Topic 4: Balance day adjustments (Part 2)
1.
Recap from Week 32. Balance day adjustments (Part 2)
•Depreciation
•Bad and doubtful debts
3. Continue with case study ‘Mel Tutoring Services’
Depreciation
•
Non-current assets (except land) represent a finite store of future benefit that the business will utilise or consume over a number of expected years of benefit.•This consumption of an economic benefit needs to be recognised in the Income Statement as depreciation expense
•As does the decrease in carrying value in the Balance Sheet (as accumulated depreciation).
•There is an Australian Accounting Standard that stipulates the accounting for Depreciation (AASB116 - PP&E)
•Depreciation is defined in para 6 as “the systematic allocation of the depreciable amount of an asset over its useful life.”
•Carrying amount is the amount at which an asset is recognised after deducting any accumulated deprecation (and accumulated impairment losses)
•The depreciable amount is “the cost of an asset, or other amount substituted for cost, less its residual value”
•Residual value of an asset is “the estimated amount that an entity would currently obtain from disposal of the asset … at the end of its useful life”
•Useful life is “the period over which an asset is expected to be available for use by an entity”
Different methods are available.
Depreciation expense is an expense account whose normal balance is a debit. This account shows the cost that has expired during the current accounting period. Accumulated depreciation is a contra asset account whose normal balance is a credit. The balance in this account is the depreciation that has been recognised from the date of acquisition to the reporting date.
“The depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity.” (AASB 116, para. 60)
•Straight-line
•Reducing balance
•Units of production (not examinable)
Dr Depreciation
Cr Accumulated Depreciation
•Accumulated depreciation is a contra asset (negative asset)
•As asset has a normal Dr balance, a contra asset has a normal Cr balance
•Reflects the amount of depreciation recorded over the life of the asset to date
• There is a separate accumulated depreciation account for each asset class
• It is deducted from the cost of the asset in the balance sheet
•
C
arrying amount, book value, written down value, carrying value, or unallocated cost.•
=Purchase price-Accumulated depreciation
• 1) Straight-line Method
•Allocates an equal amount each period for the life of the asset
• Applied to those assets that contribute equally to revenue each period over their useful life
• E.g., office furniture, buildings
• Cost – Residual value = depreciation expense Useful life
• (2) Reducing Balance Method
• Allocates a reducing amount of depreciation each period for the life of the asset
• Applies to those assets that will be used more, or contribute more to revenue initially, compared to later
• E.g., computers
• Depreciation determined by allocating a set percentage to the carrying amount of the asset
•
(Cost – Accum. Depreciation) * Rate = Depreciation p.a.
Bad and Doubtful Debts
1. Direct Write-off Method (NOT EXAMINABLE)
•Occurs when debt is bad
•Not a balance day adjustment
•Decision on when to write off – amount is known 2. Allowance method
•Estimate of bad debts (thus doubtful) relating to the accounting period
•Is a balance day adjustment
•Decision on amount to record
Dr Doubtful Debts
Cr Allowance for Doubtful Debts Dr Allowance for Doubtful Debts Cr Accounts Receivable
•The Allowance for doubtful debts account is a contra asset (negative asset)
•As asset has a normal Dr balance, a contra asset has a normal Cr balance
•It has the effect of decreasing the amount of accounts receivable shown in the balance sheet:
There are 2 ways of estimating doubtful debts expense:
The allowance for doubtful debt is a contra-asset account. It is subtracted from the gross amount of accounts receivable so that the net accounts receivable is reported in the statement of financial position.
(1) Estimate based on credit sales (NOT EXAMINABLE) (2) Estimate based on an % of accounts receivable
Amount of Bad Debts Expense = Balance at end + Accounts written off - Balance at beg
Topic 5: Completing the accounting cycle
1. Recap from week 4 2. Closing entries
3. General Purpose Financial Reports
•Income Statement
•Statement of Changes in Equity
•Balance Sheet
4. Continue with case study ‘Mel Tutoring Services’
Purpose Financial Reports
•Income Statement
•Statement of Changes in Equity
•Balance Sheet
The next step is therefore to close the books by using closingentries to close all temporary accounts.
Temporary accounts relate to only a given accounting period:
•i.e,. revenues, expenses, dividends.
These accounts must be ‘closed’ to set the account balance to zero balance at the end of each accounting period.
Permanent accounts are carried forward to future accountingperiods:
•i.e., assets, liabilities, equity.
Dr Revenue Accounts Cr P&L
Dr P&L
Cr Expense Accounts Net Profit: Dr P&L
Cr Capital (Retained Earnings if company) Dr Capital (Retained Earnings)
Cr Drawings (Dividends)
The key financial statements are:•Income Statement (I, E)
Measures financial performance over a period of time
•Balance Sheet (A, L and OE)
Measures financial position at a point in time
•Statement of Changes in Owners’ Equity (OE)
Presents a summary of changes that occurred in the entity’s equity between two successive reporting dates
•Statement of Cash Flows (the Asset Cash) (NOT EXAMINABLE) Measures cash receipts and cash payments over a period of time
Business Name
Income StatementFor the period ended 30 June 2019 Service Revenue —
less Expenses Wages (—) Advertising (—) Total expenses (—) — Net Profit —
Business Name
Statement of Changes in Owner’s Equity l For the month ended 30 June 2019 Name, capital, 1 July 2018 $—
Owner’s investment during the month —
Profit for the month (I/S) — — Withdrawals during the month (—) Name, capital, 30 June 2019 (B/S) $—
Business Name
Balance Sheet As at 30 June 2019 ASSETSCurrent Assets
Cash at bank —
Accounts receivable — — Non-current Assets
Equipment —
Total Assets $—
LIABILITIES Current Liabilities
Accounts Payable — Non-current Liabilities Long-term loan —
Total liabilities —
OWNER’S EQUITY
Capital — Retained earnings —
Total owner’s equity — Total liabilities and owner’s equity $—
Topic 6: Inventory (Part 1): Recording using both the periodic and perpetual methods
1. Identify the differences between a service entity and a retail entity 2. Understand what inventory is
3. Explain and prepare appropriate journal entries under a perpetual inventory system
4. Explain and prepare appropriate journal entries under a periodic / physical inventory system 5. Explain how to account for settlement discounts
6. Understand the basic process and journal entries of the goods and services tax (GST) Inventories are assets - (AASB 102 - Inventories para 6)
(a) held for sale in the ordinary course of business (finished goods) (b) in the process of production for such sale (work in progress); or
(c) in the form of materials or supplies to be consumed in the production process or in the rendering of services (raw materials)
What is the Perpetual Inventory Control Method?
• A continuous record of all inventory transactions is maintained
• A ledger account called Inventory (A) records all inflows and outflows of inventory at the time
• COGS is updated at the time of every sale
• The amount of inventory that should be on hand is known at all times
• This is compared with the amount actually on hand to see if there is a stock loss/gain
• Actual inventory on hand is determined by physical count
Purchase Return:
Dr Accounts payable (Bank) Cr Inventory
OR
Dr Accounts payable (Bank)
Cr Purchase return and allowances
What is the Periodic (Physical) Method?• There is no continuous record of inventory transactions
• There is no record of inventory that should be on hand (except for last period’s balance)
• Purchases of inventory is recorded in a temporary ledger account called Purchases Expense.
The acquisition of inventory creates an expense.
• Returning stock to a supplier is recorded in a Purchase Returns account.
• Inventory on hand and COGS are known only after a physical count thus you cannot determine whether there is an inventory shortage/gain
• Any actual inventory gain or loss will be assumed to have been sold
(
included as part of COGS)• COGS = Cost at beg + Cost of purchases + Freight in - Purchases returns and allowances - Cost at end
COGS
Purchases Purchase return
Inventory
Purchases beg Profit & loss summary
Advantages and Disadvantages of the Perpetual and Periodic Inventory Methods Perpetual
• Facilitates the frequency & timeliness of financial reporting, so that interim reports can be prepared
• Better control & more efficient management of inventory
• Can determine stock loss or gains
• Requires considerable record keeping, hence increasing costs
(b) The advantages for Wen Goh Warehouse of using a perpetual inventory system as opposed to a periodic inventory system are:
• Inventory is constantly updated every time a purchase or sale is made. This means that Wen Goh Warehouse will be aware of when to reorder items of inventory.
• Cost of sales is updated every time a sale is made so interim financial statements can be prepared without having to conduct an inventory count.
• When Wen Goh Warehouse does conduct an inventory count (which should be at least annually), any inventory losses can be accurately determined.
Using a perpetual inventory system would be a disadvantage for Wen Goh Warehouse if the business does not have a suitable computer system to maintain inventory records.
Periodic
• Requires a physical stock take to measure profit, stock takes can be costly & disruptive
• Not as efficient as it does not maintain records of inventory movements
• No stock loss or gains recorded; assumes all stock is sold
• Lower cost & easier recording procedures
• Lower cost now no longer an advantage
Topic 7: Inventory (Part 2): AASB102 – cost of inventory, cost-flow assumptions, lower of cost and NRV, inventory writedowns
1.Calculating the cost of inventory and Net Realizable Value (NRV) 2.Understanding the rule: Lower of cost and NRV
3.Identify and apply alternative inventory costing methods allowed under AASB 102 4.Apply each cost-flow method using the periodic and perpetual inventory approaches 5.Apply the knowledge from (2), (3), and (4) to a lecture example
Measurement of inventories:
AASB102 para 9:
"INVENTORIES MUST BE MEASURED AT LOWER OF COST AND NET REALISABLE VALUE"
•
Cost (AASB 102 para 11): of (a) purchase; (b) conversion; (c) incurred when bringing inventories to their present location and condition• purchase price
• PLUS: import duties and other taxes
• inward transport costs
• any other directly attributable costs of acquisition
• LESS: trade discounts, rebates and other similar items
• We include these incidental costs as the cost of inventory if the amount is material&can be directly associated with specific items
• AASB 1031: Old Standard on materiality
• amount ≥ 10% of an appropriate base amount, then material
• amount ≤ 5% of an appropriate base amount, then immaterial
• in between: left to professional judgement
• Overridden by ‘notion’ that
• “Omission or misstatement is material if they …. Influence economic decisions”
•
Net realizable value (AASB 102 para 7)• Estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale
According to the accounting standard (AASB 102 par 9) inventory should be valued at the lower of cost and NRV. This rule is based on the principle of conservatism. This is done to avoid
overstating the asset and profit.
• e.g., advertising costs, packaging costs involved in the resale
• Instances:
• Obsolescence (perishables)
;
• Damage (damaged goods basket at supermarket);
• Demand (‘summer clearance sale’) Cost-Flow Methods
•
Specific Identification• tracks each individual items through the inventory flow
• when stock are not interchangeable (must be possible to identify goods)
• Accurate
• Based on physical flow of goods
• Time-consuming and expensive
• e.g. house, motor vehicle, expensive jewelry
• can not used in conjunction with theperiodic method as continuous records are maintained Specific Identified Cost
AASB 102 requires that the cost of inventories of items that are not ordinarily interchangeable, or are produced and segregated for specific projects, must be assigned a cost by using specific identification. Specific costs are attributed to specifically identified items of inventory. Such inventory is usually unique for a specific purpose or contract.
•
FIFO• applies to interchangeable stock items
• Assumes the first units acquired are the first units sold
• Ending inventory costed at most recent purchase prices
• Tends to understate COGS and result in higher ending inventory when cost price increases during the period
FIFO
Assumes that inventory is sold in the order of the first in first out and that inventory on hand is the most recently purchased.
Lee Ltd is using the FIFO method of inventory costing and Lam Ltd is using the LIFO method.
Under FIFO, the latest goods purchased remain in inventory. Thus, the inventory on the statement of financial position should be close to current costs. The reverse is true of the LIFO method. Lee Ltd will have the lower gross profit because cost of goods will include a higher proportion of goods purchased at earlier (higher) costs.
•
Weighted Average• 1. Periodic Method
• Weighted average calculated as:
•
(
Total cost of goods available for sale for a period) / (Total number units available for sale for a period)• 2. Perpetual Method
• Moving weighted average, where average price is recalculated after every purchase Average
The average cost is calculated from the goods available for sale, on a periodic basis (weighted average) or as each inventory is purchased (moving average).
•
LIFO• not permitted in AUS
• applies to interchangeable stock items LIFO
Assumes that inventory is sold in the order of the last in first out and that inventory on hand is the oldest purchased.
Inventory Valuation
(i) Identify costs which 'attach' to inventory (& discuss materiality)
