Intro to Accounting - Edrolo · Accounting notes by Mr. A. Dalrymple ©Edrolo The Purpose of Accounting Accounting is an information system - it provides information about the operation

Edrolo.com.au Accounting notes by Mr. A. Dalrymple

©Edrolo

Intro to Accounting

Accounting Principles and

Qualitative Characteristics

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Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/accounting-principles-qualitative-characteristic/the-purpose-of-accounting/


























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Outline

• Purpose of Accounting

• The Accounting Process

• Accounting Principles & Qualitative Characteristics

• What are they?

• Why are they needed?

Unit 3 - Area of Study 1 • applicable accounting principles and qualitative characteristics of accounting

information

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The Purpose of Accounting

Accounting is an information system - it provides information about the operation of the business

The primary purpose of accounting is to provide financial information to the management of a business to allow them to make decisions.

Decisions to made by the management of a trading business:

• Types and Quantities of stock

• Staffing

• Assets

• Sources of Finance

• Investment by the Owner

• Loans

• Collections from Debtors

• Payments to Suppliers 3


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The Accounting Process

Accounting is the process of identifying, measuring, recording and communicating financial information to allow informed judgements and decisions.

Raw Data → Processing → Information

Steps in the Accounting Process

Source → Recording → Reporting → Advice

Documents

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Accounting Principles and Qualitative Characteristics

Accounting Principles & Qualitative Characteristics these are guidelines or rules to inform choices when implementing the accounting process in a business

Choices about issues such as:

• What to record • When to record • How to report • What to include in reports • How to value stock and other assets

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Principles and QC’s

At the start of the VCE course the accounting process is very clear cut and definite

The further you go in accounting the more opinion is involved - hence the need for principles and QC's to guide decisions

Fortunately the VCE Study Design course limits the choices we have to consider and in most cases specifies a particular approach to be used

So we need to know the definitions and be able to use them to justify how something should be done or why has it been done a particular way.

These definitions provide the building blocks for theory answers

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Principles and QC’s

Over the course of the year you will need to learn the links between these principles and QC’s and specific aspects of the course.

Early in the course you won’t get a complete understanding of each principle or QC. They will be referred to throughout the course – so your understanding will build as you learn to apply them.

At the introductory stage we need to know:

• the list of terms for each category

• the definition of each term

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Categories

Qualitative Characteristics

C Comparability

U Understandability

R Reliability

R Relevance

Accounting Principles

H Historical Cost

E Entity

R Reporting Period

M Monetary Unit

C Conservatism

C Consistency

G Going Concern

You must know the categories as exam questions will usually be specific: Explain, with reference to one accounting principle, why balance day adjustments are required. Identify the qualitative characteristic that supports the preparation of a Debtors Schedule.

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Qualitative Characteristics - definitions

Comparability

Users must be able to compare the financial reports of an entity through time to identify trends in the entity’s financial position and performance. Users must also be able to compare the financial reports of different entities to evaluate their relative financial position, financial performance and cash flows.

Hence, the measurement and display of the financial effect of like transactions and other events must be carried out in a consistent way.

e.g. consistent use of depreciation methods, stock valuation – consistent use of FIFO, consistent length of reporting periods

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Understandability

An essential quality of the information provided in financial reports is that it is readily understandable by users. Reports should be presented in a manner that makes it easy for the user to comprehend their meaning.

For this purpose, users are assumed to have a reasonable knowledge of business, economic activities and accounting, and a willingness to study the information with reasonable diligence.

e.g. standard report formats are used with standard headings, classifications and terms

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Reliability

To be useful, information must also be reliable. Information has the quality of reliability when it is free from material error and bias and can be depended upon by users for its accuracy.

(the best way to ensure that information is free from bias is to make sure it is verifiable by reference to a source document)

e.g. Source documents are required to provide evidence of any transactions, cross checking within the recording process – stocktakes, statements of account

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Relevance

To be useful, information must be relevant to the decision-making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluation.

(Reports should include all information that is useful for decision-making, and exclude information that is not)

Part of the consideration of Relevance is the issue of Materiality. Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial report.

e.g. balance day adjustments – revenue earned in the period matched with expenses incurred in the period, only transactions relevant to the business should be included (similar to entity principle),

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Accounting Principles - definitions

Historical cost All transactions are recorded at their original value. Therefore, items are shown in the accounting records at their historical (original) price. (as this value is verifiable by reference to a source document) e.g. Purchases of non current assets recorded at original cost, depreciation is

based on original cost, stock is recorded at purchase price Entity The business must be a separate accounting entity from its owner and from other entities. A common illustration of the entity principle is seen in the way in which the business will have separate records from the owner. e.g. Business is kept separate from owner, personal transactions are not

recorded through business or if paid by the business, they are treated as drawings

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Reporting period The ongoing life of a business is broken into regular intervals of time for the preparation of financial reports. Under accrual accounting profit is revenue earned less expenses incurred in that period. e.g. Reports are prepared regularly – at least every year, Balance Day

Adjustments, Closing entries Monetary unit To understand the meaning of the reported information it is necessary to use a common unit of measurement so all items must be recorded and reported in monetary terms. That is, in the currency of the country of location, so Australian dollars are used as this measure.

e.g. All recording and reports are shown in Aus $, everything is shown in $ terms e.g. Land & Buildings are shown at a $ value although it is a physical asset

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Conservatism

It is acknowledged that gains will not be recognised until earned and losses will be recognised as soon as they are likely to occur. This principle is followed so as not to overstate assets and revenues and not understate liabilities and expenses.

e.g. Stock on hand is valued at cost rather than selling price, assets are depreciated to reflect cost incurred over the asset’s life, bad debts are written off when it is believed that the debt will not be paid

Consistency

The accounting methods used by the business should be applied consistently from one reporting period to another. This allows valid comparisons of performance to be made.

e.g. Methods such as FIFO and straight line depreciation should be used consistently from period to period, consistent classification and set out of reports, consistent length of reporting periods

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Going concern

It is assumed that the business will be ongoing, i.e. the business will have an indefinite life. The purpose of this rule is so that a distinction can be made between assets, which will provide benefit to future reporting periods, and expenses that are totally consumed within one reporting period.

e.g. depreciation assumes that assets will provide benefit in future periods and there will be future periods in which to allocate the cost of the asset, prepaid expenses, non-current assets, non-current liabilities

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Summary

• Know what falls in each category

• Accounting Principles

• Qualitative Characteristics

• Know the definitions

• Use the language from the definitions to help build your answer – a pure definition will not get full marks – make the link to the situation described in the question

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Elements of Reports

Assets, Liabilities,

Revenue, Expenses and

Owner’s Equity Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/elements-reports/outline/

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Outline

• Elements of Financial Reports

• Definitions

• Types of Questions

Unit 3 - Area of Study 1 • the elements of financial reports: assets, liabilities, owner’s equity, revenue

and expenses

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Elements of Financial Reports

The Elements

• Assets

• Liabilities

• Revenue

• Expenses

• Owner’s Equity

You need to know the definitions of these elements and be able to use them to justify the treatment of particular items and transactions.

Vague responses to a question about these terms will gain no marks – you must use the terminology from the definitions.

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Assets & Liabilities

Assets An asset is:

• a resource controlled by the entity • as a result of past events • from which future economic benefits are expected to flow to the

entity Liabilities A liability is:

• a present obligation of the entity • arising from past events • the settlement of which is expected to result in an outflow from the

entity of resources embodying economic benefits

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Using the Asset definition

Assets An asset is:

• a resource controlled by the entity • as a result of past events • from which future economic benefits are expected to flow to the

entity You need to link the definition to the nature of the asset:

• Why is Debtors Control classified as an asset? The amount owing from Debtors represents a resource controlled by the business as a result of a past credit sale which is expected to result in an inflow of economic benefit when each Debtor pays what is owing.

• Why is Prepaid Rent Expense treated as a current asset? The unused rent represents a resource controlled by the business as a result of a past payment which is expected to result in an inflow of economic benefit as the business uses the rented space within the next 12 months.

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Using the Liability definition

Liabilities A liability is:

• a present obligation of the entity • arising from past events • the settlement of which is expected to result in an outflow from the

entity of resources embodying economic benefits You need to link the definition to the nature of the asset:

• Why is Creditors Control classified as a liability? The amount owing to Creditors represents a present obligation of the business as a result of a past credit purchase which is expected to result in an outflow of economic benefit when the account is settled

• Why are Accrued Wages reported as a current liability? The amount owing to employees represents a present obligation of the business as a result of past hours worked which is expected to result in an outflow of economic benefit when the employees are paid within the next 12 months.

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Revenues & Expenses

Revenue Revenue is:

• inflows of economic benefits or savings in outflows • in the form of increases in assets or decreases in liabilities • that lead to an increase in owner’s equity, except capital

contribution. Expenses Expenses are:

• outflows of economic benefits or reductions in inflows • in the form of decreases in assets or increases in liabilities • that lead to a decrease in owner’s equity, except drawings.

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Using the Revenue definition

Revenue Revenue is:

• inflows of economic benefits or savings in outflows • in the form of increases in assets or decreases in liabilities • that lead to an increase in owner’s equity, except capital contribution.

You need to identify the appropriate part of the definition to respond to any question about revenue:

• Why is cash sales treated as revenue? it is an inflow of economic benefits in the form of an increase in the asset Cash at Bank that leads to an increase in owner’s equity which is not related to a contribution of capital

• Why is discount revenue classified as revenue? it is a savings in outflows in the form of a reduction in the liability Creditors Control that leads to an increase in owner’s equity which is not related to a contribution of capital

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Using the Expense definition

Expenses Expenses are:

• outflows of economic benefits or reductions in inflows • in the form of decreases in assets or increases in liabilities • that lead to a decrease in owner’s equity, except drawings.

As with revenue, you need to identify the appropriate part of the definition to respond to any question about expenses:

• Why is cost of sales treated as an expense? it is an outflow of economic benefits in the form of a decrease in the asset Stock Control that leads to an decrease in owner’s equity not related to drawings

• Why is discount expense classified as an expense? it is a reduction in inflows in the form of a decrease in the asset Debtors Control that leads to an decrease in owner’s equity not related to drawings

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Owner’s Equity

Owner’s Equity

Equity is the residual interest in the assets of the entity after deducting all its liabilities. i.e. OE = A – L.

This is the accounting equation from which we develop our accounting system. Because owner’s equity is seen as what is left of the assets after deducting what is owed to outsiders (liabilities), the equation must always balance.

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Summary

• Learn the definitions of the elements

• Always refer to the relevant definition when asked to explain why something is reported an asset, liability, revenue or expense

• Choose the appropriate part of the definition – especially with revenues and expenses

• Link the definition to the situation that you are answering

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The Accounting

Equation

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Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/accounting-equation/outline/
















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Outline

• The Accounting Equation

• The ‘two-fold’ effect of transactions

Unit 3 - Area of Study 1 • the two-fold effect of transactions on the accounting equation • the effect of transactions on the accounting equation and the accounting

reports

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The Accounting Equation

The financial position of a business can be measured by looking at the relationship between:

Assets - resources controlled by the business (what it owns)

Liabilities - obligations of the business (what it owes to others)

Owner’s Equity - the difference between assets and liabilities

The accounting equation gives us a simple way to understand how these three amounts relate to each other.

The accounting equation for a sole trader is:

Assets = Liabilities + Owner’s Equity

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Understanding the Equation

Assets = Liabilities + Owner’s Equity Two ways of understanding the equation: 1. How have the assets been financed? If a business has assets of $400,000 - where have they come from? How have they been financed?

Either: • The owner has provided all of the funds, or • Debt has been used to finance some or all of the assets

Assets = Liabilities + Owner's Equity

400,000 = 100,000 + ?

So if we knew that this business has liabilities of $100,000 , that would mean that the owner has $300,000 invested in the business.

300,000

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Assets = Liabilities + Owner’s Equity 2. What would happen if the business is wound up or sold off?

Let's say that the business has assets of $350,000. If these assets were sold for that amount, where would the cash go? There would be two main types of claims that could be made on this $350,000. The claims on these assets are called Equities. One type of claim would come from people outside of the business - external equities (Liabilities) The other claim would come from the owner (Owner’s Equity) Assets = Equities (Claims on Assets) Liabilities + Owner's Equity

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Assets = Equities (Claims on Assets)

Liabilities + Owner's Equity

So if the assets were sold for $350,000 and $200,000 was owed to creditors, how much would be left for the owner?

Assets = Equities


350,000 = 200,000 + ? 150,000

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The 'two fold' effect

The Accounting Equation must always remain balanced (the sides must equal each other).

That means if one thing changes in the equation there must be at least one other item affected.

So whenever a transaction occurs, there will be at least two effects on the accounting equation

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The 'two fold' effect - example

For example , if we continue with the previous equation:


350,000 = 200,000 + 150,000

If the business pays $2000 owing to a creditor. Effect 1: this will decrease Cash at Bank so Assets will decrease by $2000. Effect 2: Creditors will also decrease as less is now owing - so Liabilities will

decrease by $2000. As a result, the new equation would be:


348,000 = 198,000 + 150,000

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The 'two fold' effect - example

If the owner now decides to take $3000 of stock out of the business for personal use. Effect 1: this will decrease Stock, so Assets will decrease by $3000. Effect 2: by withdrawing assets the owner has reduced her investment in the

business so Owner’s Equity would decrease by $3000 As a result, the new equation would be:


348,000 = 198,000 + 150,000


345,000 = 198,000 + 147,000

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Double Entry Recording

• Every transaction has to affect at least two items to ensure the accounting equation remains balanced

• This 'two-fold' effect is a fairly simple idea but it is crucial to everything we will do in our course

• Every time we record a transaction we will need to ensure that the Accounting Equation remains balanced

• The two fold effect on the Accounting Equation is the

foundation of the 'double entry' recording system we will use throughout Units 3 & 4.

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Double Entry

Accounting Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/double-entry-accounting-

ledger-rules/the-accounting-equation-and-the-two-fold-effect/

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https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/double-entry-accounting-ledger-rules/the-accounting-equation-and-the-two-fold-effect/



































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Outline

• The ‘two-fold’ effect of transactions

• Double Entry Accounting

• The Ledger

• Ledger Rules

Unit 3 - Area of Study 1 • the two-fold effect of transactions on the accounting equation • the general ledger using T-form accounts • the effect of transactions on the accounting equation and the accounting

reports 40


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The Accounting Equation and the Two-fold effect


Remember that every transaction will have a 'two-fold' effect on the accounting equation - at least two items must change if the equation is to remain balanced

Units 1 & 2 used 'single-entry' accounting - that involved a series of calculations and schedules to enable us to prepare reports. This is fine for relatively simple businesses with a small number of transactions to be recorded.

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Double Entry Accounting

Double entry accounting is a more complex system which uses ledger accounts to record the double effect on the accounting equation of each transaction.

This system makes the step to reporting far simpler for businesses with a large number of transactions.

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Ledger Accounts

What are ledger accounts? A ledger account is simply: • a financial record where transactions are recorded and stored • with a separate ledger account for each and every item in the firm’s

records. Each individual ledger account will record all increases or decreases in that particular item. When you receive your bank statement (or access your account on line), you are looking at your personal ledger account within the Bank’s accounting system. Your Bank Statement provides a record of each and every transaction that has affected your balance. The bank needs to have separate ledger accounts for each and every customer’s account that they have.

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Ledger Accounts

There is no limit to the amount of accounts a business could have within its ledger. There will have separate ledger accounts for Bank, Stock Control, Debtors Control, Creditors Control, Loans, Wages, Capital etc. All of these ledger accounts together are called the General Ledger.

• The Bank ledger account will record all movements of cash in and out of the firm’s bank account

• The Stock Control ledger account will record all movements of stock in and out of the business

• The Creditors Control account will record all increases and decreases in what the firm owes to its suppliers.

Ledger account – an accounting record showing all the transactions that affect a particular item General Ledger – the main group of ledger accounts

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The T-format ledger

In VCE Accounting we will use the T-form of ledger account.

A T-form account has a very simple structure with two sides

The terms Debit and Credit mean nothing more than the left hand side and right hand side of an account

Account Name

Debit Side DR

Credit Side CR

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Two fold effect and Double Entry Recording

We know that every transaction has a two-fold effect on the accounting equation.

In the ledger, every transaction will affect at least two ledger accounts.

Every transaction must be recorded on the debit side of one ledger account and the credit side of another.

The accounting equation will remain balanced as long as any Debit entries are matched by Credit entries of the same amount.

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Ledger Rules

How do we know whether to put an entry on the debit side or the credit side of an account?

All entries in ledgers are governed by a set of double entry rules.

These rules are derived from the Accounting Equation


Debit Side Credit Side

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Ledger Rules - Assets, Liabilities, OE

DR Assets CR

+ -

Increases Decreases

Liabilities & DR Owner’s Equity CR

- +

Decreases Increases

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Ledger Rules – Revenues and Expenses

DR Owner’s Equity CR

- +

Decreases Increases

DR Revenues CR

- +

Decreases Increases

DR Expenses CR

+ -

Increases Decreases

Revenues increase Owner’s Equity – so an increase in a revenue account will be a credit entry

Expenses decrease Owner’s Equity – so an increase in an expense account will be a debit entry

The ledger rules for revenues and expenses come from their impact on Owner’s Equity

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Ledger Rules – in summary

Assets & DR Expenses CR

+ -

Increases Decreases

Liabilities, Revenues & DR Owner’s Equity CR

- +

Decreases Increases

Remember that debit and credit simply mean the left and right sides of the accounts

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Ledger Rules – other ways of remembering

AID asset increase debit LIC liability increase credit PIC proprietorship increase credit RIC revenue increase credit EID expense increase debit

Simplest way is to remember ‘Asset & Expense increase debit’

ACCOUNT TYPE INCREASE DECREASE

Assets Debit Credit Liabilities Credit Debit Owner’s Equity Credit Debit Revenue Credit Debit Expenses Debit Credit

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Summary

• Every transaction has a two-fold effect on the accounting equation so in the ledger every transaction will affect at least two ledger accounts.

• The accounting equation will remain balanced as long as any Debit entries are matched by Credit entries of the same amount

• The terms Debit and Credit mean nothing more than the left hand side and right hand side of an account

• Learn the ledger rules 52


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Double Entry

Accounting

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Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/double-entry-accounting-ledger-examples/outline/






















©Edrolo

Outline

Ledger Rules - examples

• Using the Ledger Rules

• Correct Format of Ledger entries

Unit 3 - Area of Study 1 • the two-fold effect of transactions on the accounting equation • the general ledger using T-form accounts • the effect of transactions on the accounting equation and the accounting

reports

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Ledger Rules – in summary

Assets & DR Expenses CR

+ -

Increases Decreases

Liabilities, Revenues & DR Owner’s Equity CR

- +

Decreases Increases

Remember that debit and credit simply mean the left and right sides of the accounts

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Ledger Rules – ways of remembering

AID asset increase debit LIC liability increase credit PIC proprietorship increase credit RIC revenue increase credit EID expense increase debit

Simplest way is to remember ‘Asset & Expense increase debit’

ACCOUNT TYPE INCREASE DECREASE

Assets Debit Credit Liabilities Credit Debit Owner’s Equity Credit Debit Revenue Credit Debit Expenses Debit Credit

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Example 1 – using the rules To use the ledger rules we need to follow the same steps each time we enter a transaction.

1. What ledger accounts are affected? 2. Then for each account:

i. What type of account is it? (A, L, R, E or OE) ii. Is it an increase or a decrease in that account?

3. Once you’ve made these decisions, the last step is to then apply the correct ledger rule

In the first few exercises that you do, you will probably be asked to use a table like the one below – usually called an Analysing or Analysis Chart. This isn’t actually part of the recording process but is a really useful tool in learning how to apply the ledger rules.

The owner of a business deposits $10,000 in the business bank account to commence business on January 31. Date Accounts Type Inc or

Dec DR or

CR Amount

DR CR

A Increase DR 10000

OE Increase CR 10000

Bank

Capital

Jan 31

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Example 1 – the ledger

Bank (A)

Capital (OE)

The owner of a business deposits $10,000 in the business bank account to commence business on January 31.

Date Accounts Type Inc or Dec

DR or CR

Amount

DR CR

Jan 31 A Increase DR 10000


Bank

Capital

10000

10000

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Example 1 – the format of a ledger

Bank (A) Date Cross-reference Amount Date Cross-reference Amount

Capital (OE) Date Cross-reference Amount Date Cross-reference Amount

The owner of a business deposits $10,000 in the business bank account to commence business on January 31.


DR or CR

Amount

DR CR



Bank

Capital

10000

10000

Jan 31

Jan 31

Capital

Bank

Cross-reference – the name of the other account affected by a transaction 59


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Example 2

The owner also contributes a vehicle valued at $15000 for the exclusive use of the business.


DR or CR

Amount

DR CR



Vehicle

Capital


10000 Jan 31 Capital Capital (OE)

Date Cross-reference Amount Date Cross-reference Amount

10000 Jan 31 Bank

Vehicle (A) Date Cross-reference Amount Date Cross-reference Amount

15000 Jan 31 Capital

Vehicle 15000

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Summary

• Every transaction has a two-fold effect on the accounting equation so in the ledger every transaction will affect at least two ledger accounts.

• The accounting equation will remain balanced as long as any Debit entries are matched by Credit entries of the same amount

• When entering a transaction into the general ledger, • decide what accounts are effected and what type they are

• whether they increase or decrease

• then use the Ledger rules to decide which side of an account to place the entry

• The terms Debit and Credit mean nothing more than the left hand side and right hand side of an account

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Goods and Services Tax

GST

Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/gst/outline/

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Outline

• What is the GST?

• Role of business re GST

• GST Clearing Account

• Recording transactions involving GST

• GST Settlements & Refunds

• Summary

Unit 3 - Area of Study 1 • the GST Clearing account

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What is the GST?

The Goods and Services and Tax (GST) is a federal tax which applies to most goods and services.

Currently the GST is applied at the rate of 10%.

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Role of Business re GST

The role of business is to collect the GST on behalf of the government and pass it on to the Australian Tax Office (ATO). On a day to day basis a business will both collect and pay GST.

> It will collect GST by adding it to the price of goods or services charged to customers.

> It will also pay GST on goods and services that it uses.

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Role of Business re GST

GST passes through the business and needs to be tracked by the business • Any GST collected by the business is collected on behalf of the ATO

so this increases what is owed to the ATO.

• However any time a business needs to pay GST on a good or service this will reduce the amount they need to give to the ATO.

So at the end of a period, the business needs to compare the amount of GST to be collected (from customers), with the amount of GST to be paid out (to its suppliers). This comparison will show whether the business needs to make a payment to the ATO or get a refund from the ATO.

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The Tax Invoice

Every transaction involving GST must have a source document (a Tax Invoice) which provides:

> The date of the transaction

> The price of the transaction including GST

> The amount of the GST

> The name and ABN of the seller

> Details of the goods/services provided

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GST Clearing Account

When recording transactions involving GST, the GST component will need to be recorded separately

In the ledger we will use the GST Clearing Account to record all details relating to GST

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Recording GST

The GST Clearing account is one of a small number of accounts that can be either an asset or liability depending on what has happened during a period

The simplest approach is to treat the GST Clearing account as Liability when recording transactions

But be very careful check the balance at the start and the balance at end so see that these are on the correct side and that they are reported correctly

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Recording GST – a cash example

Paid Rent of $1100 including GST of $100 While $1100 has been paid by the business, the cost of the Rent is actually only $1000. The business will be able to ‘claim back’ the $100 of GST so it needs to keep track of the GST component. Using the Analysis chart to apply the ledger rules:


DR or CR

Amount

DR CR

A Decrease CR 1100

E Increase DR 1000

Bank

Rent Expense

GST Clearing L Decrease DR 100

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Recording GST – a cash example

Paid Rent of $1100 including GST of $100

Posted to the ledger:

Rent (E) Date Cross-reference Amount Date Cross-reference Amount

1000 Bank

GST Clearing (L) Date Cross-reference Amount Date Cross-reference Amount

100 Bank


1100 Rent/GST Clearing

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Recording GST – a credit example

Purchased stock on credit for $13200 including GST of $1200

Stock Control (A) Date Cross-reference Amount Date Cross-reference Amount

12000 Creditors Control


1200 Creditors Control

Creditors Control (L) Date Cross-reference Amount Date Cross-reference Amount

13200 Stock Control/GST Clearing

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End of the period

At the end of a period, the balance of the GST Clearing Account will show whether the business needs to get a refund from the ATO or if they need to pay the ATO.

GST Clearing

GST paid to or charged by suppliers

GST collected from or charged to customers

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Account Summary for GST in Unit 3

GST Clearing ① Bank ③ Bank

② Creditors Control ④ Debtors Control

⑤ Bank* ⑥ Bank*

Debit entries decrease the amount owing to the ATO

Credit entries increase the amount owing to the ATO

① GST paid to other businesses on cash purchases of stock, expenses, NCA’s

② GST charged on credit purchases of stock

③ GST collected from customers on cash sales

④ GST charged on credit sales

⑤ GST settlement – paid to ATO for amount owing or ⑥ GST refund – received from the ATO for amount owing to the business

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GST Refund or Settlement

If GST collected or charged to customers is greater than GST paid or charged by suppliers,

• the GST Clearing Account will be a liability (a present obligation which will result in an outflow of economic benefits)

• the GST Clearing Account will have a credit balance • the business will need to forward on the amount to the ATO - this payment is

referred to as the settlement If GST paid or charged by suppliers is greater than GST collected or charged to customers,

• the GST clearing account will be an asset (a resource controlled by the entity from which future economic benefits are expected to flow)

• the GST Clearing Account will have a debit balance • the business will apply for a refund from the ATO for the amount owing

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Recording GST – examples

GST Clearing Date Cross-reference Amount Date Cross-reference Amount

April 30 Bank 9800 April 1 Balance 1500

Creditors Control 4300 30 Bank 10200

Bank 1500 Debtors Control 5300

Balance 1400

17000 17000

May 1 Balance 1400

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Recording GST – examples

GST Clearing Date Cross-reference Amount Date Cross-reference Amount

Jan 1 Balance 500 Jan 31 Bank 8500

31 Bank 6100 Debtors Control 1250

Creditors Control 780 Bank 500

Balance 2870

10250 10250

Feb 1 Balance 2870

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Summary

Recording Purchases with GST

Cash Purchases of Stock Credit Purchases of Stock

Stock Control DR GST Clearing DR Bank CR

Stock Control DR GST Clearing DR Creditors Control CR

Other Cash Payments

Expense (e.g. Rent) DR GST Clearing DR Bank CR

Asset (e.g. Vehicle) DR GST Clearing DR Bank CR

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Summary

Recording Sales with GST

Cash Sales Credit Sales

Bank DR GST Clearing CR Sales CR Cost of Sales DR Stock Control CR

Debtors Control DR GST Clearing CR Sales CR Cost of Sales DR Stock Control CR

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Special Journals

Credit Journals

Control Accounts &

Subsidiary Ledgers

80

Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/special-journals-credit-journals/outline/

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/special-journals-credit-

part-2/control-accounts/



















https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/special-journals-credit-part-2/control-accounts/























©Edrolo

Outline

• The Special Journals

• Advantages of Special Journals

• Credit Journals

• Posting from Credit Journals

• Control Accounts and Subsidiary Ledgers

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Outline

Unit 3 - Area of Study 1 • special journals:

• sales journal, all credit sales of stock • purchases journal, all credit purchases of stock

• the process of posting to the general ledger from the general journal and special journals on a monthly basis

• reasons for using control accounts • control accounts for debtors, creditors and stock • subsidiary ledgers and schedules for debtors and creditors, with individual

transactions posted to the subsidiary ledger accounts on the date the transaction occurs

• internal control procedures and practices of this accounting system

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All transactions must be entered in a journal before being posted to the ledger

One important role of all journals is that they will include details of the source document – so they provide an important link between the information in reports back through the ledger to the source document

Source Documents → Ledgers → Trial Balance Reports → Journals →

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Types of Journals

There are 2 types of Journals:

• Special Journals – used to collect similar types of transactions The transactions placed together in each of the special journals will have a similar pattern when posted to the ledger

This allows us to collect and summarise these transactions before posting to the ledger (we will be able to use totals when posting rather than having to enter each individual transaction in each ledger)

• General Journal – records all transactions which cannot be recorded in one of the special journals


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Special Journals

The special journals will be used to record common types of transactions:

• Credit Journals – all credit purchases and sales of stock

> Purchases Journal – all credit purchases of stock

> Sales Journal – all credit sales of stock

• Cash Journals – all movements of cash

> Cash Receipts Journal – used to record all cash receipts

> Cash Payments – used to record all cash payments


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Credit Journals – Purchases Journal

The Purchases Journal - used to record all credit purchases of stock

A Credit Purchase of stock – what are the ledger entries involved?

Stock Control DR

GST Clearing DR

Creditors Control CR

Every credit purchase of stock will follow this pattern in the ledger

If there were 100 purchases of stock made on credit, there would be 100 of these debits in Stock Control

100 debits in GST Clearing and

100 credits in Creditors Control.

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Purchases Journal

Date Creditor Invoice Number

Stock Control

GST Creditors Control

Sept 5 L. Neubauer 346 1500 150 1650

7 M. King X158 2000 200 2200

9 S. Collett 1678 750 75 825

15 J. Ma 897N 900 90 990

5150 515 5665

Sept 5 Purchased stock on credit from Neubauer Co. for $1500 plus GST $150, Inv. 346

Sept 7 Stock purchased on credit from M. King for $2200 including GST, Inv. X158 Sept 9 Invoice received from S. Collett for purchase of stock for $750 plus GST,

Inv. 1678 Sept 15 Received invoice from J. Ma for stock purchased $990 including GST, Inv 897N

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Purchases Journal – posting to the general ledger


5150 Creditors Control Sep 30




5655 Stock Control/GST Clearing

Sep 30

Purchases Journal

Date Creditor Invoice Number

Stock Control

GST Creditors Control

5150 515 5665

DR DR CR

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Advantage of Special Journals:

Special journals summarise similar transactions allowing totals to be posted to the ledger, reducing the number of ledger entries required

Remember that in our course, we are assuming that the Journals will be totalled and posted at the end of each month – so use the last day of the month when posting from any journals into the General Ledger

(even if the last transaction occurred sometime earlier in the month)

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Credit Journals – Sales Journal

The Sales Journal - used to record all credit sales of stock

One Credit Sale of stock – what are the ledger entries involved?

There are always two aspects to consider in any sale 1. The revenue + GST - what the business is collecting from the sale

2. The stock movement - what the business is giving to the customer

Revenue Debtors Control DR GST Clearing CR Sales CR

Stock Movement Cost of Sales DR Stock Control CR

Every credit sale of stock will follow this same pattern in the ledger

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Credit Journals – Sales Journal

Sales Journal

Date Debtor Invoice Number

Cost of Sales

Sales GST Debtors Control

Sept 5 B. Kassem 138 1200 3600 360 3960

7 D. Hurst 139 2000 6000 600 6600

9 T. Iksanov 140 850 2550 255 2805

18 B. Kassem 141 1300 3900 390 4290

5350 16050 1605 17655

Sept 5 Credit Sale to B. Kassem $3600 plus GST $360 (Cost Price $1200) Inv. 138 Sept 7 Stock sold on credit to D. Hurst for $6600 including GST, (Cost Price $2000) Inv. 139 Sept 9 Invoice issued to T. Iksanov for sale of stock for $2550 plus GST (CP $850) Inv. 140 Sept 15 Issued invoice to B. Grubb for stock purchased $4290 including GST (CP $ 1300)

Inv 141

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Sales Journal – posting to the general ledger


5350 Cost of Sales Sep 30

Sales Journal


Cost of Sales


Sept

5350 16050 1605 17655

Cost of Sales (E) Date Cross-reference Amount Date Cross-reference Amount

5350 Stock Control Sep 30

DR \CR

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Sales Journal – posting to the general ledger

Sales (R) Date Cross-reference Amount Date Cross-reference Amount

16050 Debtors Control Sep 30

Sales Journal


Cost of Sales


5350 16050 1605 17655



Debtors Control (A) Date Cross-reference Amount Date Cross-reference Amount

17655 Sales/GST Clearing Sep 30

CR CR DR DR \CR

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Control Accounts

A Control Account is a summary account which contains all of the transactions relating to a particular item but in summary form.

The control accounts we will use in Units 3 & 4 are:

Debtors Control

Creditors Control

Stock Control

These accounts will provide the summary or overall picture of Debtors, Creditors and Stock.

The totals from the relevant columns of the special journals will be posted to these control accounts in the General Ledger.

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Control Accounts

A Control Account is useful to provide an overview of an area and will provide a summary figure for a report.

If a business has 80 different Debtors that they deal with, the total owing is useful as a summary but the detail about each individual debtor must also be kept – otherwise the business won’t know who to chase up for money owing.

There is no point knowing how much is owing if you don’t know who owes it.

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Subsidiary Ledgers

We will use Control Accounts for Debtors, Creditors and Stock.

Apart from the total for each item – what does management need to know?

Debtors – need to know how much each Debtor owes and when it is due

Creditors – need to know how much is owed to each Creditor and when it is due

Stock – need to know how many of each stock item is on hand and their cost for ordering and pricing

The Control Account for each of these items doesn’t provide this level of detail

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Subsidiary Ledgers

Every Control Account will have a Subsidiary ledger where the detail of each individual item is kept.

Debtors Control

Debtors Subsidiary Ledger

Debtor A

Debtor B

Debtor C

Creditors Control

Creditors Subsidiary Ledger

Creditor A

Creditor B

Creditor C

Stock Control

Stock Cards

Stock Item A

Stock Item B

Stock Item C

The sum of all the individual accounts in the subsidiary ledger should equal the total of the relevant Control Account 97


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Posting to a Subsidiary Ledger

Sales Journal


Cost of Sales


Sept 5 B. Kassem 138 1200 3600 360 3960

7 D. Hurst 139 2000 6000 600 6600

9 T. Iksanov 140 850 2550 255 2805

18 B. Kassem 141 1300 3900 390 4290

5350 16050 1605 17655



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Posting to a Subsidiary Ledger

Sales Journal


Cost of Sales


Sept 5 B. Kassem 138 1200 3600 360 3960

7 D. Hurst 139 2000 6000 600 6600

9 T. Iksanov 140 850 2550 255 2805

18 B. Kassem 141 1300 3900 390 4290

5350 16050 1605 17655

Debtor - B. Kassem (A) Date Cross-reference Amount Date Cross-reference Amount


18 Sales/GST Clearing 4290

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Benefits of using Control Accounts and Subsidiary Ledgers

• Simplifies the General Ledger As totals are posted to the control accounts this simplifies the general ledger by removing the detail of each transaction to the subsidiary ledger

• Detection of errors Having two sets of records on the same information gives us a built-in checking (or control) mechanism. The balance of the control account should match the sum of the balances of the subsidiary ledger accounts (through preparation of a Schedule).

• Allocation of responsibility Responsibility for maintaining the subsidiary ledger can be allocated to a particular employee who could then be responsible for all dealings with debtors or creditors e.g. collections from debtors, payments to creditors

• Ease of reporting The control account provides one figure to be reported in the Balance Sheet – the details of all of the individual debtors, creditors and stock items are not relevant to decision-making at that level.

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Limitations of Control Accounts and Subsidiary Ledgers

• Duplication/Extra Recording The benefits of using Control Accounts and Subsidiary Ledgers will only be gained when there are multiple accounts involved.

For example, if a business only purchases its stock from one or two Creditors there won’t be any benefit of setting up a system to summarise this.

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Summary

Posting from Special Journals

• Posting to the General Ledger • Use the totals from the columns in the journals

• Use the last day of the month as the date in the ledger

• Posting to Subsidiary Ledgers • Post the individual transactions from the journal

• Use the actual date of each transaction in the subsidiary ledger

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Special Journals

Cash Journals

Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/special-journals-cash-part-1/outline/

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/special-journals-cash-part-

2/cash-journals-cash-receipts-journal/

103





















https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/special-journals-cash-part-2/cash-journals-cash-receipts-journal/





























©Edrolo

Outline

• The Special Journals

• Advantages of Special Journals

• Cash Journals

• Posting from Cash Journals

> to General Ledger

> To Subsidiary Ledgers

• Summary

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Outline

Unit 3 - Area of Study 1 • special journals:

• cash receipts journal, all receipts of cash with GST not applicable on discount expense

• cash payments journal, all payments of cash with GST not applicable on discount revenue


• control accounts for debtors, creditors and stock • subsidiary ledgers and schedules for debtors and creditors, with individual


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We will always use a Special Journal where appropriate

Advantages of Special Journals: • Special journals collect and summarise similar transactions allowing

totals to be posted to the general ledger, reducing the number of ledger entries required

• As with all journals, they will include details of the source document – so they provide an important link between the information in reports back through the ledger to the source document

Source Documents → Ledgers

General Ledger Subsidiary Ledgers

→ Trial Balance Reports → Journals

Special Journals General Journal

→

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Special Journals

The special journals are used to record common types of transactions:

• Credit Journals – all credit purchases and sales of stock

> Purchases Journal – all credit purchases of stock

> Sales Journal – all credit sales of stock

• Cash Journals – all movements of cash

> Cash Receipts Journal – used to record all cash receipts

> Cash Payments – used to record all cash payments

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Cash Journals – Cash Payments Journal

The Cash Payments Journal - used to record all outflows of cash

Every Cash Payment will have a common ledger entry – they all will cause Bank to decrease:

Bank CR

The debit entry will vary depending on the transaction so the design of the CPJ is a bit more complicated than the Credit Journals

Cash Payments Journal

Date Details Cheque Number

Bank Discount Revenue

Creditors Control

Stock Control

* Sundries GST

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Cash Journals – Cash Payments Journal




Creditors Control

Stock Control

Wages Sundries GST

Sept 2 Purchased stock for cash for $1800 plus GST $180, Chq. 346 Sept 7 Paid wages $2400, Chq 347 Sept 9 Paid J. Ma $1500 on account , Chq. 348 Sept 15 Paid M. King $2100 and received $100 discount Chq. 349 Sept 17 Paid Rent $550 including GST Chq. 350

Sept 2 Stock Control 346 1980 1800 180

7 Wages 347 2400 2400

9 M. King 348 1500 1500

15 M. King 349 2100 100 2200

17 Rent 350 550 550

8530 100 3700 1800 2400 550 180 109


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Cash Payments Journal – posting to the general ledger


8530 Cash Payments Sep 30

Discount Revenue (R) Date Cross-reference Amount Date Cross-reference Amount



3700 Bank\Discount Rev. Sep 30




Creditors Control

Stock Control

Wages Sundries GST

Sep 17 Rent 350 550 500 50

8530 100 3700 1800 2400 500 230

CR CR DR DR DR DR DR

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1800 Bank Sep 30

Wages (E) Date Cross-reference Amount Date Cross-reference Amount

2400 Bank Sep 30

Rent (E) Date Cross-reference Amount Date Cross-reference Amount

500 Bank Sep 30




Creditors Control

Stock Control

Wages Sundries GST

Sep 17 Rent 350 550 500

8530 100 3700 1800 2400 550 230


230 Bank Sep 30

CR CR DR DR DR DR

DR

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CPJ – posting to the subsidiary ledger




Creditors Control

Stock Control

Wages Sundries GST

9 M. King 348 1500 1500

15 M. King 349 2100 100 2200

8530 100 3700 1800 2400 550 180

M. King (L) Date Cross-reference Amount Date Cross-reference Amount

4800 Balance Sep 1

Already posted to General Ledger

In the Creditors Subsidiary Ledger

1500 Bank Sep 9

2200 Bank\Discount Rev. Sep 15

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Cash Journals – Cash Receipts Journal

The Cash Receipts Journal - used to record all inflows of cash

Every Cash Receipt will cause Bank to increase so the common ledger entry will be:

Bank DR

The credit entry will vary depending on the transaction so like the CPJ the design of the CRJ is more complicated than the Credit Journals

Cash Receipts Journal

Date Details Receipt Number

Bank Discount Expense

Debtors Control

Cost of Sales

Sales Sundries GST

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Cash Journals – Cash Receipts Journal




Debtors Control

Cost of Sales

Sales Sundries GST

Sept 5 Cash Sale $2600 plus GST $260 (Cost Price $1200) Rec. 821 Sept 7 Received $2000 from B. Kassem in payment of amount owing Rec. 822 Sept 9 Cash Sale $4620 incl GST (Cost Price $2100) Rec. 823 Sept 14 Received $1700 from B. Kassem and allowed $100 discount for early payment Rec.

824 Sept 18 Received $200 interest from Term Deposit (BS)

Sept 5 Sales 821 2860 1200 2600 260

7 B. Kassem 822 2000 2000

9 Sales 823 4620 2100 4200 420

14 B. Kassem 824 1700 100 1800

18 Interest Revenue BS 200 200

11380 100 3800 3300 6800 200 680 114


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Cash Receipts Journal – posting to the general ledger


11380 Cash Receipts Sep 30

Discount Expense (E) Date Cross-reference Amount Date Cross-reference Amount



3800 Bank\Discount Exp. Sep 30




Debtors Control

Cost of Sales

Sales Sundries GST

Sep18 Interest Revenue BS 200 200

11380 100 3800 3300 6800 200 680

DR DR CR

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Debtors Control

Cost of Sales

Sales Sundries GST


11380 100 3800 3300 6800 200 680

DR DR CR


3300 Cost of Sales Sep 30

Cost of Sales (E) Date Cross-reference Amount Date Cross-reference Amount

3300 Stock Control Sep 30

DR\CR

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Debtors Control

Cost of Sales

Sales Sundries GST


11380 100 3800 3300 6800 200 680

DR DR CR DR\CR

Sales (R)


6800 Bank Sep 30

Interest Revenue (R) Date Cross-reference Amount Date Cross-reference Amount

200 Bank Sep 30


680 Bank Sep 30

CR CR CR

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Cash Journals – Recording a GST Settlement




Creditors Control

Stock Control

Wages Sundries GST

Sept 19 Paid ATO to $450 settle GST owing at end of August, Chq. 351

Sept 2 Stock Control 346 1980 1800 180

17 Rent 350 550 500 50

950 230

19 GST Clearing 351 450 450


230

Bank Sep 30

Bank

450 450 Balance Sep 1

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Cash Journals – Recording a GST Refund

Sept 19 Received $530 from ATO as refund for GST owed at end of August, Rec. 824


530 Bank Sep 30

Bank 680

530 Balance Sep 1




Debtors Control

Cost of Sales

Sales Sundries GST

Sept 5 Sales 821 2860 1200 2600 260

9 Sales 823 4620 2100 4200 420

530 680


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Recording GST in the Journals

Only use the GST column in the Cash Journals for:

• in the Cash Receipts Journal – for GST collected from customers

• in the Cash Payments Journal – for GST paid to suppliers

Any transactions relating to GST directly with the ATO must be recorded in the sundries column

• GST refund from the ATO – in the sundries column of the Cash Receipts Journal

• GST settlement paid to the ATO – in the sundries column of the Cash Payments Journal

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Summary

Posting from Special Journals

• Posting to the General Ledger • Use the totals from the columns in the journals

• Use the last day of the month as the date in the ledger

• Posting to Subsidiary Ledgers • Post the individual transactions from the journal

• Use the actual date of each transaction in the subsidiary ledger

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The General Journal

Intro & Opening Entries

122

Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/general-journal-opening-entries/outline/




















©Edrolo

Outline

• The General Journal

• Types of transactions in the General Journal

• The Format of the General Journal

• Opening General Journal Entries

Unit 3 - Area of Study 1 • the use of the general journal to record infrequent non-cash

transactions: • establishing a double entry system • contribution of non-current assets by the owner at agreed value

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We will always use a Special Journal if we can because: > Special journals collect and summarise similar transactions allowing

totals to be posted to the general ledger, reducing the number of ledger entries required

Source Documents → Ledgers

General Ledger Subsidiary Ledgers

→ Trial Balance Reports → Journals

Special Journals General Journal

→

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Special Journals / General Journal

Special Journals will be used for:

• Any cash transaction – Cash Receipts Journal &


• Credit transactions involving the purchase or sale of stock – Purchases Journal & Sales Journal

The General Journal is then used to record any other transactions that cannot be recorded in the Special Journals.

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General Journal – which transactions?

The General Journal will be used for any other transaction including:

• opening journal entries to establish a double-entry system

• contributions of non-current assets at agreed value

• withdrawals of stock by the owner

• use of stock for advertising purposes

• bad debts

• correction of errors

Later in Unit 3 -

• adjusting entries for balance day adjustments

• closing entries

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General Journal – Format

As the General Journal is used to record a variety of different transactions, its format is very simple It shows each debit and credit involved in the transaction The details column shows the names of the accounts affected by the transaction

Date Details General Ledger Subsidiary Ledger

Debit Credit Debit Credit

2013

Dec 31 Drawings 350

Stock Control 350

The owner removed a Bravo KL55 TV for personal use (Memo 34)

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General Journal – Format


2015 Debit Credit Debit Credit

Dec 31 Drawings 350

Stock Control 350


• a narration is also provided – the narration is a brief explanation of the transaction - this should include any specific details and must include document numbers so that the link back to source documents can be maintained - reliability)

• there are no columns to summarise into totals (so the amounts will be posted individually into the ledger)

• The Debit entries in a transaction are usually shown first and the accounts to be credited can be indented in the details column

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GJ Examples – Opening Entries

The General Journal is used to open up the ledgers for a business: • at the commencement of a new set of books for an existing

business, or • at the start of a new business.

The Opening Journal will provide all of the opening balances for the relevant ledger accounts. Remember that the accounting equation needs to balance at the start of business

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General Journal – New set of ledgers

New Ledgers for an existing business Western Homewares has the following assets and liabilities at the establishment of a new set of ledgers on January 1. Details provided on Memo 101 Assets: Bank $5000, Debtors Control $8000 ( M. Kerr $3000, J. Khan $5000), Stock Control $12500, Vehicle $20000, Equipment $10000 Liabilities: Loan – HBSC Bank $3000

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General Journal – new set of ledgers

Assets: Bank $5000, Debtors Control $8000 ( M. Kerr $3000, J. Khan $5000 ), Stock Control $12500, Equipment $10000 Liabilities: Loan – HBSC Bank $3000



Jan 1

Capital 32500

Assets and Liabilities at the start of new accounting records (Memo 101)

Bank 5000

Debtors Control 8000

- M. Kerr 3000

- J. Khan 5000

Stock Control 12500

Equipment 10000

Loan – HBSC Bank 3000

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General Journal – Start of a Business

Start of a new business

On 1 January, Winston provided his accountant with the following list of assets and liabilities that Winston had contributed to commence business as WC Trading

MEMO 001 January 1

ASSETS: Deposited $2000 in Business Bank Account (Rec No. 1) Other assets contributed at ‘agreed value’: Stock $4000, Furniture $2500, Vehicle $15000 LIABILITIES: Loan – $3000

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General Journal – Cash Contribution

The amount for Bank is not simply an opening balance - $2000 has been deposited in the business bank account. All cash flows must be recorded in the relevant Cash Journal




Debtors Control

Cost of Sales

Sales Sundries GST

Jan 1 Capital 1 2000 2000

MEMO 001 January 1

ASSETS: Deposited $2000 in Business Bank Account (Rec No. 1) Other assets contributed at ‘agreed value’: Stock $4000, Furniture $2500, Vehicle $15000 LIABILITIES: Loan – $3000

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General Journal – Agreed Value

Historical Cost – normally we would use the price originally paid for the asset, however, what the owner paid for these items in the past is not relevant to the business

These assets are moving from the owner into the business entity.

The agreed value is the historical cost of the assets at the time that they enter the business entity.

MEMO 001 January 1

ASSETS: Deposited $2000 in Business Bank Account (Rec No. 1) Other assets contributed at ‘agreed value’: Stock $4000, Furniture $2500, Vehicle $15000, Equipment $10000 LIABILITIES: Loan – $3000

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General Journal – Start of a Business

Assets: Stock $4000, Furniture $2500, Vehicle $15000 Liabilities: Loan – $3000



Jan 1

Capital 18500

Assets and Liabilities at the start of WC Trading (Memo 001)

Stock Control 4000

Furniture 2500

Vehicle 15000

Loan 3000




Debtors Control

Cost of Sales

Sales Sundries GST

Jan 1 Capital 1 2000 2000

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The General Journal

Other Transactions &

Posting to the Ledgers

Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/general-journal-use-stock-bad-debts/outline/

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/correcting-entries-and-

posting-ledger/general-journal-correcting-entries/

136























https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/correcting-entries-and-posting-ledger/general-journal-correcting-entries/



























©Edrolo

Outline

• The General Journal

• More transactions in the General Journal



• bad debts


• Posting from the General Journal to ledgers

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Outline

Unit 3 - Area of Study 1 • the use of the general journal to record infrequent non-cash transactions:

• correction of errors • use of stock for advertising purposes • withdrawals of stock by the owner with GST not applicable • bad debts with GST not applicable


• control accounts for debtors, creditors and stock • subsidiary ledgers and schedules for debtors and creditors, with individual


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Special Journals / General Journal

All transactions must be entered in a journal before being posted to the general ledger

Special Journals will be used for:

• Any cash transaction – Cash Receipts Journal &


• Credit transactions involving the purchase or sale of stock – Purchases Journal & Sales Journal

The General Journal is then used to record any transactions that cannot be recorded in the Special Journals.

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General Journal – which transactions?

The General Journal will be used for any other transaction including:

• opening journal entries to establish a double-entry system

• contributions of non-current assets at agreed value



• bad debts


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General Journal – Drawings of Stock

The withdrawal of stock by an owner will cause: • a decrease in the asset Stock Control which is a credit entry • an increase in ‘Drawings’ which is a debit (Drawings is a debit entry as

it is a decrease in Owner’s Equity)


Feb 21

MEMO 324 February 21 Took one TV set home for personal use – model Bravo KL55 Cost Price $350

Remember – cash drawings will be recorded in the Cash Payments Journal

Drawings 350

Stock Control 350


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General Journal – use of stock for advertising

The donation of stock to the school will cause: • a decrease in stock which is a credit entry • as the business will receive advertising in return for the donation this

can be treated as a business expense – hence a debit in Advertising


Mar 4

MEMO B238 March 4 Provided one Stallion BBQ to Eastern Hills Primary for raffle – to be acknowledged with business name on raffle tickets (Cost Price $480)

Advertising 480

Stock Control 480

1 Stallion BBQ provided to Eastern Hill PS for raffle (Memo B238)

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Effect on the Accounting Equation


Decrease $350 (decrease in Stock Control)

No Effect Decrease $350 (increase in Drawings which decreases Owner’s Equity)

Effect of a Drawing of $350 of Stock



No Effect Decrease $480 (increase in expense of Advertising which decreases Net Profit)

Effect of using $480 of Stock for Advertising

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General Journal – Bad Debts

When a business decides that a debt owed by a customer (Debtor) is not likely to be recovered, it should write off the amount as an expense called Bad Debts. The principle of conservatism demands that losses be recognised as soon as they are probable so that the asset (Debtors Control) is not overstated in the reports of the business. This also ensures that reports contain all information that affects decision making so that they are relevant.

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The entry to write off a bad debt involves: • increasing the expense of Bad Debts – hence a Debit • decreasing the asset of Debtors Control - credit

MEMO X134 May 16 Notification received that Debtor – B. Dunks has been declared bankrupt and will be unable to pay any of the $300 owing.


May 16

Bad Debts 300

Debtors Control 300

Debtor B. Dunks declared bankrupt – full amount owing to be written off (Memo X134)

Debtor – B. Dunks 300

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It is also possible that a Debtor may be able to pay some of the debt with the remainder to be written off.

MEMO X135 May 21 Notification received that Debtor – M. Uribe who owes $800 has been declared bankrupt and will only be paying 20c in the dollar.


May 21

Bad Debts 640

Debtors Control 640

Debtor M. Uribe deemed bankrupt – 80c in the dollar of debt to be written off (Memo X134)

Debtor – M. Uribe 640

’20c in the dollar’ means that only 20% is likely to be received in the future so 80% of the debt will be written off as a bad debt.

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Decrease $640 (decrease in Debtors Control)

No Effect Decrease $640 (increase in expense of Bad Debts which decreases Net Profit)

Effect of a Bad Debt of $640

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General Journal – Correcting Entries

When errors are detected in the recording process and the journals have already been posted to the ledger, errors must be corrected using a General Journal entry. The entry required for a correcting entry depends on what the original error was. The steps involved in a correcting entry are:

1. What has been recorded? 2. What should have been recorded? 3. What needs to be done to correct the error?

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1. What has been recorded? Office Expenses DR 300 GST Clearing DR 30 Bank CR 330

2. What should have been recorded? Vehicle Expenses DR 300 GST Clearing DR 30 Bank CR 330

3. What needs to be done to correct the error? The credit entry in the bank is correct as 330 has been paid out of the bank, so there is no need for another entry in the bank. The GST is also OK so nothing needs to be done there either.

However the DR in Office Expenses needs to be cancelled out, and a DR needs to be added to the Vehicle Expenses account.

MEMO 54 June 2 Correcting entry required - a cash payment of $330 for Vehicle Expenses (inc GST $30) was incorrectly recorded as Office Expenses.

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So the correcting entry would need to be:


June 2

Vehicle Expenses 300

Office Expenses 300

Vehicle expenses incorrectly recorded as Office Expenses (Memo 54)

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Correcting Entries – Example 2

1. What has been recorded? Bank DR 500 Debtors Control CR 500 (Debtor – D. Crough CR 500)

2. What should have been recorded? Bank DR 500 Debtors Control CR 500 (Debtor – T. Crowe CR 500)

3. What needs to be done to correct the error? The debit entry in the bank is correct as 500 has been received. The total owing from Debtors has decreased by 500 so the entry in Debtors Control is also correct as it is.

The only error is in the Debtors subsidiary ledger where the CR in D. Crough needs to be cancelled out, and a CR needs to be added to T. Crowe’s account.

MEMO 55 June 12 Correcting entry required - a receipt of $500 from Debtor – T. Crowe was recorded as received from Debtor – D. Crough.

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Correcting Entries – Example 2

So the correcting entry would need to be:


June 12

Debtor - D. Crough 500

Debtor – T. Crowe 500

Receipt from Debtor T. Crowe incorrectly recorded (Memo 55)

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General Journal – Posting to the ledger

The main points to remember when posting to the ledger are:

• Unlike the special journals there are no totals to post so use each individual amount shown in the General Journal

• In the General Ledger use the last day of the month as the date for each entry (remember that all Journals are posted at the end of each month)

• The only dates that will appear in the General Ledger

• are the first day of the month for any balances, and

• the last day of the month for any entries from during the month

• In the Subsidiary ledgers, use the actual date of the transaction

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General Journal– posting to the ledger

Bad Debts (E) Date Cross-reference Amount Date Cross-reference Amount

300 Debtors Control May 31


300 Bad Debts May 31


May 16

Bad Debts 300

Debtors Control 300

Debtor – B. Dunks 300

Debtor – B. Dunk (A) Date Cross-reference Amount Date Cross-reference Amount

300 Bad Debts May 16 300 Balance May 1

11200 Balance May 1

In the subsidiary ledger,

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Remember

Choosing the correct Journal:

• All cash transactions are recorded in the Cash Journals

• All credit transactions involving stock are recorded in the Credit Journals

• Any other transactions will be recorded in the General Journal

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Stock

Stock Cards & FIFO

156

Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/stock-perpetual-method-fifo-and-stock-cards/outline/


























©Edrolo

Outline

• Stock and the Trading Firm

• Perpetual Method of Stock Recording

• The Stock Control Account

• Stock Cards – purchases and sales of stock

• Cost Assignment using First in First Out

Unit 3 - Area of Study 1 • stock cards using the First In, First Out (FIFO) method for cash and credit

purchases and sales of stock • Control accounts for debtors, creditors and stock

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Trading Firms and Stock

Trading firms are businesses whose main purpose is the purchase and sale of goods at a profit.

Stock refers to any items that have been purchased by the business with the aim of reselling them at a profit.

For a trading business, effective stock management is going to be the biggest issue for management in maximising the profitability of the business and in ensuring liquidity:

• The sale of stock will be the largest form of revenue

• Cost of goods sold will probably be the biggest expense area

• The asset of Stock Control will be one of the most significant assets

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Perpetual Method of Stock Recording

The perpetual (or continuous) system involves recording all movements of stock as they occur.

The key aspect of the perpetual method is to record the details of every sale at the Point of Sale. This can be done using methods such as:

• Using Bar Code Scanners

• Manually recording the information e.g. writing out receipts

Most retail stores will use the Perpetual method.

Some businesses who may not use the perpetual method:

• A Market stall

• School Canteen

• Small Milk Bar 159


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Perpetual Method of Stock Recording

Any time you receive a receipt or invoice from a business which lists each item sold, you know that the business is using the perpetual method.

As all movements of stock are recorded as they occur, the business accounts then show the amount of stock that should be on hand based on the transactions that have been recorded.

A physical stocktake is then conducted at the end of the reporting period to verify the amounts of stock actually on hand against the business records (stock cards). In the process, any stock losses or gains will be detected.

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The Stock Control Account

The Stock Control account is used to record all movements of stock in and out of the business:

• stock ‘in’ (mainly through purchases) recorded on the debit side,

• and stock ‘out’ (mainly through sales) recorded on the credit side.

Stock Control

All Stock IN

All Stock OUT

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The Stock Control Account

Earlier topics have already dealt with entering sales and purchases of stock in journals and then in the ledger.

This topic doesn't change what we have done so far in the journals and ledgers. It adds more detail about recording and reporting for stock.

In particular it adds in the subsidiary records for the Stock Control account – these are called Stock Cards

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Subsidiary Ledgers

Every Control Account will have a Subsidiary ledger where the detail of each individual item is kept.

Debtors Control

Debtors Subsidiary Ledger

Debtor A

Debtor B

Debtor C

Creditors Control

Creditors Subsidiary Ledger

Creditor A

Creditor B

Creditor C

Stock Control

Stock Cards

Stock Item A

Stock Item B

Stock Item C

The sum of all the individual accounts in the subsidiary ledger should equal the total of the relevant Control Account 163


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Subsidiary Ledgers

While it is useful for reporting to know the total amount of stock it is also crucial to maintain details of the movement of individual lines of stock.

This detail is required for decision making about pricing, stock levels, ordering etc.

Stock Control

Stock Cards

Stock Item A

Stock Item B

Stock Item C

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Stock Cards

The Stock Control account is used to summarise all transactions affecting stock, while information relating to individual lines of stock is recorded in stock cards.

A trading firm will:

• only have one Stock Control account in the General Ledger,

• but could have a huge number of stock cards, with one stock card for every different line of stock.

Stock Control

Stock Cards

Stock Item A

Stock Item B

Stock Item C

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Stock Cards

Stock Card

Product Code No: Recording Method: FIFO

Date Details In Out Balance

Qty Cost Total Qty Cost Total Qty Cost Total

IN - all of this stock item coming in to the business e.g. purchases

OUT - all of this stock item leaving the business e.g. sales, drawings, advertising

BALANCE – the amount of this stock item thought to be on hand after each transaction

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Stock Cards

Stock Card

Product Superior Chair Code No: X125 Recording Method: FIFO



Each of the In, Out and Balance Columns is divided into: • Quantity or number of items of stock • their Unit cost – the cost price of each individual stock item • The Total of each transaction - this is calculated by multiplying the

Quantity by the Unit price. (Quantity ✕ Unit price)

Date - as this is a subsidiary record, use the actual date of the transaction

'Details’ refers to the source document for each transaction.

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Stock Cards - Recording a Stock Purchase

At the start of February the Business has 3 Icon X20 Tablet Computers on hand. The cost price of these computers was $480 per unit. On February 5 the business pays cash for 5 Icon X20’s at a cost of $550 per computer including GST (Chq 135) This transaction will be recorded in the Cash Payments Journal and then would be posted to the General Ledger resulting in a Debit in Stock Control of $2500 (5 x 500) How would this be recorded in the stock card for the Icon X20?

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Stock Cards - Recording a Stock Purchase

Stock Card

Product Icon X20 Tablet Code No: IX20 Recording Method: FIFO



At the start of February the Business has 3 Icon X20 Tablet Computers on hand. The cost price of these computers was $480 per unit. On February 5 the business pays cash for 5 Icon X20’s at a cost of $550 per computer including GST (Chq 135)

Feb 1 Balance 3 480 1440

Remember that all entries in the stock card are at cost price and this does not include GST

Feb 5 Chq 135 5 500 2500

5 500 2500

3 480 1440

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Stock Cards - Recording a Sale

Feb 7 The business makes a Credit Sale of 2 Icon X20’s for $900 each plus GST (Inv. 34)

This transaction would be recorded in the Sales Journal. However with every sale we need to know the cost price to record cost of sales in the journal. The source document (Inv. 34) will only provide the selling price of each unit $900 and the GST of $90. It will not contain the cost price of the item so we have to go to the stock card to get that information.

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Stock Cards - Recording a Sale

Stock Card




Feb 7 The business makes a Credit Sale of 1 Icon X20 for $900 plus GST (Inv. 34)

1 item needs to recorded as moving out but there are two possible

cost prices to use – the $480 paid for the older stock or the $500 paid for the recent purchase.


Feb 5 Chq 135 5 500 2500

5 500 2500

3 480 1440

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Stock Cards - FIFO

The perpetual method relies on knowing the type of stock that has been sold. So in this case we know it is an ‘Icon X20’ Tablet, this could be picked up with the standard barcode for that product. However the barcode will not distinguish between each ‘Icon X20’. It is possible to implement ways of identifying each individual computer but this is likely to be too costly and impractical to implement in relation to the benefit that might be gained. For some products it will be near impossible to track different batches of stock e.g. petrol – where deliveries are added to the existing stocks and not separated in any way.

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Stock Cards - FIFO

The VCE study design tells us to assume that we don’t actually know which batch of stock the computer has come from. So we don’t know if we paid $480 or $500 for the computer that has just been sold To fill this gap in our information we are required to make an assumption and use the ‘FIFO method of cost allocation’. FIFO means ‘First in First Out’ and it is the assumption that the stock that is purchased first will be sold first. So FIFO will allocate the cost of the stock in the order that it has been purchased.

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Stock Cards – using FIFO

Stock Card




When we recorded the purchase on Feb 5, the balance of the stock was listed in the order it had been purchased. This is vital to the application of FIFO as we need to use the oldest price first. Feb 7 Credit Sale of 1 Icon X20 for $900 plus GST (Inv. 34)


Feb 5 Chq 135 5 500 2500

5 500 2500

3 480 1440

Feb 7 Inv 34 1 480 480 2 480 960

5 500 2500 174


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Stock Cards - FIFO

Stock Card




If the next transaction relating to this stock was: Feb 11 Cash Sale of 3 Icon X20’s for $900 each plus GST (Rec. 218)


Feb 5 Chq 135 5 500 2500

5 500 2500

3 480 1440

Feb 7 Inv 34 1 480 480 2 480 960

5 500 2500

Feb 11 Rec 218 2 480 960

1 500 500 4 500 2000

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Summary

In the VCE course the recording in Stockcards is based on two methods: Perpetual Inventory • All movements of each stock item are recorded in the

individual stock cards • Stockcards therefore indicate amount of stock on hand for

each item • This allows for better decision making for timely ordering of

stock, and fast and slow moving stock can be identified to assist with decisions about stock levels and stock mix

• When combined with a physical stocktake, stock losses and gains can be identified

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Summary

The perpetual system of stock recording provides the answer to the question of how much stock is sold or on hand (i.e. quantity of stock), but does not provide the value for that stock.So we also need to allocate a cost to each unit of stock.

For purchases we will have the cost price on the source document, however for all movements OUT of stock we will need to use FIFO as our system of allocating a cost to each unit.

FIFO (First in First Out) – for all movements OUT • the assumption that the stock that is purchased first will be sold

(used) first • So FIFO will allocate the cost of the stock in the order that it has

been purchased – oldest stock out first • This also applies to stock used for advertising, drawings of stock and

stock loss 177


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Stock

Drawings/Advertising Use

Stock Loss & Stock Gain

Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/drawingsadvertising-use-stock-loss-and-gains/outline/

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/recording-stock-loss-and-gains-

cont/recording-a-stock-loss/

178























https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/recording-stock-loss-and-gains-cont/recording-a-stock-loss/





























©Edrolo

Outline

• Stock cards – Drawings and Stock used for Advertising

• Physical Stocktakes – Stock Loss or Gain

• Reporting a stock loss or stock gain

• Effects on the Accounting Equation

Unit 3 - Area of Study 1 • stock cards using the First In, First Out (FIFO) method for advertising use and

drawings • internal control procedures and practices of this accounting system • the recording and reporting of balance day adjustments:

• stock loss or gain as revealed by a physical stocktake • the two fold effect of transactions on the accounting equation 179


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Stockcards – Drawings of Stock

As the Drawings results in a movement OUT of stock we need to be consistent and use FIFO. So the withdrawn item of stock would be assumed to be from the oldest stock – that means a cost price of $350

MEMO 324 February 21 Took one TV set home for personal use – model Bravo KL55

Stock Card

Product Bravo KL55 Code No: KL55 Recording Method: FIFO



Feb 1 Balance

6 365 2190

2 350 700

1 Feb 21 Memo 324 350 350 1 350 350

6 365 2190 180


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Stockcards – Drawings of Stock in GJ

The withdrawal of stock by an owner will cause: • a decrease in the asset Stock Control which is a credit entry • an increase in ‘Drawings’ which is a debit (Drawings is a debit entry as

it is a decrease in Owner’s Equity)


Feb 21

MEMO 324 February 21 Took one TV set home for personal use – model Bravo KL55

Remember – cash drawings will be recorded in the Cash Payments Journal

Drawings 350

Stock Control 350


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Once again we will use FIFO for this movement of stock OUT of the business. So the donated BBQ would be assumed to be from the oldest stock – so a cost price of $480

MEMO B238 March 4 Provided one Stallion BBQ to Eastern Hills Primary for raffle – to be acknowledged with business name on raffle tickets

Stock Card

Product Stallion BBQ Code No: STN Recording Method: FIFO



Mar 1 Balance

8 470 3760

1 480 480

1 Mar 4 Memo B238 480 480 8 470 3760 182


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The donation of stock to the school will cause: • a decrease in stock which is a credit entry • as the business will receive advertising in return for the donation this

can be treated as a business expense – hence a debit in Advertising


Mar 4

MEMO B238 March 4 Provided one Stallion BBQ to Eastern Hills Primary for raffle – to be acknowledged with business name on raffle tickets

Advertising 480

Stock Control 480

1 Stallion BBQ provided to Eastern Hill PS for raffle (Memo B238)

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No Effect Decrease $350 (increase in Drawings which decreases Owner’s Equity)

Effect of a Drawing of $350 of Stock



No Effect Decrease $480 (increase in expense of Advertising which decreases Net Profit)

Effect of using $480 of Stock for Advertising

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Physical Stocktakes

As the stockcards record every transaction relating to every item of stock, the balance on the stock cards shows the amount of stock that should be on hand at that time. However, the actual number on hand may be not be the same as the stock card indicates. The actual number of units of stock on hand needs to be manually checked by doing a physical count of the stock.

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Stock Loss and Gains

A stocktake involves a physical count of the number of units of each line of stock on hand. The result of the physical stocktake will then be compared against the balances in the stock cards to detect any stock losses or gains. (this aids in satisfying Reliability) Stock loss – when the result of the physical count for an item is less than the quantity shown as the balance on the stock card Stock gain– when the result of the physical count for an item is more than the quantity shown as the balance on the stock card

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Stock loss- possible causes

Possible Causes of Stock Loss: • Theft • Breakages and Damage that haven’t been recorded • Undersupply from a supplier • Oversupply to a customer • Errors in recording – e.g. a sale hasn’t been recorded, or the

owner may not have recorded a withdrawal of stock • Errors in the stocktake process – some items of stock have been

missed in the count e.g. stock in a display

These are possible reasons because if a loss is detected we cannot say for certain what has caused it – if the business knew the reason it would have already been recorded

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Stock gain - possible causes

Possible Causes of Stock Gain: • Oversupply from a supplier • Undersupply to a customer • Errors in recording – e.g. a sale has been recorded twice,

purchase of stock may have been recorded incorrectly • Errors in the stocktake process – some stock may have

been double counted e.g. moved in the process

Again these are possible reasons for a gain because we won’t know for certain what has caused a gain

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Recording a Stock Loss

Stock Card

Product Espire Monitor Code No: ESPM1 Recording Method: FIFO



A physical stocktake on Feb 28 reveals that there are 6 Espire Monitors on hand (Memo 21). When we compare this to the amount on the stockcard we can see that this is one less than we expected to have on hand. So there is a stock loss of one unit. To record the stock loss we need to know not only the number of items lost but we must determine a value for this stock.

Feb 1 Balance

1

4 290 1160

3 310 930

Feb 28 Memo 21 189


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Recording a Stock Loss

Stock Card




We have previously recorded movements OUT of stock using FIFO so for consistency/comparability we need to continue to apply FIFO. So that means we will assume that the missing unit has come from the oldest stock – that is the first cost price listed in the balance column - $310. Notice that this is not the lowest cost – it is the oldest.

Feb 1 Balance

1

4 290 1160

3 310 930

Feb 28 Memo 21 310 310 2 310 620

4 290 1160 190


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General Journal – Stock Loss

The adjustment for the stock loss needs to be recorded in the General Journal. The stock loss will cause: • an increase in Stock Loss which is an expense – therefore a debit

entry • a decrease in the asset Stock Control which is a credit entry


Feb 28

Stock Loss 310

Stock Control 310

Stocktake revealed the loss of one Espire Monitor (Memo 21)

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Recording a Stock Gain

Stock Card




A physical stocktake on Feb 28 reveals that there are 9 Espire Monitors on hand (Memo 21). When we compare this to this amount on the stockcard we would see that this is two more than we expected to have on hand. So there is a stock gain of two units. Once again we need to determine a value to attach to these items

Feb 1 Balance

2

4 290 1160

3 310 930

Feb 28 Memo 21 192


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Recording a Stock Gain

Stock Card




For a stock loss we used FIFO to be consistent with all of our recording of movements OUT of stock. For stock gains, we need to need to adhere to Conservatism – to avoid overstating the stock gain and the value of stock on hand. So that means we will value the returning stock at the lowest cost price currently on hand.

Feb 1 Balance

2

4 290 1160

3 310 930

Feb 28 Memo 21 290 580 3 310 930

6 290 1740 193


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General Journal – Stock Gain

The adjustment for the stock gain also needs to be recorded in the General Journal. The stock gain will cause: • a increase in the asset Stock Control which is a debit entry • an increase in Stock Gain which is a revenue – therefore a credit entry


Feb 28

Stock Gain 580

Stock Control 580

Stocktake revealed the gain of two Espire Monitors (Memo 21)

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Reporting a Stock Loss or Stock Gain

Stock Loss is an expense Stock Gain is a revenue Where do they appear in the Income Statement?

REVENUE

Less: COST OF GOODS SOLD

Cost of Sales

GROSS PROFIT

Add: Stock Gain or

Less: Stock Loss

ADJUSTED GROSS PROFIT

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No Effect Decrease $310 (increase in expense of Stock Loss which decreases Net Profit)

Effect of a Stock Loss of $310


Increase $580 (increase in Stock Control)

No Effect Increase $580 (increase in revenue item Stock Gain which increases Net Profit)

Effect of a Stock Gain of $580

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Remember

For Stock Losses use FIFO – use the oldest value of the stock on hand For Stock Gains – use the lowest available price in the balance column of the stock card

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Preparing the ledger for the

next reporting period

Balancing of Ledger

Accounts

Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-1/balancing-accounts/outline/

198
















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Outline

• Balancing of A, L & OE accounts

Unit 3 - Area of Study 1 • the process of balancing the general ledger and subsidiary ledger

accounts in preparation for the next reporting period

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The end of the reporting period

For reporting purposes the ongoing life of the business is broken into reporting periods.

Once all transactions and adjustments for the period have been recorded for a reporting period:

• reports are prepared, and

• the ledger needs to be prepared for the next period

Source Docs

→ Ledgers →

Pre Adj. Trial

Balance

Reports → Journals → →

Balance Day Adj.

→ Closing Entries →

Post Adj. Trial

Balance

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End the Reporting Period

The ledger needs to be prepared for the next period

Revenue and Expense accounts need to be ‘reset to zero’ using ‘closing entries’

Asset, Liability and Owner’s Equity accounts need to be formally balanced - the balance of these accounts is carried forward into the new period as these represent:

• future economic benefits (Assets) and

• present obligations for future outflows of benefit (Liabilities) which carry forward into the next period

Source Docs

→ Ledgers →

Pre Adj. Trial

Balance


Balance Day Adj.


Post Adj. Trial

Balance

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Balance Accounts

The ‘balance’ of an account simply means the difference between the two sides.

To find the balance:

1. Total the amounts on each side of the accounts, and write the larger of these two totals on both sides. (and show these on the same line)

Debtors Control Date Cross-reference Amount Date Cross-reference Amount

Jan 31 10000

40000

25000

40000

Jan 1 Balance

Jan 31

Bank\Disc. Exp.

Sales \ GST Clearing 15000

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Balance Accounts

2. Calculate the difference between the totals of each side – in this case:

Debits of $40 000 – Credits of $10 000 = Difference of $30 000

3. Enter the difference on the lesser side so that the two sides are now equal


Jan 31 10000

Balance 30000

40000

25000

40000

Jan 1 Balance

Jan 31

Bank\Disc. Exp.

Sales \ GST Clearing 15000 Jan 31

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Balance Accounts

In this case we needed to add $30 000 to the credit side – this means that the debits were $30 000 dollars more than the credit entries.

4. So the final step is to bring down the balance to the debit side as this is the balance of the account for the start of the next period


Jan 31 10000

Balance 30000

40000

25000

40000

Jan 1 Balance

Jan 31

Bank\Disc. Exp.

Sales \ GST Clearing 15000

Feb 1 30000 Balance

Jan 31

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Balancing of Accounts

Creditors Control Date Cross-reference Amount Date Cross-reference Amount

Jan 1 12000

Balance 37000 49000

26000

49000

Jan 31 Balance

Jan 31 Bank\Disc. Revenue.

Stock Control\ GST Cl 23000

Feb 1 23000 Balance

Jan 31

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Balancing of Subsidiary Accounts

Creditor – L. Newgent Date Cross-reference Amount Date Cross-reference Amount

Jan 1 1200

Balance

2700

7100

1200

7100

Jan 9 Balance

Jan 31

Bank\Disc. Revenue. Stock Control\ GST Cl

5900

Feb 1 5900 Balance

Jan 3

Exactly the same process applies in any subsidiary ledger

3200 Stock Control\ GST Cl Jan 15

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Balancing of Accounts

When do we need to balance accounts?

A, L & OE accounts would normally be formally balanced at the end of each month

In exams, you will not be expected to formally balance every account – the question will clearly state when you are being asked to balance an account so read questions carefully

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Preparing the ledger for the

next reporting period

Closing Entries

208

Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-2/closing-ledger/outline/
















©Edrolo

Outline

• Reporting Period

• The Profit and Loss Summary Account

• Closing Entries for Revenue and Expenses

• Transfer of Profit or Loss to the Capital account

• Transfer of drawings to the Capital account

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Outline

Unit 3 - Area of Study 2 • closing entries for revenue and expenses in the general journal and

in the general ledger • the preparation of the Profit and Loss Summary account with

transfer of profit or loss to Capital account • transfer of Drawings to Capital account

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The Reporting Period


The reporting periods are regular intervals of time – months, quarters, ½ year or 1 year at most.

At the end of each reporting period, the business prepares reports so that the performance of the business can be examined and decisions can be made about the future of the business.

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Source Docs

→ Ledgers →

Pre Adj. Trial

Balance


Balance Day Adj.


Post Adj. Trial

Balance

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End of the Reporting Period

Reports are prepared:

The balances of accounts within the General Ledger are used as the basis for two accounting reports:

• the Income Statement - which reports on the Net Profit made in the period by comparing revenues earned in the period with expenses incurred in the period

• The Balance Sheet – which reports on the remaining assets, liabilities and owner’s equity as at the end of the period

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End the Reporting Period

The ledger needs to be prepared for the next period

Revenue and Expense accounts need to be ‘reset to zero’ using ‘closing entries’

Asset, Liability and Owner’s Equity accounts need to be formally balanced - the balance of these accounts is carried forward into the new period as these represent:

• future economic benefits (Assets) and

• present obligations for future outflows of benefit (Liabilities) which carry forward into the next period

Source Docs

→ Ledgers →

Pre Adj. Trial

Balance


Balance Day Adj.


Post Adj. Trial

Balance

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Closing Entries

Closing the Ledger

• Closing the ledger involves transferring all balances from revenue and expense accounts to a special account called the Profit and Loss Summary account.

• This Profit and Loss Summary account collects all revenue and expenses into one account, the difference between the revenues and expenses will be the profit or loss for that Reporting period.

• In the process, the revenue and expense accounts will be ‘emptied’, or reset to zero – ready for the next Reporting period.

Source Docs

→ Ledgers →

Pre Adj. Trial

Balance


Balance Day Adj.


Post Adj. Trial

Balance

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Closing Entries

So there are the two key reasons for ‘closing’ the ledger:

• to transfer revenues and expenses to the Profit and Loss Summary account in order to calculate profit for the current Reporting period

• to reset revenue and expense accounts to zero in preparation for the next Reporting period.

Source Docs

→ Ledgers →

Pre Adj. Trial

Balance


Balance Day Adj.


Post Adj. Trial

Balance

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Closing Entries

Closing Revenue & Expense Accounts

• Only revenue and expense accounts are closed, because only revenues and expenses are used to determine profit.

Revenues and expenses exist only during a particular Reporting period, while assets and liabilities and owner’s equity will exist into the future.

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Closing Revenue Accounts

Revenue accounts usually have a credit balance (as they represent an increase in owner’s equity)

In order to transfer balances from these accounts, the revenue accounts must be debited (to reduce the account to zero), with a matching credit to the Profit and Loss Summary account.

Sales Date Cross-reference Amount Date Cross-reference Amount

Dec 31 Bank 10000


25000

25000

25000

Dec 31 P & L Summary

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Closing Revenue Accounts

Sales Date Cross-reference Amount Date Cross-reference Amount

Dec 31 Bank 10000


25000

Dec 31 P & L Summary 25000

25000

Profit and Loss Summary Date Cross-reference Amount Date Cross-reference Amount

Dec 31 25000

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Closing Expense Accounts

Expense accounts usually have a debit balance (as they represent a decrease in owner’s equity)

In order to transfer balances from these accounts, the expense accounts must be credited (to reduce the account to zero), with a matching debit to the Profit and Loss Summary account.

Wages


10000 Dec 31 Bank 10000 Dec 31 P & L Summary

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Closing Entries

All closing entries must first be recorded in the General Journal, before being posted to the General Ledger accounts.

The first step is to identify the revenue and expense accounts

Post Adjustment Trial Balance as at December 31

Accounts Debit Credit

Bank 20000

Capital 43200

Cost of Sales 16000

Creditors Control 2000


Discount Expense 200

Discount Revenue 500

Drawings 1800

Office Expenses 400

Rent 1500

Sales 35000

Stock Control 32000

Wages 4800

80700 80700 221


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Closing entries - General Journal



Dec 31

Sales 35000

P & L Summary 35500

Cost of Sales 16000


Transfer of revenue accounts at end of the period (Memo 101)

P & L Summary


Office Expenses 400

Rent 1500

Wages 4800

Transfer of expense accounts at end of the period (Memo 101)

22900

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The P & L Summary Account

Here’s how the P & L Summary Account would appear once all of the revenue and expense accounts have been closed

All of the revenue and expense accounts would now have a balance of zero

P & L Summary Date Cross-reference Amount Date Cross-reference Amount

22900 Dec 31 Expenses 35500 Dec 31 Revenues

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The P & L Summary – Calculating Net Profit

The P & L Summary account is a temporary account which only exists to calculate profit (or loss) in the ledger.

Once the revenues and expenses have been transferred we can now transfer the profit (or loss) to the Capital account


22900 Dec 31 Expenses 35500 Dec 31 Revenues

35500 35500

12600 Capital

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Transfer of Net Profit - General Journal



Dec 31

Sales 35000

P & L Summary 35500

Cost of Sales 16000


P & L Summary


Office Expenses 400

Rent 1500

Wages 4800

22900

Capital 12600

P & L Summary 12600

Transfer of Net Profit to Capital (Memo 101)

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Drawings and Capital

Now that all of the revenue and expenses have been closed and the P & L Summary account has also been closed off to Capital, there is one final ledger to close

The Drawings account has been used during the period to record any withdrawals of capital by the owner – in the form of cash or other assets.

Drawings


1300 Dec 31 Bank

500 Stock Control

Dec 31 1800 Capital

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Drawings and Capital

At the end of the period the Drawings account needs to be transferred to the Capital account in order to calculate the investment by the owner for the start of the new period.

Drawings Date Cross-reference Amount Date Cross-reference Amount

1300 Dec 31 Bank

500 Stock Control



Dec 31

Drawings 1800

Capital 1800

Transfer of Drawings to Capital (Memo 101)

1800 1800

Dec 31 1800 Capital

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The Closing Entries - General Journal



Dec 31

Sales 35000

P & L Summary 35500

Cost of Sales 16000


P & L Summary


Office Expenses 400

Rent 1500

Wages 4800

22900

Capital 12600

P & L Summary 12600

Drawings 1800

Capital 1800

1. Transfer all revenues to P&L Summary

2. Transfer all expenses to P&L Summary

3. Transfer Net Profit (or loss) to Capital

4. Transfer Drawings to Capital 228


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The Capital Account

Once all of the closing entries are complete the Capital account will show how the owner's investment has changed through the period. The balance at the end of the period becomes the Capital for the start of the next period.

Capital Date Cross-reference Amount Date Cross-reference Amount

1800 Dec 31 Drawings

12600 P & L Summary

55800 55800

Dec 1 43200 Balance Dec 31

54000 Balance Dec 31

Jan 1 54000 Balance

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The Capital Account and the Balance Sheet

The account will match the detail in the Owner's Equity Section in the Balance Sheet as at December 31

Capital Date Cross-reference Amount Date Cross-reference Amount

1800 Dec 31 Drawings

12600 P & L Summary

55800 55800

Dec 1 43200 Balance Dec 31

54000 Balance Dec 31

Jan 1 54000 Balance

Owner’s Equity

Capital 43200

Add: Net Profit 12600

55800

Less: Drawings 1800 54000 230


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Summary Why close?

• to transfer revenues and expenses to the Profit and Loss Summary account in order to calculate profit for the current Reporting period

• to reset revenue and expense accounts to zero in preparation for the next Reporting period

The closing entries

1. Transfer all revenues to P&L Summary – Revenues DR

P&L Summary CR

2. Transfer all expenses to P&L Summary – P&L Summary DR

Expenses CR

3. Transfer Net Profit (or loss) to Capital

PROFIT P&L Summary DR LOSS Capital DR

Capital CR P&L Summary CR

4. Transfer Drawings to Capital Capital DR

Drawings CR

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Preparing Accounting

Reports

Income Statement

Balance Sheet

Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-2/accounting-reports-income-and-balance-sheet/introduction/

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Outline

Accounting Reports

• Income Statement

• Gross Profit

• Net Profit

• Balance Sheet

Unit 3 - Area of Study 2 • classified accounting reports:

• Income Statement • Balance Sheet

• the effect of transactions on the accounting equation and the accounting reports

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The Reporting Period


The reporting periods are regular intervals of time – months, quarters, ½ year or 1 year at most.

At the end of each reporting period, the business prepares reports so that the performance of the business can be examined and decisions can be made by management.

234


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Source Docs

→ Ledgers →

Pre Adj. Trial

Balance


Balance Day Adj.


Post Adj. Trial

Balance

235


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Reports are prepared


• the Income Statement - which reports on the Net Profit made in the period by comparing revenues earned in the period with expenses incurred in the period

• The Balance Sheet – which reports on the remaining assets, liabilities and owner’s equity as at the end of the period

The post adjustment trial balance provides the balances of all accounts in the General Ledger

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Income Statement

Once the ledger has been closed, the Profit & Loss Summary account will show whether the business has made a profit or a loss for the period

However the P & L Summary will only show total revenues and total expenses – so it summarises the overall position – in this case a Net Profit of $19 270.

So it doesn’t provide any detail that would enable management to understand causes of changes in performance and to make decisions about the business performance.


66300 May 31 Expenses 85570 May 31 Revenues

85570

19270 Capital

85570

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Income Statement

The Income Statement is a formal report that shows the details of revenues and expenses for the reporting period.

It will provide the detail that management would need to understand what has affected the profit performance of the business.

The purpose of all reports is to provide information to management to assist with decision making.

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Income Statement

In Unit 3 and 4 we are dealing with trading businesses - businesses whose main purpose is purchase and sale of goods at a profit.

So the format of the Income Statement will provide information about:

• the trading aspects of the business – Gross Profit

• the overall effect of all revenues and expenses – Net Profit

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Gross Profit

• Revenue – relates only to trading revenue i.e. Sales (both cash and credit)

• Cost of Goods Sold – any costs associated with getting the stock into a condition and position for sale.

The basic item is the direct cost of the stock that has been sold – Cost of Sales

Also includes other costs like transport in, packaging

Income Statement for the month ended May 31

Revenue

Sales 85000

less Cost of Goods Sold

Cost of Sales 43000

Buying Expenses 3000

Freight In 4000 51000

Gross Profit 34000

The Income Statement shows all revenues and expenses that have occurred within the reporting period.

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Gross Profit

Revenue – Cost of Goods Sold =

• Gross Profit

The Gross Profit shows the difference between the selling price and cost price of the items that have been sold – this can be used to assess the mark up/margin that the business is applying

• Adjusted Gross Profit

Any adjustments for stock gain or stock loss are then added or subtracted

Income Statement for the month ended May 31

Revenue

Sales 85000

less Cost of Goods Sold

Cost of Sales 43000

Buying Expenses 3000

Freight In 4000 51000

Gross Profit 34000 less Stock Loss

(or Add: Stock Gain) 1500

Adjusted Gross Profit 32500

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Net Profit

• Other Revenue

Any revenue earned other than sales

The figure of Adjusted Gross Profit + Other Revenue must be shown in this case 32500 + 570 = 33070

• Other Expenses

Any expenses other than Cost of Goods Sold

• Net Profit

This is the overall result now that all revenues have been included and all expenses subtracted

Adjusted Gross Profit 32500

Add Other Revenue Discount Revenue 250

Interest Revenue 320 570

33070 less Other Expenses

Wages 6200


Rent Expense 4800

Depreciation of Truck 860

Interest Expense 340

Freight Out 1250 13800

Net Profit 19270

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Balance Sheet

The Balance Sheet is a formal report that presents the detail of the accounting equation of a business at a particular point in time.

Remember that at the end of the reporting period:

• Revenue and expense accounts will have been closed to the P&L Summary account

• Asset, Liability and Owner's Equity accounts will have been formally balanced

So once the revenue and expense accounts have been reported in the Income Statement, the remaining accounts from the General Ledger (A, L & OE) will be reported in the Balance Sheet

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Balance Sheet


Balance Sheet as at May 31

$ $ $ $

Current Assets Current Liabilities

Non-Current Liabilities

Non-Current Assets

Owner’s Equity

Total Assets Total Equities

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Balance Sheet



$ $ $ $



Non-Current Assets Owner’s Equity


Current Asset • a resource controlled by the entity • as a result of past events • from which future economic benefits are

expected to flow to the entity within the next 12 months

Non-Current Asset • a resource controlled by the entity • as a result of past events • from which future economic benefits are

expected to flow to the entity for longer than the next 12 months

Common examples - Debtors Control, Stock Control Be careful with - Bank, GST Clearing Don’t forget - Prepaid Expenses

Common examples – Equipment, Premises, Vehicles Don’t forget – Acc. Depn. accounts must be subtracted from the asset

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Balance Sheet



$ $ $ $


Non-Current Assets Non-Current Liabilities

Owner’s Equity


Current Liability • a present obligation of the entity • arising from past events • the settlement of which is expected to

result in an outflow of economic benefits within the next 12 months

Non-Current LIability • a present obligation of the entity • arising from past events • the settlement of which is expected to

result in an outflow of economic benefits in more than 12 months

Common example – Creditors Control Be careful with - Bank, GST Clearing Don’t forget – Accrued Expenses, Loans due within 12 months

Common example – Loan, Mortgage Don’t forget – only loans > 12 mths

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Balance Sheet



$ $ $ $



Non-Current Assets Owner’s Equity Capital 135 000

Add: Profit 19 270

154 270 Less: Drawings 2 400 151 870


Owner’s Equity Equity is the residual interest in the assets of the entity after deducting all its liabilities. i.e. OE = A – L Remembering that this is a report, we need to show what has caused changes to Owner’s Equity not just the final amount. So we include: • Capital – the capital at the start of the

period • Additional Capital added by the owner • Drawings by the owner • The Net Profit (or net Loss) generated

through the operation of the business 247


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Balance Sheet


$ $ $ $


Debtors Control 20 500 Bank 3 500

Stock Control 73 580 Creditors Control 12 200

GST Clearing 1 850 Loan – ZNB Bank 6 000 21 700

Prepaid Rent Expense 3 600 Non-Current Liabilities

99 530 Loan – ZNB Bank 25 000

46 700

Non-Current Assets Owner’s Equity

Trucks 130 000 Capital 135 000

Less: Accumulated Depreciation 30 960 99 040 Add: Profit 19 270

154 270 Less: Drawings 2 400 151 870

Total Assets 198 570 Total Equities 198 570 248


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Balance Day Adjustments (1)

Prepaid and Accrued

Expenses

249

Link to the Videos

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-2/balance-day-adjustments-prepaid-expenses/balance-day-adjustments/

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-2/balance-day-adjustments-

accrued-expenses/accrued-expenses-an-example/

























https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-2/balance-day-adjustments-accrued-expenses/accrued-expenses-an-example/



























©Edrolo

Outline

• What are balance day adjustments? Why are they needed?

• Prepaid expenses – the asset approach

• Accrued Expenses – payment of accrued expenses

Unit 3 - Area of Study 2 • the recording and reporting of balance day adjustments:

• the asset approach to recording prepaid expenses with GST being recorded at the time of payment

• accrued expenses with GST being recorded at the time of payment • the payment of accrued expenses in the subsequent reporting period

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Balance Day Adjustments

What are Balance Day Adjustments? For the purposes of reporting and decision-making, the life of the business is broken down into reporting periods (eg months, quarters, six-months, a year).

Balance Day is the last day of the reporting period.

These reporting periods do not necessarily match the life of the business, i.e. all transactions will not fall neatly within each reporting period.

Adjustments are done after all transactions have been entered for the period and before the ledger is closed and reports are prepared.

Source Docs

→ Ledgers →

Pre Adj. Trial

Balance


Balance Day Adj.


Post Adj. Trial

Balance 251


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Balance Day Adjustments

• Why are Balance Day Adjustments necessary?

On balance day (the last day of the period), all revenue and expense accounts are closed in order to determine the profit for the reporting period.

If this profit figure is to be an accurate reflection of performance in the reporting period, the revenue earned in the period must be matched with the expenses incurred (consumed) in that period. This ensures relevance in the reports by including all information which is useful for decision making (while excluding information which is not relevant).

To achieve an accurate reporting of profit for the period, balance day adjustments are completed before the ledger is closed. These entries adjust the revenue and expense accounts so that the relevant amount is closed and consequently shown in the reports.

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Prepaid Expenses

Prepaid Expenses - expenses which that have been paid in advance and have not been completely used in the current period –

some common examples: insurance, rent, office supplies

When recording these advance payments we need to use the ‘asset approach’ where the payments of prepaid expenses are initially recorded as assets – as they represent a future economic benefit

Adjustments are then made for the amount used in each period – as the economic benefit is consumed

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Prepaid Expenses – an example

Advance payment of Rent of $1800 plus $180 GST, paid on June 1 for the months of June, July and August Chq 435

The payment is initially recorded as an asset – Prepaid Rent Expense – as it represents a future economic benefit as the business will have access to the rented space over the next 3 months




Creditors Control

Stock Control

Wages Sundries GST

June 1 Prepaid Rent Exp 435 1980 1800 180

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Prepaid Expenses – an example

If the reporting period is the year ended June 30, a balance day adjustment is required to report the amount of rent that has been consumed in the year i.e. the rent expense for the year.

In this case, the Prepaid Rent is for the months of June, July and August.

So at the end of June:

• one month of rent has been consumed – rent expense

• two months remains unused and is still a current asset

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Prepaid Expenses – an example Prepaid Rent for June, July and August was $1800

At the end of June: • one month of rent has been consumed – rent expense

• two months remains unused and is still a current asset

Prepaid Rent Expense Date Cross-reference Amount Date Cross-reference Amount

1800 June 30 Bank

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Prepaid Expenses – an example All balance day adjustments must be recorded in the General Journal

This adjustment needs to transfer the amount used from the asset account to the relevant expense account – this increases the expense and decreases the current asset


June 30

Rent Expense 600

Prepaid Rent Expense 600

One month of prepaid rent used (Memo 324)

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Prepaid Expenses – an example Posted to the ledger

Prepaid Rent Expense Date Cross-reference Amount Date Cross-reference Amount

1800 June 30 Bank

1200 Balance June 30 600 Rent

1800 1800

July 1 1200 Balance

Rent Expense Date Cross-reference Amount Date Cross-reference Amount

600 June 30 Prepaid Rent Exp June 30 600 P & L Summary

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Prepaid Expenses

• Expenses paid in advance are recorded as a Current Asset – Prepaid ………. Expense

• On Balance Day we need to calculate how much of the asset has been consumed by that date

• An adjustment is required in the General Journal to transfer the amount used from the asset account to the relevant expense account – this increases the expense and decreases the current asset

……………….. Expense DR

Prepaid ……….. Expense CR

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Accrued Expenses

Accrued Expenses - goods/services that have been used or consumed but not yet recorded -

Some common examples: electricity, wages, interest expense

The amount outstanding on balance day needs to reported as a current liability as there is a present obligation to pay the amount owing

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Accrued Expenses – an example

$1400 of Wages remains unpaid on balance day

Wages Date Cross-reference Amount Date Cross-reference Amount

21000 June 30 Bank

The account shows that $21000 has already been paid in wages during the period.

If another $1400 is owing but is unpaid, the total wages incurred/used for the period should be $22400 - so the expense needs to be adjusted to show this amount

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Accrued Expenses – an example

An adjustment is required in the General Journal to increase the expense and increase the current liability


June 30

Wages Expense 1400

Accrued Wages 1400

Wages owing on Balance Day (Memo 325)

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Accrued Expenses – an example The adjustment is

Wages Expense Date Cross-reference Amount Date Cross-reference Amount

21000 June 30 Bank

22400 June 30 P & L Summary

22400 22400

Accrued Wages Expense Date Cross-reference Amount Date Cross-reference Amount

June 30 1400 Wages

1400 Accrued Wages

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Accrued Expenses

• On Balance Day we need to determine how much of an expense has been consumed/used but is still not recorded

• An adjustment is then required in the General Journal to increase the expense and increase the current liability

……………….. Expense DR

Accrued ……….. Expense CR

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Payment of Accrued Expenses

In the following period the wages owing on June 30 will be paid.

On July 8 wages of $3500 are paid to employees Chq 235 (including the $1400 owing from the previous period)


July 1 1400 Balance

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On July 8 wages of $3500 are paid to employees Chq 235 (including the $1400 owing from the previous period) So $1400 of this payment settles the outstanding liability, the remaining $2100 is payment of wages for the new period.




Creditors Control

Stock Control

Wages Sundries GST

July 8 Accrued Wages Exp 235 3500 1400

Wages 2100

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July 1 1400 Balance July 31 1400 Bank

Wages Expense Date Cross-reference Amount Date Cross-reference Amount

July 31 2100 Bank

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Accrued Expenses – an example with GST

On June 30 $350 of Electricity has been used but has not been paid

Electricity Date Cross-reference Amount Date Cross-reference Amount

1270 June 30 Bank

The account shows that $1270 has been paid for electricity during the period. If another $350 is owing but is unpaid the total electricity incurred/used for the period should be $1620 - so the expense needs to be adjusted to show this amount

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Accrued Expenses – example

The balance day adjustment in the General Journal


June 30

Electricity Expense 350

Accrued Electricity 350

Electricity owing on Balance Day (Memo 326)

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Accrued Expenses – example The adjustment is

Electricity Expense Date Cross-reference Amount Date Cross-reference Amount

1270 June 30 Bank

1620 June 30 P & L Summary

1620 1620

Accrued Electricity Expense Date Cross-reference Amount Date Cross-reference Amount

June 30 350 Electricity

350 Accrued Electricity

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On July 10 Electricity of $2750 (inc GST of $250) was paid Chq 239


July 1 350 Balance

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On July 10 Electricity of $2750 (inc GST of $250) was paid Chq 239

So $350 of this payment settles the outstanding liability, the remaining $2100 is payment of electricity used for the new period plus any GST applying to the complete transaction




Creditors Control

Stock Control

Wages Sundries GST

July 8 Accrued Elect. Exp 239 2750 350

Electricity 2150 250

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July 1 350 Balance July 31 350 Bank

Electricity Expense Date Cross-reference Amount Date Cross-reference Amount

July 31 2150 Bank

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Summary

Prepaid Expenses

• Expenses paid in advance are recorded as a Current Asset – Prepaid ………. Expense

• The adjustment increases the expense and decreases the current asset ……………….. Expense DR Prepaid ……….. Expense CR

Accrued Expenses

• On Balance Day we need to determine how much of an expense has been consumed/used but is still not recorded

• The adjustment increases the expense and increases the current liability ……………….. Expense DR Accrued ……….. Expense CR

• When the next payment is recorded relating to the expense remember to firstly debit the Accrued ….. Expense account and then the remainder is an expense for the new period

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Balance Day Adjustments (2)

Depreciation - the basics

275

Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-2/depreciation-1/outline/

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-2/depreciation-2/slm-example-calculation/


































©Edrolo

Outline

• What is depreciation? why depreciate?

• How to calculate straight line depreciation

• Mechanics of recording and reporting

• Effects on reports

• Some issues to watch out for in exam questions about depreciation

Unit 3 - Area of Study 1 • the recording and reporting of balance day adjustments:

• straight-line method of depreciation

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Why Depreciate?

• What is depreciation?

the allocation of the cost of a non current asset over its useful life

• Why depreciate?

Non–current assets are items such as Vehicles, Machinery, Furniture, Fittings

Assets – each of these represents a future economic benefit

Non-current – this benefit will last over a number of reporting periods

As the business uses up (consumes) the economic benefit of each asset, this needs to be reported as an expense.

So depreciation will allocate part of the cost of the asset to each period that the asset is used in the business – to each period that the asset contributes to revenue

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Why Depreciate?

Depreciation is a balance day adjustment To report an accurate net profit we need to show the expense that is incurred each period that the asset is used. Accounting Principles – Reporting Period – report accurate profit by matching revenues earned in the period with expenses incurred in the period

Conservatism – losses are recognised when they are likely to occur – this avoids understating expenses and overstating assets

Qualitative Characteristic – Relevance – reports should include all information related to the period that is useful to decision-making

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Straight Line Method of Depreciation

• The only method that is used in Unit 3 (Unit 4 introduces the Reducing Balance as well)

• The Straight Line Method > assumes the asset will be used evenly over its useful life –

that it will make an even contribution to revenue > it therefore allocates the cost of the asset evenly to each

period that the asset is used

Depreciation Expense = Original Cost - Residual Value Estimated Life

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The ‘cost to be allocated’

• What is the 'cost' of the asset to the business? The cost to the business will be the total value of the asset to be consumed by the business - this is known as the depreciable value.

• This cost is the difference between what the business paid for the asset (original cost) and what the business expects to collect when the asset is disposed of (residual value)

‘Original Cost’ less ‘Residual Value’

• The depreciable value is the total value of the asset to be consumed by the current owner or entity so it is the cost to be allocated.

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Original Cost

• What needs to be included in the Original Cost of the asset? • The original cost includes:

> The purchase price of the asset (not including GST) plus

> Any costs involved: in getting the asset into a position and condition to earn

revenue which will also have a benefit over the life of the asset e.g.

installation, modifications, signage

‼ don't include annual costs such as insurance, registration – these are not for the life of the asset and will be recorded separately


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Why is the residual value subtracted from the original cost?

• The estimated residual value is not going to be used by this business in earning revenue so it is not part of the cost to be allocated.

• It represents a potential inflow of future economic benefit at the end of the asset’s life. This portion of the asset will be used up by someone else (another entity) once the asset has

been sold.


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SLM Example – calculation

e.g. Office Furniture purchased for cash on Jan 1, 2013 for $20 900 (including $1 900 GST).

Another $1 100 (inc GST) was spent on modifications before the furniture could be used in the business.

It is planned to use the furniture for 5 years and the estimated resale value at the end of the five years is $5 000. (memo 34)

Depreciation Expense = Original Cost - Residual Value Estimated Life Depreciation Expense = (19000 + 1000) – 5000 = 15000 = $3 000 pa 5yrs 5 Once the initial SLM calculation has been made, it can then be expressed as a % to simplify adjustments in later periods: Depreciation Rate = Depn Expense X 100 = 3000 X 100 = 15% pa Original Cost 20000 283


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SLM Example – General Journal



2013

Dec 31 Depreciation of Office Furniture 3000

Acc. Depn. of Office Furniture 3000

Office Furniture depreciated at the rate of 15%pa Straight Line Method (Memo 34)

So the Depreciation entry for the first year of the furniture’s use would be:

The Depreciation adjustment will always be: DR Depreciation of ……… (this is an expense which will be reported under ‘other expenses’ in the Income Statement) CR Accumulated Depreciation of ………. (this will increase a negative asset account which will be reported in the Balance Sheet)

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SLM Example – General Ledger

The General Journal entry would then be posted to the ledger as follows:

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Effect on the Reports

• Income Statement – The annual depreciation expense will appear in the Income Statement under ‘other expenses’. In this example the item would be:

Depreciation of Office Furniture 3000

So Net Profit decreases by $3 000

• Balance Sheet -

• Cash Flow Statement There is no cash involved in the adjustment for depreciation so there is no impact on Cash Flow

Non Current Assets

Office Furniture 20 000

Less: Accumulated Depreciation 3 000 17 000

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Decrease $3 000 (increase in Negative Asset of Acc. Depn.)

No Effect Decrease $3 000 (increase in expense which decreases Net Profit)

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Effect on the Reports – a year later

(assuming that nothing had changed in relation to the asset)

• Income Statement – > As the method being used is Straight Line, the annual depreciation

expense would remain the same:

Depreciation of Office Furniture 3000

• Balance Sheet - As at December 31, 2014

Non Current Assets

Office Furniture 20 000

Less: Accumulated Depreciation 6 000 14 000

Original Cost – only changes if some of the asset is bought or sold or modified

Allocated Cost – the cost that has been allocated as an expense so far in the asset’s life

Carrying Value – includes the cost still to be allocated plus any residual value 288


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Watch out for

• Make sure that you identify the asset when naming the accounts e.g. Depreciation of Office Furniture it’s OK to abbreviate in the journal and the ledger using ‘Depn’ or ‘Acc Depn’ as long as you name the asset being depreciated.

Don’t abbreviate in reports

• The amount of depreciation will vary depending on the rate of depreciation and the time period involved – • check the length of the reporting period (are we depreciating for

a month, quarter, 6 months or a year?)

• watch out for assets purchased during the period. i.e. have we had the asset for the full reporting period?

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Also, watch out for

• Do you need to set up the SLM formula or is the rate already provided as a % per annum?

• Some aspects of the original cost may be in the additional information or on other source documents

• Remember to record separately any costs that will not have a benefit over the life of the asset – prepaid insurance, registration

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Reports

Cash Flow Statement

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Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-2/preparing-accounting-reports-cash-flow-statement/outline/
























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Outline

• Accounting Reports

• Cash Flow Statement

• Operating Activities

• Investing Activities

• Financing Activities

Unit 3 - Area of Study 2 • classified accounting reports:

• Cash Flow Statement using the transaction approach

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Source Docs

→ Ledgers →

Pre Adj. Trial

Balance


Balance Day Adj.


Post Adj. Trial

Balance

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Accounting Reports


• the Income Statement which reports on the Net Profit made in the period by comparing revenues earned in the period with expenses incurred in the period

• the Balance Sheet which reports on the remaining assets, liabilities and owner’s equity as at the end of the period

(these balances are provided in the post adjustment trial balance)

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Cash Flow Statement

The Cash Flow Statement is a report that explains the changes in the cash position of the business.

The Cash Flow Statement reports on all cash inflows (cash received), and

cash outflows (cash paid).

The Cash Flow Statement will usually be prepared using the information in the cash journals.

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Cash Flow Statement

In Units 1 & 2 we used a Statement of Receipts and Payments – but as the name suggests this just listed receipts and payments with out any meaningful groupings to assist in interpreting the cash flow of the business.

The Cash Flow Statement is essentially a classified Statement of Receipts and Payments.

The classifications used in the Cash Flow Statement are:

Operating activities

Investing activities

Financing activities. 296


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Operating Activities

• Operating activities - all cash flows related to the firm’s day-to-day trading activities

Operating inflows – all cash received relating to transactions with the various customers of the business –

cash sales, receipts from debtors, GST on cash sales, GST refund and any other cash revenues e.g. interest revenue or rent revenue

Operating Outflows - all cash paid relating to transactions with suppliers and employees of the business –

cash purchases of stock, payments to creditors, GST paid, GST settlement, all expenses paid including prepaid expenses and payment of accrued expenses

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Investing Activities

• Investing activities - cash flows relating to the purchase or sale of non-current assets

Investing inflows – cash received from the sale of a non-current asset (Unit 4)

Investing outflows – cash payment for a non-current asset

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Financing Activities

• Financing activities - cash flows that are the result of changes in the firm’s financial structure These cash flows only relate to:

• changes in loans, or

• direct changes in Owner’s Equity as a result of cash transactions

Financing inflows – cash received from

• Cash contributions by the owner

• The receipt of a loan

Financing outflows – cash paid

• Cash drawings by the owner

• Repaying the principle of a loan

(not interest on a loan – this is operating)

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Format of the Cash Flow Statement

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Format of the Cash Flow Statement

Inflows and outflows must be clearly distinguished.

There are two accepted ways of doing this:

• Use Headings for Inflows\Outflows, and\or

• Show all outflow amounts in brackets

Whether you choose to use headings or not, it is always a good idea to show all outflow amounts in brackets to avoid making mistakes when calculating totals.

Cash Flow Statement for the month ended May 31

Cash Flow from Operating Activities

Operating Inflows

Cash Sales 85000

Receipts from Debtors 23000

GST Received 8500 116500

Operating Outflows

Cash Purchases of Stock (35000)

Payment to Creditors (60000)

Wages (20000)

GST Paid (1800)

GST Settlement (3200) (120000)

Net Cash flows from Operations (3500) 301


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Classifying Cash Flows – an example

Cash Receipts Journal (extract)



Debtors Control

Cost of Sales

Sales Sundries GST

Sept 5 Capital 821 9200 9200


20980 300 3800 3300 6800 10000 680

Cash Payments Journal (extract)



Creditors Control

Stock Control

Wages Sundries GST

Sept 2 Prepaid Rent 346 1980 1800 180

7 Loan 351 3600 3600

19 Interest Expense 352 280 280

26860 100 3700 1800 2400 17680 1380

23 Vehicle 358 12000 12000 1200

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Cash Flow Statement - example


Cash Flow from Operating Activities

Receipts from Debtors 3500

Cash Sales 6800

GST Received 680

GST Refund 800 11780

Payment to Creditors (3600)

Cash Purchases of Stock (1800)

Wages (2400)

Prepaid Rent (1800)

Interest Expense (280)

GST Paid (1380) (11260)

Net Cash flows from Operations 520

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Cash Flow Statement - example


Net Cash flows from Operations 520

Cash Flow from Investing Activities

Net Cash flows from Investing Activities

Cash Flow from Financing Activities

Net Cash flows from Financing Activities

Net Increase/Decrease in Cash Position

Bank Balance at start

Bank Balance at end

(12000)

(12000)

Capital Contribution

Loan Repayment

9200

(3600) 5600

5600

(5880)

9600

3720

Vehicle

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Take Care – non cash items

Points to watch:

• Cost of sales is not a cash flow item

• Discount is not a cash flow so it does not appear as an item in the cash flow statement - it is a reduction in a cash flow - you must show the actual amount paid to creditors and received from debtors Payments to creditors = Total of creditors column less Discount revenue

Receipts from debtors = Total of debtors column less Discount expense

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Take Care – non cash items

• Watch for other non cash items in additional information that should not be included such as:

• Depreciation

• Drawings of Stock or assets other than cash

• Capital Contributions other than cash

• Credit sales & GST charged on credit sales

• Credit purchases & GST charged on credit purchases

• Expenses owing but not paid

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Reports

Cash Flow Statement

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Link to the Video

https://edrolo.com.au/vce/subjects/accounting/vce-accounting/unit-3-area-study-2/distinction-between-cash-and-profit/outline/






















©Edrolo

Outline

• Distinction between cash and profit

Unit 3 - Area of Study 2 • the distinction between cash and profit.

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Reporting of Cash and Profit

How are cash and profit reported?

• Cash is reported in the Cash Flow Statement This reports on the change in cash (bank balance) by comparing:

cash inflows (cash received) and cash outflows (cash paid)

• Profit is reported in the Income Statement This reports on the Net Profit made in the period by comparing:

revenues earned in the period with expenses incurred in the period

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Cash ≠ Profit

Why will cash and profit be different?

CASH = cash received less cash paid

PROFIT = revenue earned less expenses incurred

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The distinction between Cash and Profit

Cash and profit are not the same - they are different resources, and business owners need to understand this difference in order to manage both effectively.

The change in a firm’s cash (or bank balance) is calculated by comparing cash inflows and cash outflows in a period, whereas profit is determined by comparing revenues earned and expenses incurred in that period.

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Causes of the Difference

• Some cash items do not affect profit

• Some profit items do not affect cash

• Some items affect both cash and profit, but by differing amounts

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Cash only items

Some cash items do not affect profit

• Some cash receipts are not revenue

e.g. capital contributions, loans received

• Some cash payments are not expenses

e.g. cash drawings, loan repayments, cash purchase of non current assets

• GST received/paid (including settlement and refunds)

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Non Cash items

some profit items do not affect cash

• Some revenues are not receipts

e.g. stock gain

• Some expenses are not payments

e.g. stock loss, depreciation, bad debts, stock write-downs (U.4)

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Cash only items

Some items affect both cash and profit, but by differing amounts

• Credit sales & receipts from debtors

• Cost of sales & payments to creditors

• Expenses paid & expenses used (prepaid and accrued)

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Profit > Cash

If a business has a higher profit than cash flow

• Higher profit but no effect on cash

Non cash revenues e.g. stock gain

• No effect on profit but decreases cash

Cash Payments that are not expenses e.g. cash drawings, loan repayments, cash purchase of non current assets

• Increases profit more than cash

Credit sales > receipts from debtors

Cost of sales < payments to creditors

Prepaid Expenses > expenses used

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Profit < Cash

If a business has a lower profit than cash flow

• Lower profit but no effect on cash

Non cash expenses e.g. stock loss, depreciation, bad debts, stock write-downs

• No effect on profit but increases cash

Cash Receipts that are not revenues e.g. capital contributions, loans received

• Decreases profit more than cash

Credit sales < receipts from debtors

Cost of sales > payments to creditors

Expenses paid < expenses used (Accrued expenses owing, expenses prepaid last period)

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Questions about Cash and Profit

When you are asked to explain why the cash situation is different to profit for a particular firm you need to be careful to choose reasons that are relevant to the scenario you are given.

You need to base your comments on the evidence provided in the reports and in any additional information.

Also, check that you have not been limited to one area of cash flow e.g. only Operating Cash Flow

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Questions about Cash and Profit

• Be clear about what the situation is that you are being asked to explain:

is it? Profit > Cash or Profit < Cash

• Look for items that will produce that effect in 3 possible ways:

Cash items that do not affect profit

Profit items that do not affect cash

Items that affect both cash and profit, but by differing amounts

• You then need to explain how any that items you have identified will contribute to the difference.

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