year 1 Year 2
Electricity exp
Weeks 6 and 7
Example 6 21
Reversals: Income received in
advance
Year 1 Year 2
Received R37 500 – not The business will earn R37 500 by
yet earned supplying the goods – no further
cash will be received
Sales
Weeks 6 and 7
Example 8 22
Reversals: Accrued income
Year 1 Year 2
Interest income
Weeks 6 and 7
Example 10 23
Example of accrued interest
expense
On 1 February 2009, Play World acquired a loan from
Lenders Bank. The loan agreement stated that the loan
would be paid back in five equal annual instalments starting
on 1 February 2010. Interest is paid every six months in
arrears on 1 August and 1 February. The interest rate
charged by Lenders Bank decreased from 12% to 11% on 30
April 2012. All payments of interest are debited to the
interest expense account.
The pre-adjustment trial balance of Play World as at 31 May
2012 showed the loan as having a credit balance of R240
000.
Weeks 6 and 7 24
Dealing with the loan itself
• How many loan repayments have been made by Play World
by 31 May 2012?
Weeks 6 and 7 25
Dealing with the interest
• How much interest was paid on:
– 1 August 2011?
– 1 February 2012?
Weeks 6 and 7 26
2012
Year
Interest expense
Bank Acc int exp
Acc int exp Profit & loss
43 200 14 400
General ledger:
9 400 38 200
52 600 52 600
Accrued interest expense Income statement
Int exp Bal b/d Amount
Bal c/d Int exp Interest expense 38 200 used
14 400 14 400
SOFP Used, but
9 400 9 400
Weeks 6 and 7
23 800 23 800 Accrued int exp 9 400 27paid
not
Impairment adjustments
An asset may never be reported at an
amount above the value of the probable
future economic benefits.
•Can it be reported at an amount below the
probable future economic benefits?
•How does one determine what the probable
future benefits are?
•What must happen if an asset has a carrying
amount above probable FEBs?
Weeks 6 and 7 28
Impairment of inventory
• If items of inventory are lost, stolen, perish or
disappear, then what?
• If items of inventory are damaged or become
obsolete:
– The carrying amount of inventory cannot be greater
than the probable FEBs. What are the probable FEBs?
– What are these expected FEBs known as?
– What is the official definition of NRV?
– By what amount should the inventory be impaired?
• Both such decreases in the carrying amount of
inventory are expensed in which account?
Weeks 6 and 7
Example 11 29
Impairment of trade receivables 1
• Carrying amount of trade receivables
cannot be greater than the probable
FEBs.
• What are the probable FEBs?
• By what amount should the trade
receivables asset be impaired?
• If the business has identified that a
debtor will not pay, what is the journal
entry?
Weeks 6 and 7
Example 12 30
Impairment of trade receivables 2
Weeks 6 and 7 33
Depreciation continued
• What is an item of PPE’s EUL?
• In what two types of ways might an item of PPE’s
EUL be measured?
• What is the most common way to measure EUL (i.e.
most common depreciation method)?
• When does depreciation start on this method?
So, depreciation is ...
Weeks 6 and 7 34
Accumulated depreciation
• When we record depreciation, what is the
journal entry?
• What type of account do we credit?
• Why?
• Will this account appear in the general
ledger?
• Will this account appear in the TBs?
• Will this account appear on the SOFP?
Weeks 6 and 7
Example 14 35
Summary example
Extract of AA Stores
Pre-Adjustment trial balance
as at 31 August 2011
Debit Credit
Sales income 1 000 000
Rent income 16 500
Rent expense 56 000
Water & electricity expense 8700
Weeks 6 and 7 36
Additional information
• AA Stores rents a property and is charged R4 000
rental per month. The bookkeeper records all cash
payments for rent as expenses.
• AA Stores estimates it used water and electricity
worth R9 000 during the year. The bookkeeper
records all payments of electricity as an expense.
• On 1 August 2010, a customer ordered and paid for
running shoes amounting to R3 500. The shoes will
only be delivered during September. The
bookkeeper included this amount in sales income.
• AA Stores owns a building in Parow industrial. The
rent income is R1 500 per month. The tenant has
occupied the building for the full financial year.
Weeks 6 and 7 37
Prepaid expense
From Pre-Adj TB
Weeks 6 and 7 38
Post adjustment trial balance
Extract of AA Stores Extract of AA Stores
Pre-Adjustment trial balance POST-Adjustment trial balance
Sales income 1 000 000 Sales income 996 500
Rent income 16 500 Rent income 18 000
Rent 56 000 Rent 48 000
expense expense
Water & 8 700 Water & 9 000
electricity exp electricity exp
Inc received 3 500
in advance
Accrued inc 1 500
Prepaid exp 8 000
Accrued exp 300
Weeks 6 and 7 39
Additional information
• AA Stores rents a property and is charged R4 000
rental per month. The bookkeeper records all cash
payments for rent as expenses.
• AA Stores estimates it used water and electricity
worth R9 000 during the year. The bookkeeper
records all payments of electricity as an expense.
• On 1 August 2010, a customer ordered and paid for
running shoes amounting to R3 500. The shoes will
only be delivered during September. The
bookkeeper included this amount in sales income.
• AA Stores owns a building in Parow industrial. The
rent income is R1 500 per month. The tenant has
occupied the building for the full financial year.
Weeks 6 and 7 40
Accrued expense
From Pre-Adj TB
Weeks 6 and 7 41
Post adjustment trial balance
Extract of AA Stores Extract of AA Stores
Pre-Adjustment trial balance POST-Adjustment trial balance
Sales income 1 000 000 Sales income 996 500
Rent income 16 500 Rent income 18 000
Rent 56 000 Rent 48 000
expense expense
Water & 8 700 Water & 9 000
electricity exp electricity exp
Inc received 3 500
in advance
Accrued inc 1 500
Prepaid exp 8 000
Accrued exp 300
Weeks 6 and 7 42
Additional information
• AA Stores rents a property and is charged R4 000
rental per month. The bookkeeper records all cash
payments for rent as expenses.
• AA Stores estimates it used water and electricity
worth R9 000 during the year. The bookkeeper
records all payments of electricity as an expense.
• On 1 August 2010, a customer ordered and paid for
running shoes amounting to R3 500. The shoes will
only be delivered during September. The
bookkeeper included this amount in sales income.
• AA Stores owns a building in Parow industrial. The
rent income is R1 500 per month. The tenant has
occupied the building for the full financial year.
Weeks 6 and 7 43
Income received in advance
From Pre-Adj TB
Weeks 6 and 7 44
Post adjustment trial balance
Extract of AA Stores Extract of AA Stores
Pre-Adjustment trial balance POST-Adjustment trial balance
Sales income 1 000 000 Sales income 996 500
Rent income 16 500 Rent income 18 000
Rent 56 000 Rent 48 000
expense expense
Water & 8 700 Water & 9 000
electricity exp electricity exp
Inc received 3 500
in advance
Accrued inc 1 500
Prepaid exp 8 000
Accrued exp 300
Weeks 6 and 7 45
Additional information
• AA Stores rents a property and is charged R4 000
rental per month. The bookkeeper records all cash
payments for rent as expenses.
• AA Stores estimates it used water and electricity
worth R9 000 during the year. The bookkeeper
records all payments of electricity as an expense.
• On 1 August 2010, a customer ordered and paid for
running shoes amounting to R3 500. The shoes will
only be delivered during September. The
bookkeeper included this amount in sales income.
• AA Stores owns a building in Parow industrial. The
rent income is R1 500 per month. The tenant has
occupied the building for the full financial year.
Weeks 6 and 7 46
Accrued income
From Pre-Adj TB
Weeks 6 and 7 47
Post adjustment trial balance
Extract of AA Stores Extract of AA Stores
Pre-Adjustment trial balance POST-Adjustment trial balance
Sales income 1 000 000 Sales income 996 500
Rent income 16 500 Rent income 18 000
Rent 56 000 Rent 48 000
expense expense
Water & 8 700 Water & 9 000
electricity exp electricity exp
Inc received 3 500
in advance
Accrued inc 1 500
Prepaid exp 8 000
Accrued exp 300
Weeks 6 and 7 48