Study Guide 13-B3 Accounting Page 1

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ACCOUNTING

Study Guide 13-B3

Double Entry Accounting (2014 VERSION 1)

Acknowledgement: Mark Wilson has kindly given us permission to use some of the materials from his text Accounting Alive for Study Guide purposes only.

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CONTENTS:

Double Entry Accounting

Chapter Title Page 1 Accounting the Language of Business 3 2 The General Ledger 11 3 Income and Expenses 23 4 Journals 49 5 Closing the General ledger 55 6 Depreciation and Disposal of Assets 62 7 Balance Day Adjustments 70

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Accounting … ‘The Language of Business’

Contents 1.1 Introduction - What is Accounting? 1.2 Users of Accounting Information 1.3 Fundamental Qualitative Characteristics 1.4 The Accounting Process 1.5 Accounting Reports - Balance Sheet 1.6 Exercises for you to try.

1.1 Introduction: What is Accounting?

Definition: Accounting is the process of identifying, measuring recording and communicating financial information in order to permit informed decisions to be made by the users of the information.

Key Words: Process: Organised, purposeful way of doing things Identifying: Knowing, being aware Measuring: Able to quantify, ‘how much’ Recording: Keeping information which can be referred to again Communicating: To tell someone, impart news Financial information: Related to money and the use of money

Accounting is about communicating financial information so that better decisions can be made. Accounting involves not only the recording and reporting of financial transactions, but also the interpretation, analysis, preparation and distribution of this information to the various users.

1.2 Users of Accounting Information:  Employees, unions: are interested in the operating results of the business in order to negotiate wages, conditions.  Shareholders, owners: are interested in the past performance and current position of the business so that they can determine how well the business has performed.  Taxation authorities and other government authorities require businesses to provide reports for each financial year and to ensure the business pays the correct tax and economic growth can be measured accurately.  Investors: are interest in predicting future benefits and financial risk of their investment.  Managers: are interested in how well the business is performing and its financial position. They make daily decisions regarding the operation of the business.  Auditors: are interested in checking the accounts for accuracy in order to determine whether the reports show a true and fair view of profits and financial position.  Creditors, Accounts Payable, lenders: want to know if they can extend credit to the business or provide finance in the form of loans.

1.3 Fundamental qualitative characteristics of financial statements: Financial information must meet the qualitative characteristics of relevance and faithful representation. Financial statements provide information that is useful for decision making.

You are learning from a Taylors Study Guide. Study Guide 13-B3 Accounting Page 4 1.4 The Accounting process

1. Transaction

as evidenced by

2. Document

recorded in

3. Journals General Journal

Cash Receipts Petty Cash Book

Cash Payments

post totals to Credit Fees/Sales

Credit Purchases

Sales Returns & Allowances

Purchase Returns & Allowances

4. Ledgers General

Subsidiary A/c Receivable

A/c Payable

foot ledgers and summarise in Inventory

Property, Plant and Equipment Register

5. Trial Balance

1. Balance Day Entries General Journal & Adjustments General Ledger 7. Adjusted Trial Balance

8. Closing the Ledger General Journal

General Ledger 9. Post-closing Trial Balance

10. Final Report Income Statement

Statement of Cash Flows 10A. Analysing 10B. Budgeting & Interpretation & Planning for Bank Reconciliation Statement of Reports the Future Balance Sheet 11. Opening Books for new Accounting Period General Journal - Opening entries - Reversing entries General Ledger

You are learning from a Taylors Study Guide. Study Guide 13-B3 Accounting Page 5 1.5 Accounting Reports – Balance Sheet The owner of a business has invested time, effort and capital into his/her business. He/she will be particularly interested in assessing the performance of the business, how the business is going, how profitable the business is over a given accounting period or period of time.

The owner is also interested in the financial position of the business, does it have the ability to repay debts and to survive over the long term, that is, for many years.

In order to assess the above, the owner/accountant prepares the following accounting reports:

Balance Sheet Definition: The Balance Sheet is a formal accounting document, showing the assets, liabilities and equity of a business at a given date. It shows the financial structure of the business.

Definition: An Asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

Assets for a business include cash, bank, accounts receivable, inventory, vehicles, machines, buildings, land. An asset is an item of value owned by the business.

Definiton: 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.

A liability for a business would be: bank overdraft, accounts payable, short term loan, mortgage. A liability is what the business owes (must pay back) to other parties or businesses.

Definition: Equity, is the residual interest in the entity’s assets after deducting its liabilities. The capital account records increases in equity for a sole trader. The drawings account is debited when the owner takes money or goods for personal use.

Classification of assets and liabilities: Assets and liabilities can be classified into current and non-current.

Definition: Current assets are those assets which we expect to obtain a future economic benefit from in the next accounting period only, usually one year. The business expects to realise the asset, or intends to sell or consume it, in its normal operating cycle. NZ IAS 1 para 66 Note: inventory can be sold on credit, it does not have to turn into cash within the next reporting period to make it a current asset. Example: bank account, accounts receivable, inventory.

Definition: Non-current assets are those assets which we expect to obtain a future economic benefit from for many accounting periods, usually many years.

We do not expect to use up these assets or turn them into cash. We hold onto these assets and use them to earn income for the business. Example: vehicles, equipment, buildings, land.

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Definition: Current liabilities are obligations must be met no more than twelve months after the reporting period.

They are amounts we owe and must repay in one year. Example: bank overdraft, accounts payable, short term loans.

Definition: Non-current liabilities – obligations that must be met more than twelve months after the reporting period.

They are amounts we owe and must repay but we have longer than one year to repay them. Example: loan, mortgage.

What does the Balance Sheet show us?

The Balance Sheet shows us the basic Accounting Equation:

ASSETS = LIABILITIES + EQUITY A = L + EQ

OR

EQUITY = ASSETS - LIABILITIES EQ = A - L

Example: Balance Sheet Information required to produce a Balance Sheet: Dales Automotive Electrical Account Balances as at 30 June 20X1 Assets Liabilities Bank 6 800 Mortgage 25 000 Accounts Receivable* Accounts Payable* Byrne 120 Tway 790 Apex 540 Inventory 1 260 Equity Motor Vehicles 4 680 Capital D. Dale ??? Land and Buildings 40 000

Note: The Mortgage is repayable at the rate of $3 000 a year.

* Accounts receivable is money owed to a business by its customers for goods and services sold on credit. Accounts receivable is an asset because it represents future economic benefit for the business.

Accounts payable is the amount a business owes to its suppliers for the purchase of goods or services on credit. Accounts Payable is a liability because the business has an obligation to pay the amount owing in the future.

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Dales Automotive Electrical Balance Sheet as at 30 June 20X1 Current Assets Current Liabilities Bank 6 800 Accounts Payable: Tway 790 Accounts Receivable: Mortgage 3 000 3 790 Bryne 120 Apex 540 Non Current Liabilities Inventory 1 260 8 720 Mortgage 22 000 Non Current Assets Equity Property, Plant and Equipment Capital D. Dale 27 610 Motor Vehicle 4 680 Land & Buildings 40 000 44 680 _____ $53 400 $53 400

1.6 Exercises for you to try: 1.6.1 Complete the following two tables by filling in the missing amounts: ASSETS LIABILITIES EQUITY $ $ $ i. 2,400 200 ii 3,000 1,560 iii 2,500 1,300 iv 10,000 5,250 v 2,000 3,000 vi 2,580 2,620 vii 25,500 12,750 viii 32,300 16,450 ix 28,500 16,321 x 30,596 15,678

1.6.2 Prepare the Balance Sheet of Burwood Real Estate on 30 September 20X1 from the following list of assets and liabilities. Calculate equity by using the accounting equation. Cash at Bank $11 600 Cash on hand 240 Commission receivable 25 000 Accounts Payable 2 600 Motor Vehicles 32 000 Office Furniture 2 400 Office Equipment 1 600 Inventory of Stationery 260 Loan from Finance Bank Ltd (due 10 August 20X5) 20 000

1.6.3 Prepare the classified Balance Sheet of F Devon, a doctor, who has the following assets and liabilities on 30 June 20X1. Cash on Hand $ 100 Cash at Bank 4 000 Subscription due to Medical Association 240 Owing to D Furness (Chemist) 90 Owing to Drug Supplies Ltd 1 800 Amounts owing by patients 3 600 Surgery Furniture and Fittings 2 200 Inventory of Drugs 400 Motor Car 8 200

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1.6.4 From the following information, prepare a Balance Sheet for UniversityTraining School as at 4 February 20X1. Cash at Bank 2 000 Accounts Receivable 4 000 Accounts Payable 3 000 Office Equipment 10 000 Loan (due 20X8) 4 000

1.6.5 From the following information, prepare a Balance Sheet for Accountants Training School as at 4 February 20X1. Cash at Bank 4 500 Accounts Receivable 5 600 Accounts Payable 1 675 Office Equipment 11 250 Loan (due 20X9) 6 000

1.6.6 A Sweet operates the Warewood Entertainment Centre and at 31 December 20X1 had the following assets and liabilities. Calculate equity and present his classified Balance Sheet as at 31 December 20X1. $ Bank (overdraft) 2 700 Cash on hand 150 Cleaning materials on hand 100 Entertainment equipment 100 000 Ten Pin Supplies – loan ($5 000 repayable each year) 40 000 Land and buildings 240 000 Mortgage (due 20X3) 100 000 Restaurant equipment 20 000 Inventory of refreshments 8 900 Accounts Receivable Hawthorn Social Club 600 Burwood Social Club 200 Malvern Social Club 1 200

1.6.7 Alan Rankin, a carpenter, asks you to prepare a classified Balance Sheet for his business, Burwood Extension Services, at 30 June 20X1. He supplies you with the following information: $ Utility truck (used in business) 6 400 Trailer (used in business) 200 Motor car (used by family) 8 000 Building materials 1 200 Cash on Hand 80 Land and business premises 88 000 Land and private home 240 000 Shares in Hiway Ltd (private investment) 6 000 Mortgage on business premises (repayable at $3 000 a year) 30 000 Mortgage on private home (repayable at $1 200 a year) 15 000 Work-in-progress (partly completed extension for client) 6 000 Business equipment and tools 2 500 Amounts owing for work done 4 500 Business accounts payable 2 300 Business bank account (overdraft) 1 600

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1.6.8 State the effect of each of the following transactions on the accounting equation (Assets Liabilities + Equity) of Zippie Taxi Trucks (Owner, T Samuel). Set out your answer in a table as shown below. Do not complete the last column at present. It will be completed later. The first transaction is done for you.

ZIPPIE TAXI TRUCKS ACCOUNT CLASSIFICATION TABLE FOR THE WEEK ENDED 5 APRIL 20X1

DATE ACCOUNT TYPE +/- 20X1 Apr 1 Bank Asset + Capital Equity + 20X1 Apr 1 T. Samuel starts his business with $10,000 cash and Accounts Receivable $420. The business buys a delivery van for $12 000 on credit from Trusty Cars Ltd. 2 The business pays $500 owing to accounts payable, A & J Traders. 3 T Samuel withdraws $2 000 to reduce his basic investment in the firm. 4 The business receives $420 from A Landy, an accounts receivable. 5 The business buys furniture for cash, $180, from Trendy Furnishings.

1.6.9 Prepare an Account Classification Table to show the effect of each of the following transactions on the accounting equation (A = L + EQ), of T Viner, dentist for the week ended 6 April 20X1.

20X1 Apr 3 Deposited $5 000 in the business bank account to help finance the expansion of his surgery. 4 Extended the premises at a cost of $12 000 to be paid to Peninsula Building Co within 6 months. 5 Bought additional surgery equipment for $2 000 cash. 6 Borrowed $4 000 from Medical Financiers Ltd.

1.6.10 State the effect of each of the following transactions on the accounting equation (A = L + EQ), of Express Messenger Service (N Andrews, owner). Prepare an Account Classification Table for the week ended 5 May 20X1. 20X1 May 1 Andrews commenced business by depositing $2 000 in the business bank account and bringing in his car valued at $4 500 2 Bought a van for $15 000 on credit from Fineway Motors 3 Paid Fineway Motors $1 000, the balance to be paid by 31 May 4 Sold old car for $4,500 5 Bought office equipment for cash $700

REVIEW Accounting Elements are used to group the economic activities of an accounting entity. The first three elements are: Assets Liabilities Equity

Monetary Measurement concept: All transactions, assets, liabilities, incomes, expenses and equity are recorded in a common dollar unit such as the $NZ.

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1.6.11 MODEL BALANCE SHEET Hedley Caravan Park Balance Sheet as at 31 March 20X1 Notes $NZ $NZ $NZ Assets Current Assets Petty Cash Imprest 100 Bank 5,000 Accounts Receivable 10,767 Inventory 14,560 Accrued Income 613 Prepayments 100 Total Current Assets 31,140 Non Current Assets Investments Term Deposit 6,000 Property, Plant and Equipment 1 Total Carrying Amount 57,910 Intangible Assets Goodwill 4,000 Total Non Current Assets 67,910 Total Assets 99,050

Less Liabilities Current Liabilities Accounts Payable 7,440 Accrued Expenses 140 Total Current Liabilities 7,580 Non Current Liabilities Loan (9% due 20X5) 8,613 Total Non Current Liabilities 8,613 Total Liabilities 16,193 Net Assets $82,857

Equity Opening Capital 96,200 Plus Profit 10,657 106,857 Less Drawings 24,000 Closing Capital $82,857

Notes to the Balance Sheet 1 Property, Plant and Equipment Equipment Machinery Total $NZ $NZ $NZ Cost 8,600 70,000 78,600 Less Accumulated Depreciation 1,720 18,970 20,690 Carrying Amount $6,880 $51,030 $57,910

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Chapter 2

Recording transactions in the General Ledger

Contents

2.1 Double Entry Accounting 2.2 The General Ledger 2.3 Features of the General Ledger 2.4 The Chart of Accounts 2.5 Rules for Double Entry Accounting 2.6 Example 2.7 The Trial Balance 2.8 Exercises for you to try

2.1 Double Entry Accounting

A double entry system recognises the fact that each and every financial transaction will always affect at least two items in the final reports.

Transaction: A transaction is a business event that is expressed in money terms.

Cash Transaction: Money is paid when the transaction occurs. e.g. Sell equipment for $600 cash.

Credit Transaction: Money is paid at a later date than the transaction. eg Sell equipment for $600 to Traders Ltd on credit.

Measurement: Transactions are usually measured using the Historical Cost Concept. Assets are recorded at their price at the time of acquisition, that is at their original purchase price.

2.2 The General Ledger

The systematic recording of transactions in a ledger of accounts is called the General Ledger. Accounts can be likened to separate note books in which we record changes that have affected assets, liabilities, equity, revenues or expenses.

The entire group of accounts kept by a business is referred to as the 'ledger'.

The purpose of keeping a ledger is to enable us to calculate, at any given point of time, the balance in each account which can be used to prepare the Income Statement and Balance Sheet.

You are learning from a Taylors Study Guide. Study Guide 13-B3 Accounting Page 12 2.3 Features of the General ledger

Ledger accounts group together and summarise business transactions that affect a particular Income Statement or Balance Sheet item.

The use of ledger accounts allows us to record (or process) many transactions quickly and efficiently before the preparation of accounting reports.

For example, all transactions affecting the business bank account; cash coming in and going out of the business will be put into a ledger account called “Bank”.

2.4 The Chart of Accounts

A ledger, as we have noted, is made up of accounts. The number of accounts found in the ledger will depend on the size of the firm and the frequency and type of transactions. The larger the firm and the more frequent and varied the transactions the greater the number of accounts needed. The problem is that the larger the ledger, the harder it becomes to find accounts quickly. This can be solved by the use of some sort of index to accompany the ledger.

The Chart of Accounts is an index of all accounts found in the ledger.

Features of the chart of accounts Each account has been classified into one of five main groups:

Assets, Liabilities, Equity, Income and Expenses. These groups have each been assigned a particular number range, for example:

Current Assets (100-199)

Non Current Assets (200-299)

Current Liabilities (300-399)

Non Current Liabilities (400-499)

Equity (500-599)

Income (600-699)

Expenses (700-799)

Due to the small number of income and expense accounts no attempt has been made to classify them further. They could, however, be grouped according to function, that is, distribution costs (700-719), vehicle expenses (720-739), administrative expenses (740-759), occupancy expenses (760-779), and finance costs (780-799).

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The end result is that each specific account has been given an account number, for example accounts receivable is account number 120. This tells us two things:  the accounts receivable account is a current asset because all current assets are numbered between 100 and 199  where the accounts receivable account is located in the ledger. The number itself is listed on the right side of the account.

Turner's Plumbing Services Chart of accounts Current Assets 100 110 Cash at Bank 120 Accounts Receivable 130 Inventory 140 Accrued Income 150 Prepayments

Non-current assets 200 Investment Assets 210 Term Deposit 220 Shares in XYZ Ltd Property Plant and Equipment 230 Motor vehicles 240 Equipment 250 Premises Intangible Assets 280 Goodwill 290 Patents

Current Liabilities 300 310 Accounts Payable 320 Accrued Expenses Non-current Liabilities 400 410 Loan, ANZ Bank 420 Mortgage Equity 500 510 Capital, F Turner 520 Drawings Income 600 610 Sales Revenue 611 Sales Returns and Allowances 620 Fees Revenue 630 Interest Income 640 Discount Received 650 Commission Income

Expenses 700 710 Purchases 711 Purchases Returns and Allowances 720 Advertising Expense 730 Commission Expense 740 Office Salaries Expense 750 Stationery Expense 760 Telephone Expense 770 Rates Expense 780 Interest expense 790 Discount Allowed

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2.5 Rules for Double Entry Accounting

Ledger recording is based on a widely accepted set of rules.

The left hand column of all ledger accounts is known as the DEBIT column and is abbreviated as “DR”.

The right hand column of all ledger accounts is known as the CREDIT column and is abbreviated as “CR”. The ledger recording rules are derived (obtained) from the basic accounting equation:

A = L + EQ

It is commonly accepted that Assets increase on the debit side; that is, left hand side and decrease on the right hand side.

Changes in Liabilities must be recorded on the opposite side to assets, in order to keep the accounting equation in balance.

Liabilities increase on the credit side and decrease on the debit side.

Changes in Equity are recorded on the same side as Liabilities, again so the basic accounting equation remains in balance.

A table can be set up to summarise our ledger recording rules:-

ASSETS LIABILITIES + EQUITY

INCREASE Debit Credit

DECREASE Credit Debit

NOTE: - Each ledger entry and transaction must follow the above rules - For each transaction, the total value of debit side entries must equal the total value of credit side entries

Following the above rules will ensure that for each transaction, our accounting equation remains in balance. This is essential for our “double entry” recording process to work properly and for the Balance Sheet to remain “in balance”.

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2.6 Example:

20X1 July 1 Lee Lee Chan contributed cash of $27 000 to start her hairdressing salon called Trim and Shape Beauty Salon.

Required: Enter the above transaction into an account classification table and record in the General Ledger

TRIM AND SHAPE BEAUTY SALON ACCOUNT CLASSIFICATION TABLE FOR 1 JULY 20X1 DATE ACCOUNT TYPE +/- DEBIT/CREDIT 20X1 Jul 1 Bank Asset + Debit Capital Equity + Credit

TRIM AND SHAPE BEAUTY SALON GENERAL LEDGER BANK 110 20X1 DEBIT CREDIT BALANCE Jul 1 Capital 27 000 27 000 Dr

CAPITAL 510

Jul 1 Bank 27 000 27 000 Cr

2.7 The Trial Balance A Trial Balance lists all the ledger account balances. The total of the debit balances must equal the total of the credit balances if the processing is correct.

The purpose of a Trial balance is to check that each transaction has been accurately recorded ie. the two fold effect of each transaction. However, it is still possible that errors may have been made in the recording of the transactions.

The following errors may have taken place despite the trial balance showing that total debit balances equal total credit balances: 1. Complete omission of transactions. 2. Reversal of the recording of the transactions ie: the debit and credit entries reversed. 3. Transactions recorded twice. 4. Entering (called posting) of the transaction in the wrong account eg. Machinery account debited instead of Office Equipment. 5. Wrong amounts entered, eg. Rent expense recorded in both bank account and rent account as $400 instead of $600. 6. Compensating errors, eg. Wages overstated by $200 and rent understated by $200. NB: The extraction of the trial balance is a necessary preliminary step prior to the preparation of the Income Statement and Balance Sheet..

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2.8 Exercises for you to try: 2.8.1 L. Bow is a physiotherapist. He commenced business on 6 June 20X1 and the following trans- actions occurred in the first half of the month. 20X1 June 6 L Bow deposited $30 000 in a bank account to start the practice. 7 Bought equipment worth $18 000 on credit from Medical Supplies. 8 Paid $2 400 cash for office furniture. 11 Paid Medical Supplies $8 000 on account. 12 L Bow decided to use his own car valued at $6 000 for business purposes. 14 Bought more equipment for cash $2 000. 15 Paid Medical Supplies a further $5 000 on account. REQUIRED: a. Complete the Transaction Analysis table below:

Assets = Liabilities+ Equity Office Motor Accounts 20X1 Bank Equipment Capital Furniture Vehicle Payable $NZ $NZ $NZ $NZ $NZ $NZ Jun 6

7

8

11

12

14

15

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b. an Account Classification Table c. Record the transactions in a three column ledger. Prepare your three column paper using the Chart of Account numbers provided below.

L. BOW General Ledger Accounts Account Number Lines Bank 110 6 Equipment 210 3 Office Furniture 220 2 Motor Car 230 2 Accounts Payable 310 4 Capital 510 3 d. Prepare a Trial Balance as at 15 June 20X1. e. Prepare a Balance Sheet as at 15 June 20X1.

2.8.2 The Rock Shop is a business which sells guitars. The business Trial Balance as at 1 January 20X1 was as follows: TRIAL BALANCE As at 1 January 20X1 Bank 10 250 Accounts Payable – goods 1 150 Accounts Receivable 3 300 Accounts Payable – other 2 270 Equipment 35 000 Loan 4 800 Office Furniture 4 550 Capital ???

YOU ARE REQUIRED TO: a. Enter these balances into 3-column ledger accounts – use the table below as a guide. THE ROCK SHOP Ledger Accounts Account Number Lines Bank 110 9 Accounts Receivable 120 3 Office Furniture 210 3 Equipment 220 4 Accounts Payable - Goods 310 3 Accounts Payable – Other 311 3 Loan 410 3 Capital 510 3

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b. Record the following transactions in the ledger for the month of January c. Prepare a 2 column Trial Balance and a Balance Sheet as at 31 January 20X1.

Jan 2 Received $1 300 from accounts receivable 8 Paid Accounts Payable $750 for goods 9 Bought office furniture for cash $2 250 14 Sold equipment for cash $4 000 15 The owner invested $6 000 cash into the business 25 Repaid $1 000 off loan 28 Bought equipment on credit for $8 880

2.8.3 Taylors College is a business which provides education for international students. The business Trial Balance as at 1 February 20X1 was as follows:

TRIAL BALANCE As at 1 February 20X1 Bank 12 600 Accounts Payable – goods 2 000 Accounts Receivable 2 400 Accounts Payable – other 3 000 Equipment 20 000 Loan 3 000 Office Furniture 6 000 Capital ???

YOU ARE REQUIRED TO: a. Enter these balances into 3-column ledger accounts – use the table below as a guide.

TAYLORS COLLEGE Ledger Accounts Account Number Lines Bank 110 9 Accounts Receivable 120 3 Office Furniture 210 4 Equipment 220 3 Accounts Payable - Goods 310 3 Accounts Payable – Other 311 3 Loan 410 3 Capital 510 3

b. Record the following transactions in the ledger for the month of February 20X1. c. Prepare a 2 column Trial Balance and a Balance Sheet as at 28 February 20X1. Feb 3 Received $400 from accounts receivable 8 Paid Accounts Payable $1 000 for goods 9 Bought office furniture on credit $900 14 Bought equipment for cash $1 500 15 The owner invested $2 000 cash into the business 25 Repaid $1 000 off loan 28 Sold old office furniture for $300 cash

The Accounting Entity Concept states that the financial affairs of the business are kept separate and distinct from the financial affairs of the owner.

Drawings are money or goods taken by the owner for personal use. Drawings decrease equity.

You are learning from a Taylors Study Guide. Study Guide 13-B3 Accounting Page 19 2.8.4 The following balances are from the books of A Peacock who runs a business trading as Fancyfree Decorators as at 30 September 20X1. Bank 200 Accounts Payable 2,500 Inventory 4,000 Loan (due 31.1.20X5) 2,000 Accounts Receivable 750 Mortgage (due 20X2) 118,000 Premises 226,000 Capital ??? Fittings 1,500 Furniture 500

a. Calculate the capital of Fancyfree Decorators b. Design a Chart of Accounts for Fancyfree Decorators c. Enter the above balances in the general ledger. Make sure you label each account with its correct number from your chart of accounts. d. Prepare a Trial Balance as at 30 September 20X1. e. Prepare a Balance Sheet as at 30 September 20X1.

2.8.5 M Campbell started a plumbing business. Record the following transactions in an Account Classification Table and the ledger. Complete a Trial Balance as at 31 July 20X1.

20X1 July 29 M Campbell deposited $12 000 into a bank account to start the business of Suburban Plumbing Services. 30 Purchased a panel van for $6 000 cash Purchased plumbing equipment worth $800 on credit form McEwan Ltd 31 Bought tools for $100 cash

2.8.6 Record the following transactions in an Account Classification Table and the ledger of R Fletcher, real estate agent. Prepare a Trial Balance as at 3 March 20X1.

20X1 March 1 R Fletcher commenced business by depositing $6 000 in the business bank account and bringing in a car valued at $5 000 2 Office furniture was purchased for $350 cash Office stationery was bought on credit from Northern Printers $200 3 Purchased a computer on credit from Oliver Ltd $4 000

2.8.7 The following is an analysis of the transactions to start the Peninsula Coaching College of S Taylor. You are required to: a. Explain the actual transactions b. Record the analysed transactions in the ledger of Peninsula Coaching College c. Prepare a trial balance at 5 August 20X1

Account Classification Table

Date Ledger Account Type +/- Debit/Credit Amount

20X1 Aug l Bank Asset Increase Debit 40 000 S. Taylor, Capital Equity Increase Credit 40 000

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2 Premises Asset Increase Debit 50 000 Bank Asset Decrease Credit 20 000 Mortgage Liability Increase Credit 30 000

3 Motor Vehicle Asset Increase Debit 7 000 Accounts Payable Liability Increase Credit 5 000 Bank Asset Decrease Credit 2 000

4 Classroom Furniture Asset Increase Debit Accounts Payable Liability Increase Credit 10 000

5 Office Furniture Asset Increase Debit Bank Asset Decrease Credit 1 000

2.8.8 Enter the following transactions in the ledger of R Martin (who is starting a gymnasium, Stretch Fitness Centre), and prepare a trial balance at 4 June 20X1.

20X1 June 1 R Martin deposited $20 000 in the business bank account Purchased a building for $135 000, paying $5 000 cash and the balance on mortgage (repayable $6 000 per annum) 2 Bought equipment for $5 000 cash 3 Purchased office furniture for $500 cash 4 Borrowed $10 000 from National Finance Ltd

2.8.9 Explain the transactions that have been recorded below in the ledger of I. Green, painter.

I. GREEN - PAINTER GENERAL LEDGER

Bank 110 20X1 Jan 6 Capital I Green 10 000 10 000 Dr 7 Equipment 800 9 200 Dr 8 Motor Vehicle 5 000 4 200 Dr

Equipment 210 Jan 7 Bank 800 800 Dr 10 Accounts Payable 12 000 12 800 Dr

Motor Vehicles 220 Jan 8 Bank 5 000 5 000 Dr

Accounts Payable 310 Jan 10 Equipment 12,000 12 000 Cr

Capital I Green 510 Jan 6 Bank 10 000 10 000 Cr

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2.8.10  Enter the following transactions in the ledger of R Pollock, dentist.  Prepare a Trial Balance as at 9 May 20X1  Prepare a Balance Sheet as at 9 May 20X1

20X1 May 5 R Pollock deposited $120 000 in the business bank account to commence practice 6 Bought premises worth $136 000 by paying a deposit of $10 000 and the balance on mortgage from the Fidelity Loan Co. 7 Purchased surgery equipment on credit from Dental Supplies Ltd $2 500 8 Bought office equipment and furniture for $1 000 cash 9 Paid Dental Supplies Ltd $500 on account

2.8.11  Record the following transactions in the ledger of M McKenzie, owner of a child minding centre (Kiddytime Centre)  Prepare a Trial Balance at 8 August 20X1  Prepare a Balance Sheet at 8 August 20X1

20X1 Aug 4 M McKenzie deposited $50 000 in the business bank account Bought premises worth $138 000 on a deposit of $20 000 and the balance payable to Ace Realty Co in 3 years 5 Purchased playground equipment on credit from Playcraft Ltd $3 000 6 Bought furniture and fittings for $3 000 cash 7 Bought a mini-bus costing $8 000 from Eastside Motors on terms of $4 000 cash deposit and the balance payable over 2 years 8 Paid Playcraft Ltd $1 000 on account

2.8.12  Enter the following in the General ledger of A Norris who is starting a business called Guardian Security Services.  Prepare a Trial Balance at 10 April 20X1.  Prepare a classified Balance Sheet at 10 April 20X1.

20X1 Apr 2 A Norris deposited $100 000 in a bank account to start the business 3 Purchases premises worth $120 000 from National Investments on $60 000 deposit and the balance payable over 5 years 3 Borrowed $40 000 repayable in 2 years, from the Australian Finance Co 6 Bought cars for $55 000 cash 7 Purchased uniforms on credit from Custom Tailors $2 800 8 Purchased office furniture for $2 000 cash 10 Paid Custom Tailors $1 000 on account

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2.8.13 The following trial balance was extracted from the ledger of R Lehman, caravan-park operator, at 30 June 20X1.

Holiday Park (R Lehman, proprietor) Trial Balance as at 30 June 20X1

Brighton Travel Club 500 Capital, R Lehman 228 000 Land 30 000 Mortgage (due 20X5) 136 000 Buildings 295 000 Accounts Payable 2 300 On-site caravans 24 000 Bank 1 200 Motor vehicle 15 000 Laundry equipment 3 000

$ 367 500 $ 367 500

 Enter the account balances, listed in the trial balance above, in the ledger of Holiday Park  Enter the transactions below in the ledger and extract a trial balance for Holiday Park at 5 July 20X1

20X1 July 1 Received $500 from Brighton Travel Club in full settlement of their account 2 Paid Accounts Payable $200 on account 3 R Lehman invested another $4 000 cash in the business 4 Bought $300 refreshments on credit

 Prepare a classified Balance Sheet at 5 July 20X1.

2.8.14 A Searle operates a tennis ranch and the following is the Trial Balance as at 31 December 2011.

Southport Tennis Ranch (A.Searle, proprietor) Trial Balance as at 31 December 20X1

Bank 2 500 Accounts Payable 2 100 Accounts Receivable 100 Loan (due 20X5) 3 000 Equipment 2 500 Mortgage due (20X9) 60 000 Land 55 000 Loan (due 20X6) 15 000 Tennis courts 20 000 Buildings 120 000 Capital - A. Searle 120 000 $ 200 100 $ 200 100

 Enter the account balances, listed in the Trial Balance above, in the ledger of Southport Tennis Ranch.  Record the following transactions in the ledger and prepare a Trial Balance and a Balance Sheet as at 5 January 20X1.

20X1 Jan 2 Paid accounts payable $1 800 on account 3 Received $100 owing by customer in full settlement 4 Bought more equipment for $1 500 cash after arranging for overdraft facilities at the bank 5 A Searle decided to use his car, worth $4 000, for business purposes

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Chapter 3 Income and Expenses

Contents 3.1 Income Recognition 3.2 Expense Recognition 3.3 Accrual Basis Accounting 3.4 Expanded Rules for Double Entry Accounting 3.5 Illustrative Exercise 3.6 Exercises for you to try 3.7 Trading Statement 3.8 Accounting for Sales Revenue and Purchases Returns 3.9 Classification of Expenses 3.10 Model Income Statement 3.11 Exercises for you to try

3.1 Income Recognition Income is the money earned by a business for selling goods or providing services, eg Sales, Fees. Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. Eg Sales Revenue, Fees Revenue

Criteria for Income Recognition Income shall be recognised in the determination of the results for the reporting period, when and only when:  It is probable that the inflow or other enhancement of assets or decreases in liabilities has occurred and  An increases in future economic benefits related to an increase in an asset or decrease of a liability has arisen that can be can be measured with reliability.

3.2 Expense Recognition Expenses are the costs a business must pay in the process of earning income, eg wages. Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. e.g. wages expense.

Criteria for expense recognition Expenses shall be recognised in the determination of the result for the reporting period, when and only when:  The decrease in equity must be probable.  The consumption or loss of service potential or future economic benefits can be measured with reliability

3.3 Accrual Basis Accounting The Accrual Basis concept states that the effects of transactions and other events are recognized when they occur and are reported in the financial statements of the periods to which they relate. Income is recognized when it is earned and expenses are recognized when they are incurred whether or not cash has been received or paid. Profit = Income earned - Expenses incurred

An Income Statement is a financial statement that measures an accounting entity’s financial performance over a specific accounting period. It informs the owner if the business has made a profit or loss.

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Example: The Shiny Window Service is a business run by Chris Kleer. Chris advertises in the local press and most of the work is done for local firms. He receives enquiries via his car phone or his wife who works from home and maintains the accounts. Chris visits the proposed jobs and prepares quotes. If accepted, he then compiles an order for work to be done which is then authorised by his clients. He invoices* his clients when a job takes place. About 60% of his clients accept the 14 day credit terms he offers. Those who pay by cash immediately obtain a 5% discount and he issues receipts at this time. We can show the above in a flow diagram.

Advertise

Enquiry made

Quotes given

Job accepted

Job completed

Invoice prepared

Money received

Receipt sent

There are a number of possible revenue recognition points in this flow diagram.

If we delay recording the job until cash is received then the cash method of recognition of a transaction is being used.

However, if we are reasonably certain that payment will be received, then we would record the job at time of invoice preparation. If this was done then we would be using the accrual method of recognising a transaction.

* An invoice is the source document that provides the original record of a credit transaction. a. Invoices sent or issued record the amounts the customers owe to the business. According to the Accrual Basis concept, the income can now be recorded as it has been earned. Accounts Receivable account is debited to recognise an asset.

b. Invoices received record amounts the business owes to others. For example, received an invoice for van repairs. According to the Accrual Basis concept, the expense can be recorded as it has been incurred. Accounts Payable account is credited to recognize a liability.

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3.4 Expanded Rules for Double Entry Accounting

ASSETS + EXPENSES LIABILITIES + EQUITY + INCOME

INCREASE Debit Credit

DECREASE Credit Debit

3.5 Illustrative Exercise:

L Mann started the Hitone Cleaning Service by depositing $5 000 in a business bank account on 10 August 20X1. Your teacher will help you to complete this illustrative exercise as a model for your future exercises. a. Prepare an Account Classification Table b. Record the following transactions in the ledger of Hitone Cleaning Service. c. Prepare a trial balance at 24 August 20X1. d. Prepare an Income Statement for the 2 weeks ended 24 August 20X1. e. Present a Balance Sheet as at 24 August 20X1.

20X1 Aug 10 Deposited $5 000 in the business bank account. Paid for advertising $50 cash. 11 Bought a panel van from Richmond Motors for $6 500 paying $2 000 cash deposit. Purchased cleaning equipment on credit for $1 000 from Delta Equipment Ltd. 12 Banked cleaning fees $200 13 Bought cleaning material $30 cash 14 Banked cleaning fees $350 Paid advertising $50 cash 17 Withdrew $50 cash for private use 18 Banked cleaning fees $250 19 Paid petrol $10 cash Charged Hillview Hospital for cleaning $250 20 Banked cleaning fees $300 21 Paid wages $80 cash 24 Withdrew $50 cash for private use.

HITONE CLEANING SERVICE ACCOUNT CLASSIFICATION TABLE FROM 10-24 AUGUST 20X1 Date Account Type +/- Debit/Credit 20X1 Aug 10 Bank A + Debit Capital EQ + Credit Advertising Expense Bank 11 Van Bank Accounts Payable

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Equipment Accounts Payable 12 Bank Cleaning Fees 13 Cleaning Materials Expense Bank 14 Bank Cleaning Fees Revenue Advertising Expense Bank 17 Drawings Bank 18 Bank Cleaning Fees Revenue 19 Petrol Expense Bank Accounts Receivable Cleaning Fees Revenue 20 Bank Cleaning Fees Revenue 21 Wages Expense Bank 24 Drawings Bank

HITONE CLEANING SERVICE GENERAL LEDGER Bank 110

Accounts Receivable 120

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Van 210

Equipment 220

Accounts Payable 310

Capital 510

Drawings 520

Cleaning Fees Revenue 610

Advertising Expense 710

Cleaning Materials Expense 720

Wages Expense 730

Petrol Expense 740

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HITONE CLEANING SERVICE TRIAL BALANCE AS AT 24 AUGUST 20X1 $NZ $NZ Bank Accounts Receivable Van Equipment Advertising Expense Cleaning Materials Expense Wages Expense Petrol Expense Drawings Accounts Payable Capital Cleaning Fees Revenue

Hitone Cleaning Service Income Statement For the period ended 24 August 20X1 $NZ $NZ Cleaning Fees Revenue Less Expenses Advertising Expense Cleaning Materials Expense Wages Expense Petrol Expense TOTAL EXPENSES PROFIT

Hitone Cleaning Service Balance Sheet as at 24 August 20X1 $NZ $NZ $NZ

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3.6 Exercises for you to try

3.6.1 Analyse the following transactions of H King, pleasure-boat operator, in an account classification table before recording in the ledger accounts.

20X1 March 15 H King banked $1 000 takings after a holiday weekend

3.6.2 M Yates operates a merry-go-round. Analyse the following transactions in an account classification table before entering them in the ledger accounts.

20X1 May 1 Bought merry-go-round for $5 000 cash 2 Banked takings $100 Paid wages $25

3.6.3 A Bright started a lawn-mowing service. Analyse the following transactions in an account classification table before entering them in the ledger accounts.

20X1 July 29 A Bright deposited $300 into the business bank account and decided to use his own utility (value $4 500) in the business Bought a motor mower for $180 cash

30 Banked $40 lawn-cutting fees Bought petrol $15 cash

31 Banked $50 cutting fees

3.6.4 Collins operates the Ace Driving School transactions for the week ending 8 November 20X1 were:

20X1 Nov 3 Bought petrol $20 Banked $50 received from students 4 Banked $45 received from students 5 Bought petrol $22, tyres $45 6 Banked $68 received from students 7 Paid wages $80 8 Banked $110 received from students

Enter the above transactions in the ledger of Ace Driving School.

Matching Costs with Income Concept: The Matching Costs with Income Concept states that profit is determined by matching the expenses incurred against the income earned in an accounting period.

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3.6.5 The following is an analysis of the transactions to start the swimming coaching business, Poolside Coaching, of R Wood.

Analysing Chart

Date Ledger Account Type Increase or Debit or Amount Decrease Credit 20X1 $ $ June 10 Bank Asset Increase Debit 5 000 Capital Equity Increase Credit 5 000

11 Pool & Premises Asset Increase Debit 25 000 Bank Asset Decrease Credit 4 000 Mortgage Liability Increase Credit 21 000

12 Bank Asset Increase Debit 500 Fees Revenue Income Increase Credit 500 Norwood High School Asset Increase Debit 110 Fees Revenue Income Increase Credit 110

13 Bank Asset Increase Debit 300 Fees Revenue Income Increase Credit 300

14 Wages Expense Expense Increase Debit 100 Electricity Expense Expense Increase Debit 50 Bank Asset Decrease Credit 150

You are required to: a. write down the actual transactions b. record the analysed transactions in the ledger of Poolside Coaching c. prepare a trial balance at 14 June 20X1

3.6.6 R.Baron established an aircraft charter service. a. Record the following transactions in the ledger of Stratos Air Services. b. Prepare a trial balance at 14 July 20X1. c. Prepare an Income Statement for the 2 weeks ended 14 July 20X1. d. Comment on the profitability of R. Baron's investment. What other information would assist you in your assessment of the profitability of the business?

20X1 July 3 R Baron deposited $20 000 in the business's bank account to start business Bought a Piper Commanche for $38 000 from Laverton Aircraft Co, paying $16 000 cash deposit and the balance payable in 2 years Paid hangar rent $150 4 Paid advertising $200 5 Banked charter fees $250 Banked charter fees $400 7 Paid fuel account $ 100 10 Banked charter fees $850 Paid hangar rent $150 Invoiced Castle Hill Mining Co $350 for charter fee 11 Banked charter fees $ 100 Paid aircraft maintenance $350 12 Paid aircraft landing fees $200 and R Baron's personal insurance $50

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13 Banked charter fees $1 000 Purchased office furniture $750 on credit from Atlas Furniture Co 14 Banked charter fees $100 Paid fuel account $230 Paid aircraft maintenance $450

3.6.7 B Child commenced the Stork Nappie Service on 11 October 20X1. a. Record the following transactions in the ledger of Stork Nappie Service. b. Prepare a trial balance at 24 October 20X1. c. Prepare an Income Statement for the 2 weeks ending 24 October 20X1. d. Prepare a Balance Sheet as at 24 October 20X1. d. Comment on the profitability of B Child's investment. e. Comment on the short-term financial position of Stork Nappie Service

20X1 Oct 11 Started the Stork Nappie Service by bringing in cash $150 000, delivery van $6 000 Paid rent $200 cash Bought $6 000 worth of nappies on credit from Cottonweave Ltd 12 Paid advertising $200 cash Bought laundry supplies $100 cash Bought laundry equipment worth $12 000 from Thor Industries, paying $7 000 cash and the balance payable in 12 months 13 Banked receipts $200 Paid office expenses $30 14 Banked receipts $120 15 Banked receipts $150 Received an invoice from Clark Motors for delivery van repairs $210 Withdrew $100 for personal use 18 Banked receipts $170 Paid rent $200 and paid advertising $250 19 Paid Cottonweave Ltd $3 000 on account 20 Banked receipts $250 Paid vehicle expenses (2 tyres) $100 21 Banked receipts $300 Paid wages $180 22 Banked receipts $320 24 Sent invoice to St Mary's Babies Home for $350 Account Lines Account Number Bank 21 110 Accounts Receivable 2 120 Delivery Van 2 210 Laundry Equipment 2 220 Accounts Payable 6 310 Capital 3 510 Drawings 2 520 Fees 9 610 Nappies Expense 2 710 Rent Expense 3 720 Advertising Expense 3 730 Vehicle Expenses 3 740 Wages Expense 2 750 Office Expenses 2 760 Laundry Supplies Expense 2 770

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3.6.8 M.Franklin operates an advertising agency and his Balance Sheet as at 30 June 20X1 was:

Slick Advertising Agency (M.Franklin, proprietor) Balance Sheet as at 30 June 20X1

Current Assets $ $ Current Liabilities $ $ Bank 5 000 Accounts payable Accounts Receivable Hanson & Duke 1 000 Peerage Ltd 15 000 Non Current Liabilities Baton Traders 5 000 25 000 Loan (due 20X5) 10 000 11 000 Non Current Assets Property, Plant and Equipment Equity Motor vehicle 12 000 Capital – M Franklin 30 000 Equipment 20 000 32 000 plus Profit 16 000 46 000 $ 57 000 $ 57 000

a. Enter the account balances (above) in the ledger of the Slick Advertising Agency. b. Record the following transactions in the ledger. c. Prepare a trial balance at 14 July 20X1. d. Prepare an Income Statement for the 2 weeks ended 14 July 20X1. e. Present a Balance Sheet as at 14 July 20X1.

20X1 July 1 Received $4 000 from Peerage Ltd on account 2 Paid rent $500, cleaning $100 3 Invoiced APC Industries $6 000 for a TV commercial 4 Paid Hanson & Duke $1 000 5 Paid models' fees $600 Bought equipment $1 000 on credit from Phillips & Co. 8 Invoiced Glamour Cosmetics $750 for magazine advertisements 9 Paid rent $500, cleaning $100 10 Invoiced Macrob Confectionery $5 000 for a TV commercial 11 Received $3 000 from Baton Traders on account 12 Paid wages $4 000 14 Withdrew $200 computer for personal use Contract for a $4 000 TV commercial signed with Seagull Outboards

Account Lines Account Number Bank 12 110 Accounts Receivable 7 120 Motor Vehicles 2 210 Equipment 4 220 Accounts Payable 4 310 Loan 2 410 Capital 2 510 Drawings 2 520 Fees 4 610 Rent 2 710 Cleaning Expenses 3 720 Models’ Expense 2 730 Wages 2 740

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3.6.9 M Jenkins operates the Timber Ridge Bus Service and her assets and liabilities at 1 April 20X1 are as follows:

Timber Ridge Bus Service (proprietor, M.Jenkins) Balance Sheet as at 31 March 20X1 Current Assets $ $ Current Liabilities $ $ Bank 6 000 Accounts Payable Accounts Receivable Drayton & Sons 500 Education Dept 5 500 Baynes Ltd 2 000 2 500 11 500 Non Current Assets Non Current Liabilities Property, Plant and Equipment Loan (Ford Credit) 24 000 Motor Vehicles 58 000 Mortgage (due 20X5) 15 000 39 000 Office Equipment 1 500 Equity Land & Buildings 43 000 102 500 Capital – M Jenkins 50 000 plus Profit 27 500 77 500 less Drawings 5 000 72 500 $ 114 000 $ 114 000

a. Enter the account balances (above) in the ledger of Timber Ridge Bus Service. b. Record the following transactions in the ledger and extract a trial balance at 30 April 20X1. 20X1 Apr 2 Banked fares $150 5 Banked fares $720 6 Invoiced the Education Department for school-bus services $250 M Jenkins withdrew $100 for personal use 9 Banked fares $180 11 Received $3 000 from Education Department on account 12 Banked fares $230 Paid Drayton & Sons $500 13 Paid wages $800, tyres $220 Invoiced the Education Department for school-bus services $280 Banked fares $210 15 Invoice received from Ampol Petroleum on delivery of $200 worth of petrol 18 Banked fares $480 Paid Baynes Ltd $250 19 Paid Ford Credit $500 (including $100 interest) Banked fares $200 20 M Jenkins withdrew $150 for her own use Invoiced Education Department for school-bus services $350 23 Banked fares $240 24 Paid Ampol Petroleum $200 26 Received $1 000 on account from the Education Department 27 Paid wages $800 Invoiced the Education Department for school-bus services $300 Banked fares $320 30 Banked fares $110

c. Prepare an Income Statement for the month ended 30 April 20X1. d. Present a Balance Sheet as at April 20X1. e. Comment on the change in the short term financial position of Timber Ridge Bus Service over the month.

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3.6.10 J Gale operates the Hellenic Travel Agency and the assets and liabilities at 1 July 20X1 were as follows:

Hellenic Travel Agency Balance Sheet as at 1 July 20X1 Current Assets $ $ Current Liabilities $ $ Bank 1 500 Accounts Payable Accounts Receivable American Airlines 1 500 C Makris 1 200 Panjan Airlines 3 400 T Dayton 6 000 Olympic Airways 1 600 6 500 Mason Ltd 4 800 13 500 Non Current Assets Non Current Liabilities Property. Plant and Equipment Loan from Victoria Office furniture 1 200 Finance (due 20X5) 2 000 Motor vehicle 5 000 6 200 Equity Capital - Gale 11 200 $ 19 700 $ 19 700

a. Enter the account balances (above) in the ledger of Hellenic Travel Agency. b. Record the following transactions in the ledger. c. Extract a trial balance at 31 July 20X1. d. Prepare an Income Statement for the month ended 31 July 20X1 and a Balance Sheet as at 31 July 20X1.

20X1 July 2 Received $1 200 from C Makris, a customer who owes money on his account. 5 Paid office expenses $65 7 Sent invoice to Brighton College $6 000 for school tour 8 Received cash from Mason Ltd for holiday bookings $4 800 12 Paid $1 500 to American Airlines, an accounts payable 14 Paid office girl's wages $120 18 Sent a cheque to Olympic Airways for $1 600 owing 22 Paid Panjan Airlines $2 000 on account 24 Received $4 000 cash for holiday bookings from T Dayton 25 Invoiced the Bellevue Social Club for $7 000 for travel arrangements 26 Received payment in full from Brighton College 27 Invoice received for travel expenses $8 000 from Olympic Airways 28 Paid office girl's wages $120 31 Purchased air ticket on credit $200 from Olympic Airways for personal holiday Paid rent $400 cash

REVIEW:

Accounting Elements are used to group the economic activities of a business entity. The five elements are:

Assets Liabilities Equity

Expenses Income

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e. Enter the second month's transactions in the ledger accounts then: i) extract a trial balance at 31 August 20X1 ii) prepare an Income Statement for the 2 months ended 31 August 20X1 and a Balance Sheet as at 31 August 20X1 20X1 Aug 2 Paid signwriter $100 cash 5 Received $5 000 from Bellevue Social Club 8 Bought new office desk for cash $150 13 Paid Olympic Airways $6 000 on account 15 Paid office girl's wages $120 18 Hi-way Motels sent an invoice for $4 000 for travel expenses 20 Paid Panjan Airlines $1 400 22 Paid telephone account $240 23 Invoiced St James College $10 000 for travel arrangements 24 Paid $ 100 cash for office cleaning 26 Paid $1 080 to Victoria Finance (including $80 interest) 28 Received invoice from Olympic Airways $800 travel expenses 29 Received $6 000 cash from St James College 30 Paid office girl's wages $120 31 J Gale withdrew $500 cash Paid rent $400 cash 3.7 Trading Statements A business which earns its revenue from selling goods must complete a Trading Statement to calculate Gross Profit.

Role Play illustration – Props: Sunglasses Characters: Teacher (student volunteer), Student (another student volunteer)

Teacher: How much do you think I paid for these sunglasses? Student: About $50 Teacher: Do you think that the shopkeeper bought the sunglasses at this price? Student: No Teacher: How much do you think the shopkeeper may have paid for these sunglasses? Student: $20 Teacher: Gross Profit equal the selling price of an item less the price the shopkeeper bought it for. How much is the Gross Profit for the sunglasses? Student: $30

GROSS PROFIT = SELLING PRICE – COST PRICE = SALES REVENUE – COST OF GOODS SOLD

3.7.1 Complete the following table. An example has been given for you to follow: SALES COST OF GROSS EXPENSES PROFIT REVENUE GOODS PROFIT (LOSS) SOLD Example $50 000 $20 000 $30 000 $10 000 $20 000 A $75 000 $25 000 $12 000 B $420 000 $288 000 $118 000 C $55 000 $40 000 $18 000 D $161 000 $78 000 $29 250 E $359 280 $248 000 $(500) F $72 000 $12 000 $4 280

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3.7.2 Complete Trading Statements from the following information for the month ended 28 February 20X1. Business A is done for you as an example. (Wilson p232)

Business A B C Sales Revenue 360 000 224 000 300 000 Opening Inventory 20 000 65 000 85 000 Purchases Expense 340 000 150 000 80 000 Closing Inventory 35 000 55 000 55 000

EXAMPLE: Business A Trading Statement for the month ended 28 February 20X1 $NZ $NZ Sales Revenue 360 000

Less Cost of Goods Sold Opening Inventory 20 000 Plus Purchases Expense 340 000 GOODS AVAILABLE FOR SALE 360 000 Less Closing Inventory 35 000 COST OF GOODS SOLD 325 000 GROSS PROFIT $35 000

3.8 Analysing the Trading Statement There are three ways to analyse the Trading Statement: a. Gross Profit%

Formula Gross Profit x 100 Gross Profit % = Net Sales Revenue 1

Example Business A: 35,000 x 100 360,000 1 = 9.72%

This means that for every dollar of goods sold by the business, the business earns almost 10 cents Gross Profit. It is not possible to state whether 9.72% is satisfactory or not. It must be compared with the gross profit percentage of other firms in the same industry or other accounting periods. If the percentage remains constant between periods, there should be no cause for concern. If the percentage increases or decreases, the reason should be investigated.

Possible causes for a change in Gross Profit % are: M Mark-up – the business may have chosen to change the mark-up % I Inaccurate recording of closing inventory S Stealing of stock (Gross Profit% decreases) F Failure to take discounts (Gross Profit% decreases) I Inaccurate recording of credit sales T Theft of cash (Gross Profit% decreases)

Possible suggestions for improvement are: 1 Improve inventory control 2 Investigate purchasing policy 3 Improve control of cash

You are learning from a Taylors Study Guide. Study Guide 13-B3 Accounting Page 37 b.Mark-Up % Formula Gross Profit x 100 Mark-Up % = Cost of Goods Sold 1

Example Business A: 35,000 x 100 325,000 1 = 10.77%

The mark-up percentage represents the proportion of the cost price that is added to achieve the selling price. The type of business will determine the appropriateness of this percentage. Supermarkets can afford to have a low mark-up as their sales volume is sufficient to allow enough gross profit to be made to cover other expenses. A jeweller will have a high mark-up as it has a low inventory turnover.

Expectation: The Mark- up % should remain unchanged from year to year.

Causes for change: o The firm may have purchased goods that are difficult to sell because they are out-of-date. o Mark-downs required to solve overstocking.

Suggestions for improvement: o Investigate purchasing policy. o Up skill purchasing personnel. c.Inventory Turnover Formula: Cost of Goods Sold Rate of Inventory Turnover Average Inventory

Example Business A: 325,000 (20,000+ 35,000)/2 = 11.82 times p.a.

The inventory turnover shows how many times the inventory in the shop is sold (turned into cash) during the reporting period. The inventory turnover will differ according to the type of business activity the enterprise is engaged in. A bread shop will have a rate of inventory turnover of approximately 365 times a year whereas an antique shop may have an inventory turnover of only twice a year.

When writing a report on the importance of trends in the rate of inventory turnover, it is helpful to determine the Inventory Turnover period. For example, to find out how many days on average it takes to sell the inventory for Business A, you would complete the following calculation:

Formula: Days in the Inventory turnover 365 period: Rate of Inventory Turnover

Example Business A: 365 11.82 = 31 days

Note: The days in the inventory turnover period must always be rounded up to the next day. e.g. 20.01 days = 21 days.

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Expectation: The rate of inventory turnover should remain constant or increase between accounting periods. The days in the inventory turnover period should decrease.

Evidence for concern: A decreasing rate of inventory turnover or below normal for the type of business.

Causes for concern: o Poor merchandising. o Insufficient advertising. o Too much competition. o Products do not meet customer requirements. o Overstocking.

Suggestions for improvement: o Eliminate slow moving lines by having a sale with mark downs. o Improve staff efficiency. o Advertise. o Conduct market research.

Costs of incorrect inventory turnover include: Too high (Inventory Turnover) Too Low (Inventory Turnover) Lack of choice for customers Extra storage costs Loss of sales Obsolete stock Higher delivery costs Items stolen Damaged stock Liquidity problems

Illustration: e.g. Krazy Clothes Limited. Income Statement 20X2 for the year ended 31 March 20X3 $NZ $NZ 1,200,000 Sales Revenue 1,400,000 700,000 less Cost of Goods Sold 750,000 500,000 Gross Profit 650,000

Inventory balances for the last three years ending 31 March 20X3include: 20X1 20X2 20X3 Inventory $42,000 $65,000 $137,000

20X2 20X3 Inventory = 700,000 13.08 = 750,000 7.43 Turnover (42,000+65,000)/2 times (65,000+137,000)/2 times p.a. p.a.

Inventory = 365 28 = 365 50 Period 13.08 days 7.43 days

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3.9 Accounting for Sales Revenue and Purchases Returns When goods that are purchased are faulty, the consumer is able to return them. If the goods have been purchased or sold on credit, cash will not be refunded but a credit note will be issued. The credit note is a source document that authorizes a reduction in the amount owing by the customer. The following illustrations show the accounting treatment.

Illustration 1 Sales Returns: March 1 Sell 3 pairs of shoes on credit at $150 each. March 2 Customer returns 1 pair of shoes

DATE ACCOUNT TYPE +/- Debit/Credit Mar 1 Accounts Receivable A + Debit Sales Revenue I + Credit Mar 2 Sales Returns I - Debit Accounts Receivable A - Credit

Shoe Shop General Ledger ACCOUNTS RECEIVABLE 120 Mar 1 Sales Revenue 450 450 Dr 2 Sales Returns 150 300 Dr

SALES REVENUE 610 Mar 1 Accounts Receivable 450 450 Cr

SALES RETURNS 611 Mar 2 Accounts Receivable 150 150 Dr

TRIAL BALANCE (EXTRACT)

Accounts Receivable 300 Sales Revenue 450 Sales Returns 150

Illustration 2 Purchases Returns: March 1 Order 500 cartons of yoghurt at 40 cents each March 2 Return 100 cartons of yoghurt that were past their expiry date.

DATE ACCOUNT TYPE +/- Debit/Credit Mar 1 Accounts Payable L + Credit Purchases Expense E + Debit Mar 2 Purchases Returns E - Credit Accounts Payable L - Debit

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SUPERMARKET General Ledger

ACCOUNTS PAYABLE 310 Mar 1 Purchases Expense 200 200 Cr 2 Purchases Returns 40 160 Cr

PURCHASES EXPENSE 710 Mar 1 Accounts Payable 200 200 Dr

PURCHASES RETURNS 711 Mar 2 Accounts Payable 40 40 Cr

TRIAL BALANCE (EXTRACT)

Accounts Payable 160 Purchases Expense 200 Purchases Returns 40

3.10 Practice Exercises: 3.10.1 (Wilson 6.29) Calculate and comment on the inventory turnover for the following businesses.

Trading Accounts for the year ended 31 March 20X3 Papas Bakery Dinah’s Desks Sales Revenue (credit) 490,000 490,000 Less Cost of Goods Sold Opening Inventory 650 34,000 Purchases Expense 260,000 310,000 Less Closing Inventory (450) (21,000) Cost of Goods Sold 260,200 323,000 Gross Profit $229,800 $167,000

3.10.2 (Wilson 6.30) Pedro Hats Limited has the following information from their financial statements. (use 365 days per year.) Income Statement extract 20X1 20X2 20X3 Sales Revenue – cash 380,000 290,000 243,000 Sales Revenue – credit 1,150,000 1,200,000 990,000 Cost of Goods Sold (1,120,000) (995,000) (830,000) Gross Profit 410,000 495,000 403,000

Balance Sheet extract Current Asset (extract) 20X0 20X1 20X2 20X3 Inventory 54,000 68,000 75,000 81,000

Required: Calculate the rate of inventory turnover and the Inventory Turnover Period for Pedro Hats Limited for the years ending 20X2 to 20X3.

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3.10.3 Practice: Mid-Course Examination January/April 2009

QUESTION 4: Financial Reporting for Trading Enterprises (19 marks) Marc Booth is a sole proprietor who owns Crazy Hats. Crazy Hats is a retail store that sells a variety of goods suitable for theme parties.

CRAZY HATS Trial Balance (Extract) As at 31 March 20X9 $NZ $NZ Inventory (1 April 20X8) 14,690 Freight In 1,450 Purchases Expense 62,950 Sales Returns 1,250 Sales Revenue 119,200

Additional Information: Inventory on 31 March 20X9 was $17,756.

REQUIRED: (a) Prepare an Income Statement Extract to determine Gross Profit for Crazy Hats for the year ended 31 March 20X9. Use the information from the Trial Balance extract together with the additional information provided above. 9 marks

CRAZY HATS Income Statement (extract) for the year ended 31 March 20X9 $NZ $NZ $NZ

% Change in Net Sales Formula:

New result – original result x 100 Original result 1

Expectation: it is good if the % remains constant between accounting periods. If it increases, it is very good. If it decreases, there are causes for concern and it should be investigated.

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(b) Analysis and Interpretation:

(i) Use the Income Statement (extract) on page 41 to complete the following worksheet showing full working and entering your answers in the schedule below correct to two decimal places for 20X9. 4 marks

CRAZY HATS WORKSHEET FOR ANALYSIS FOR THE YEAR ENDED 31 MARCH 20X9 WORKING SCHEDULE 20X8 20X9 Gross Profit % Gross Profit x 100 40% Turnover 1 Mark Up% Gross Profit x 100 66.67% Cost of Goods Sold 1

Inventory Turnover Cost of Goods Sold 5 times pa Average Inventory

(ii) Explain the meaning of the calculations you have completed for 20X9. 2 marks

Gross Profit %

Mark-up %

Inventory Turnover

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3.10.4 Practice: Mid-Course Examination January/April 2010

QUESTION 4: Financial Reporting for Trading Enterprises (19 marks) Charles Chung is the owner of Bathroom Ware Enterprises which is a retail store that sells a variety of materials used in the construction and renovation of bathrooms. The following table summarises financial data for Bathroom Ware Enterprises for the years ended 31 March 20X8 and 31 March 20X9.

BATHROOM WARE ENTERPRISES Year ended Year ended Year ended 31 March 20X7 31 March 20X8 31 March 20X9 $NZ $NZ $NZ Inventory 15,000 22,500 25,000 Net Sales Revenue 263,208 290,882 Net Purchases Expense 127,000 133,000

REQUIRED: (a) Prepare an Income Statement Extract to determine Gross Profit for Bathroom Ware Enterprises for the year ended 31 March 20X9. Include comparative figures for the year ended 31 March 20X8. 7 marks

BATHROOM WARE ENTERPRISES Income Statement (extract) for the year ended 31 March 20X9 20X8 20X9

(b) Analysis and Interpretation

(i) Use the Income Statement (extract) above to complete the following worksheet showing full working and entering your answers in the schedule on page 43 correct to two decimal places for 20X8 and 20X9. 5 marks

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BATHROOM WARE ENTERPRISES WORKSHEET FOR ANALYSIS FOR THE YEAR ENDED 31 MARCH 20X8 and 20X9 WORKING SCHEDULE Gross Profit % 20X8 Gross Profit x 100 Net Sales 1 20X9

Inventory Turnover 20X8 Cost of Goods sold Average Inventory 20X9

% Change in 20X9 Net Sales

Mark-Up % 20X8 Gross Profit x 100 Cost of Goods Sold 1 20X9

(ii) Explain fully what the percentage change in net sales for 20X9 tells Charles about his business. 2 marks

(iii) Carefully examine the worksheet analysing the trading results of Bathroom Ware Enterprises above.. Identify ONE unsatisfactory trend in the results from 20X8 to 20X9. 1 mark

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(iv) Suggest TWO possible causes for the unsatisfactory trend you have identified above. 2 marks

(v) Recommend TWO strategies that Charles can use to correct the unsatisfactory trend in the next reporting period. 2 marks

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3.11 Classification of Expenses and Income The following table provides a guide to the classification of expenses in the Income Statement. As you learn more examples, add them to the table.

COST OF GOODS SOLD ADMINISTRATIVE EXPENSES Purchases Expense Accountancy Fees Expense (Purchases Returns and Allowances) Depreciation on Buildings* Customs Duty Depreciation on Office Equipment Cartage Inwards Expense Electricity Expense Freight Inwards Expense General Expenses Insurance Expense Rates Expense Repairs and Maintenance on Buildings Office Salaries Expense Stationery Expense Telephone Expense Rent Expense Discount Allowed Bad Debts Doubtful Debts

DISTRIBUTION COSTS FINANCE COSTS Advertising Expense Interest on Loan Delivery Expenses Interest on Mortgage Freight Outwards Expense Interest on Overdraft Cartage Outwards Expense Depreciation on Vehicles Depreciation on Shop Fittings Repairs and Maintenance on Delivery Vehicles Expense Sales Commissions Expense Sales Wages Expense Shop Electricity Expense

OTHER EXPENSES REVENUE Loss on Sale Sales Revenue (Sales Returns and Allowances) Fees Revenue

OTHER INCOME Gain on Sale Commission Received Discount Received

*NZ tax law currently does not allow depreciation on buildings to be treated as an expense. However in order to comply with IAS 16 Accounting for Property, Plant and Equipment, depreciation is still recorded on buildings for financial reporting purposes.

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3.10 MODEL INCOME STATEMENT Kasey’s Kayeks Income Statement for the year ended 31 March 20X1 $NZ $NZ $NZ Sales Revenue 877 800 Less Sales Returns and Allowances 18 500 859 300 Less Cost of Goods Sold Opening Inventory 150 000 Plus Purchases Expense 455 000 Less Purchases Returns and Allowances 15 500 439 500 Plus Customs Duty 10 500 450 000 GOODS AVAILABLE FOR SALE 600 000 Less Closing Inventory 145 000 COST OF GOODS SOLD 455 000 GROSS PROFIT 404 300 Plus Other Income Discount Received 10 000 414 300 Less Expenses Distribution Costs Advertising Expense 15 300 Wages (shop) Expense 118 000 Depreciation – delivery van 8 800 142 100 Administrative Expenses: Electricity Expense 9 000 Insurance Expense 3 000 Stationery Expense 10 000 Salaries (office) Expense 90 000 Bad Debts 900 Discount Allowed 600 Telephone expense 9 000 Depreciation - equipment 6 000 128 500 Finance Costs Interest on Loan 4 900 Interest on Mortgage 5 600 10 500 Other Expenses Loss on Sale of Vehicles 500 TOTAL EXPENSES 281 600 PROFIT $132 700

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3.11 Exercises for you to try

3.11.1 From the following balances for G. Joyco, prepare:

a. A Trial Balance as at 31 March 20X1 b. An Income Statement for the year ended 31 March 20X1 c. A Balance Sheet as at 31 March 20X1 Inventory 1.4.X0 $993.25, Purchases Expense $7 728.95, Wages Expense $854.35, Advertising Expense 169.62, Rent Expense 720.55, Repairs Expense $58.28, Bad Debts $69.00, Bank $779.28, Accounts Receivable $325.60, Furniture $496.75, Equipment $1 250.00, Drawings $1 500.00 Sales Revenue $11 257.00, Discount Received $64.91, Accounts Payable $175.35, Capital $3 448.37. Inventory 31.3.X1 $1 085.53

3.11.2 From the following balances for Ed Ward prepare:

a. A Trial Balance as at 31 March 20X1 b. An Income Statement for the year ended 31 March 20X1 c. A Balance Sheet as at 31 March 20X1

Inventory 1.4.X0 $895.35, Sales Returns $56.72, Salaries Expense $1 055.35, Purchases Expense $4 696.68, Advertising Expense 325.20, Discount Allowed $94.22, General Expenses 282.57, Bank $1 000.58, Accounts Receivable $497.26, Furniture $849.00, Equipment $3 000, Drawings $1 680.00, Sales Revenue $8 575.82, Purchases Returns $64.49, Accounts Payable $495.62, Capital $5 297.00. Inventory 31.3.X1 $715.22.

3.11.3 From the following balances for Easter Shop prepare:

a. A Trial Balance as at 31 March 20X1 b. An Income Statement for the year ended 31 March 20X1 c. A Balance Sheet as at 31 March 20X1

Inventory 1 April 20X0 $23 000, Purchases Expense $77 000, Cartage Inwards Expense $3 000, Wages Expense $30 000, Advertising Expense $4 000, Salaries Expense $50 000, Rent Expense $28 000, Office Expenses 10 000, Delivery Expenses $5 000, Interest Expense $2 000, Bank $5 000, Accounts Receivable $15 000, Motor Vehicles $27 000, Equipment $10 000, Drawings $25 000, Sales Revenue $240 000, Purchases Returns $2 000, Sales Returns $1 000, Commission Received $3 000, Accounts Payable $10 000, Loan $20 000, Capital $40 000. Inventory 31 March 20X1 $30 000.

NOTE:

 The Income Statement shows the profitability of the business. The Income Statement shows the operating results of the business for the period.

 The Balance Sheet shows the financial structure of the business.

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Chapter 4

Journals

Contents 4.1 Introduction 4.2 Source Documents 4.3 Journals 4.4 The General Journal 4.5 Exercises for you to try

4.1 Introduction

The accounting process can be shown diagrammatically as follows:

Transaction Document Journal Ledger Trial Balance

Income Statement Balance Sheet

Whenever a transaction takes place in business, a source document (or business document) is prepared to record the details of the transaction to ensure an accurate record is provided. Source documents are part of the accounting process because they are used to record information in the journals. Different journals are used for each category of transactions. All entries made in the journals are then transferred to or 'posted' using the rules of double entry accounting.

From the ledger balances we can then construct a trial balance to prove the accuracy of our double entry in the ledger. Finally, from the trial balance we can prepare our financial reports, that is, an Income Statement and a Balance Sheet.

4.2 Source Documents

The most common source documents used for accounting recording purposes are:

1. Receipt 2. Invoice 3. Credit Note 4. Cheque/cheque butt 5. Bank Statement

Source Documents should have at least two copies - the original sent to the supplier or customer and the copy retained by the business for future reference.

The input of the accounting system should be in the form of consecutively pre-numbered multi-copied documents. Reasons for pre-numbered documents include:

The documents provide an audit trail to trace a transaction through the accounting system.  It is easy to file and retrieve source documents.  Any false documents can be identified.  The customer has a number to quote when making enquiries.  All documents can be accounted for.

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4.3 Journals

A journal is a book that collates and summarises information from similar source documents in date order. For example, The Cash Payments Journal summarises all cheques, the Sales Journal summarises all invoices issued to customers. There are two types of journals - specialised journals and general journals.

A specialised journal groups large number of transactions into frequently used similar business events. All in all, there are six specialist journals.

1. Cash Receipts Journal, to record all cash received. Source document: Cash invoice, receipt, bank deposit form or bank statement.

2. Cash Payment Journal, to record all cash paid. Source document: Cheque/butt, or bank statement. Note: Cash includes cheques.

3. Sales Journal, to record sales of merchandise on credit. Source document: Invoice issued.

4. Purchases Journal, to record purchases of merchandise on credit. document: Source document: Invoice received.

Those transactions which do not 'fit' into the special journals are entered into the General Journal.

4.4 General Journal

Transactions that do not occur frequently enough to warrant a special journal are recorded in the general journal from various source documents depending on the transaction. (eg. memos).

Format of the General Journal:

Date Particulars Folio Debit Credit

An important aspect of formatting in the journal is to ensure that the credit entry is indented in the particulars column.

The major types of general journals entries are: 1. Commencement of business 2. Contribution or withdrawal of assets other than cash by proprietor 3. Purchase of non-current assets on credit 4. Bad Debts written off 5. Interest Expense owing to a creditor 6. Interest Receivable from a debtor 7. Contra, or offsetting, entries 8. Adjusting and reversing entries 9. Doubtful debts 10. Depreciation of non-current assets 11. Inventory of an item (apart from merchandise) that requires adjustment 12. Disposal of a non-current asset 13. Closing entries

1-7 will be examined in this chapter. 8-13 will be examined in later chapters.

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4.4.1 Commencement of Business

Example:

On 1 October 20X1 Pink's Boutique, proprietor Paula Brown had the following assets and liability:

Cash at Bank $3 500, Equipment $6 900, Vehicle $10 000 and liability a loan of $6 000 from AGP Finance. To establish a double entry set of records, a general journal entry would show:

Pink’s Boutique General Journal GJ1 Date Particulars Ref Debit Credit 20X1 Oct 1 Bank 3 500 Equipment 6 900 Vehicle 10 000 Loan – AGP 6 000 Capital – P Brown 14 400

(Assets and liabilities contributed by the owner).

Note: The amount of $14 400 was calculated by subtracting the liability from the assets. The total debits now equal the total credits.

4.4.2 Purchases of non-current assets on credit

Example: On October 3, Pink’s Boutique purchases equipment from Guy's Computer Supplies on credit for $3000.

General Journal GJ2 20X1 Oct 3 Computer Equipment 3 000 Guy’s Computer Supplies 3 000

Purchased computer equipment on credit

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4.4.3 Contribution or withdrawal of assets other than cash by the owner Example: Nov 11 The owner contributed an office desk to the business valued at $200. The owner withdrew tools with a value of $ 100 for personal use. The owner took goods home for private use. The business (a service firm) purchased the materials at a cost of $50.

General Journal GJ 3 20X1 Nov 11 Office Furniture 200 Capital 200 (Contribution of desk by owner) Drawings 100 Tools 100 (Owner withdrew tools for personal use) Drawings 50 Purchases Expense 50 (Owner withdrew goods for personal use)

4.4.4 Interest Expense

Example: On 11 December Paula overlooked payment of an account to S Brown. The amount is $600 and the account is one month overdue. Interest of 10% p.a. is charged.

General Journal GJ 4 20X1 Dec 11 Interest Expense 5 Accounts Payable – S. Brown 5

(Charged interest on overdue account by S. Brown at 10% p.a.)

4.4.5 Interest Income

Example:

On 12 December R. Taylor's account is overdue - he owes $750 and is charged interest of $25.

General Journal GJ 5 20X1 Dec 12 Accounts Receivable – R. Taylor 25 Interest Income 25 (Charged interest on overdue account)

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4.4.6 Bad Debts Written Off

Bad Debts are debts (accounts receivable) that will not be collected by the business.

Example: On 6 January 20X1 Paula receives notification that one of her customers, B James has been declared bankrupt. The balance of B James’ account of $200 is to be written off.

General Journal GJ6 20X1 Jan 6 Bad Debts 200 Accounts Receivable – B. James 200

(For bad debts written off).

4.4.7 Contra, or Offsetting, Entries

It may happen that a business may owe money to an accounts payable who at the same time is an accounts receivable of the business. If both parties agree it is possible to off set the lower balance against the larger balance. This is known as a contra, or offsetting entry.

Example: Peters Traders is owed $70 by John Smith, for goods supplied. At the same time John Smith who is an electrician has provided services for $160. Both parties agree that the balances owing should be off set on 7 February 20X1.

Peters Traders General Journal GJ81 20X1 Feb 7 Accounts Payable – John Smith 70 Accounts Receivable – John Smith 70 (Contra Entry)

4.5 Exercises for you to try 4.5.1 T Phillips decided to commence business as Topflight Mowers and on 1 August 20X1 deposited $5 000 into a business bank account. His motor vehicle, a utility valued at $3 500, is to be used as a business vehicle for pickups and deliveries. a. Show the general journal entry required to commence a double-entry set of accounting records. b. Record the following transactions in his general journal: c. Post all journal entries to the general ledger of Topflight Mowers and extract a trial balance as at 4 August 20X1.

20X1 Aug 2 A Cash register was purchased on credit from I.B.R Ltd for $580 (invoice B748) 3 Shelving and counters (shop fittings) were purchased on credit from Mildara Pty Ltd for $400 (invoice 79) 4 An account was received from Hiway Garage for modifications to the utility for delivery purposes, $90 (invoice 3291)

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4.5.2 S James has been trading as Supreme Gifts for 12 months and has the following assets and liabilities on 1 July 20X1: furniture and fittings $1 200; equipment $320; Inventory $8 900; cash on hand $60; bank overdraft $1 300; Accounts Payable, Healy Ltd $700. a. Show the general journal entry required to commence a set of double-entry records for Supreme Gifts. b. Record the following transactions in the general journal of Supreme Gifts

20X1 July 1 Bought glasses from Healy Ltd on credit for $165, Invoice A770 2 Additional shelving was purchased and fitted at a total cost of $120, payment to be made within 60 days to Bullet Shop Supplies (invoice 8491) 3 James took a set of glasses, cost $65, from inventory and gave them to his wife for her birthday 4 A supply of special wrapping paper was purchased on credit from Healy Ltd, $180 (invoice A779)

c. Post the journal entries from a. and b. to the general ledger of Supreme Gifts and extract a trial balance.

4.5.3 Brian Megan, an electrician, has decided to set up his own business called Megan Electrics, and on I June 20X1 he deposited $2 000 in a special cheque account at the ANZ Newton Branch. He intends using his own utility valued at $4 000 as the business vehicle, and he has tools valued at $1 200. During the first week while he was getting his business organised, he had the following transactions:

20X1 June 2 Electrical supplies were bought from Electron Ltd on credit for $300 3 His utility was fitted out to facilitate its use as a service van. The work was carried out by Hisco Motors on 30 days credit terms for $140 4 Alterations were made to Megan's garage to fit it out as a workshop at a cost of $380. The business has 60 days credit on this work done by Bayside Constructions Ltd

a. Show the general journal entries required to record the above items from 1 to 4 June 20X1. b. Post the journal entries to the general ledger. c. Extract a trial balance at 4 June 20X1.

4.5.4 a. Enter the following items in the general journal of Topical Toys (owner, D Menzies) On 1 September 20X1 a double-entry set of records was commenced with the following assets and liabilities: Cash $200, Accounts Receivable A. Lane $600, D. Denver $140, T. Blight $1 200; Furniture and Fittings $700; Inventory $10 000; Motor Vehicle $3 900; Bank Overdraft $140, Accounts Payable D. Lane, $200; Toy Traders Ltd $12 000; Toy Imports Ltd $800. Sep 2 A cheque for $200 received from A Lane on 24 August, had been incorrectly credited to D Lane. This error must now be corrected. 3 T Blight was charged $6 interest on his overdue account 4 Stationery supplies were bought on credit from Atlas Office Supplies $140 (invoice 8491) 5 Notification was received that D Denver was bankrupt and his debt was written off as irrecoverable 6 The business purchases toys for $300 paying from the bank account. 7 D Menzies took toys to the value of $80 home for his children b. Post the entries to the General Ledger of Topical Toys. c. Prepare a trial balance at 6 September 20X1.

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Chapter 5

Closing the Ledger

5.1 Introduction 5.2 Example of Closing Journal entries for a service business 5.3 Exercises for you to try 5.4 Example of Closing Journal entries for a business which trades in goods

5.1 Introduction

The business records the assets and liabilities at commencement in the General Journal. Capital is calculated using the accounting equation:

Equity = Assets – Liabilities (Capital)

Temporary equity accounts – income, expense and drawings are opened to record the transactions that occur during the accounting period. At the end of each period income and expense accounts must be closed.

 Income and expense accounts are closed to the Income Summary account.

 Income Summary account is closed by transferring the final balance to the Capital account. A credit balance represents Profit while a debit balance represents a Loss.

 Finally when the Drawings account is closed to the Capital account, the ledger is ready to commence a new accounting period with only Asset, Liability and Equity accounts remaining open.

5.2 Example for Closing a Service Business:

A Business commenced on 1 January 20X1 and prepared the following journal entry. a. Calculate the capital.

A BUSINESS General Journal GJ1 Date Particulars Ref Debit Credit 20X1 Jan 1 Bank 2 000 Equipment 20 000 Loan 5 000 Capital – A Business ?

(Assets and liabilities contributed) b. Post the journal into the ledger accounts given on the next page. The teacher will help you to work through this model which you can use to revise from later.

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A BUSINESS General Ledger Bank 110

Equipment 210

Loan 410

Capital 510

Drawings 520

Income Summary 530

Fees Revenue 610

Expenses 710

c. The following transactions occurred during the month of January:  Received fees of $16 000  Paid expenses $10 000  The owner took $4 000 for personal use Enter the double entry record for these transactions directly into the correct ledger accounts.

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d. The following journal entries are prepared to close the journal at balance day. Your teacher will show you how to post them to the ledger so that the income, expense and drawings accounts are closed.

A BUSINESS General Journal GJ10 Date Particulars Ref Debit Credit 20X1 Jan 31 Fees Revenue 16 000 Income Summary 16 000 (Closing Entry) Income Summary 10 000 Expenses 10 000 (Closing Entry) Income Summary 6 000 Capital 6 000 (Transfer of Profit) Capital 4 000 Drawings 4 000 (Closing Entry)

e. The following Trial Balance is prepared after the closing journal entries have been posted. You will notice that only Asset, Liability and Capital accounts remain open ready to start the next accounting period. A BUSINESS POST CLOSING TRIAL BALANCE AS AT 31 JANUARY 20X1

$NZ $NZ Bank 4 000 Equipment 20 000 Loan 5 000 Capital 19 000 $24 000 $24 000

5.3 Exercises for Closing Journal entries for a Service Business

5.3.1 a. Open ledger accounts using the information given in the Trial Balance for Manton Photographic Services as at 30 June 20X1 on the next page. Account number 530 should be Income Summary.

Your teacher will work through this problem with you.

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The following trial balance was extracted from the ledger of Manton Photographic Services: Manton Photographic Services Trial Balance at 30 June 20X1 A/c No $NZ $NZ Bank 110 5 820 Accounts Receivable – Syndal High School 120 680 Accounts Receivable – Mason High School 130 410 Accounts Payable – T Milne Ltd 310 720 Capital – I Manton 510 5 500 Drawings – I Manton 520 1 500 Income Summary 530 Fees Revenue 610 15 800 Materials Expense 710 2 810 Office Salaries Expense 720 3 000 Photographer Salary Expense 730 7 000 Advertising Expense 740 200 Rent Expense 750 520 Bad Debts 760 80 $22 020 $22 020

MANTON PHOTOGRAPHIC SERVICE GENERAL LEDGER

20X1

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b Prepare closing journal entries and post to the ledger c Prepare a post closing trial balance d Prepare an Income Statement for the year ended 30 June 20X1 e Prepare a Balance Sheet as at 30 June 20X1

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5.3.2 The following trial balance was extracted from the ledger of Henley Dry Cleaning Service (owner, B Henley)

Henley Dry Cleaning Service Trial Balance at 30 June 20X1 $NZ $NZ Accounts receivable, Denning Ltd 820 Accounts payable, Banco Sons 1 640 Close Bros 950 Bank 5 690 Capital, B Henley 10 000 Drawings, B Henley 10 000 Cleaning revenue 65 400 Advertising Expense 1 820 Rates Expense 640 Agent's commission Expense 6 540 Electricity and power Expense 1 400 Salaries Expense 18 780 Loan from ANZ Finance (due 20X5) 10 000 Cleaning Materials Expense 7 400 Interest Expense 1 000 Equipment 18 000 Motor vehicles 14 000 Motor vehicle expenses 1 900 $ 87 990 $ 87 990 a. Open ledger accounts using the information given in the Trial Balance for Henley Drycleaning Service as at 30 June 20X1. Include account number 530 as the Income Summary. b. Prepare closing journal entries and post to the ledger c. Prepare a post closing trial balance d. Prepare an Income Summary for the year ended 30 June 20X1 e. Prepare a Balance Sheet as at 30 June 20X1

5.4 Example of Closing Journal entries for a business which trades in goods using periodic inventory

B BUSINESS Trial Balance As at 31 March 20X1 Account Account Number Lines Debit Credit Bank 110 2 2 000 Inventory 120 4 2 000 Equipment 210 2 32 000 Accounts Payable 310 2 1 000 Capital 510 4 28 000 Drawings 520 2 5 000 Income Summary 530 6 Sales Revenue 610 2 25 000 Purchases Expense 710 2 10 000 Expenses 720 2 3 000 $54 000 $54 000 Inventory 31 March 20X1 $4 000

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REQUIRED: a. Open ledger accounts using the information given in the Trial Balance for B Business as at 31 March 20X1. Your teacher will explain how to do Step b. as illustrated below. b. Prepare closing journal entries and post to the ledger. c. Prepare a post closing trial balance. d. Prepare an Income Summary for the year ended 31 March 20X1 e. Prepare a Balance Sheet as at 31 March 20X1

B BUSINESS General Journal GJ10 Date Particulars Ref Debit Credit 20X1 Mar 31 Sales Revenue 25 000 Income Summary 25 000 (Closing Entry) Income Summary 13 000 Purchases Expense 10 000 Expenses 3 000 (Closing Entry) Income Summary 2 000 Inventory 2 000 (To close inventory 1.04.10) Inventory 4 000 Income Summary 4 000 (For inventory as per stock sheets A55-B68) Income Summary 14 000 Capital 14 000 (Transfer of Profit) Capital 5 000 Drawings 5 000 (Closing Entry)

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Chapter 6

Depreciation and Disposal of Assets

6.1 Concept of Depreciation and Historical Cost 6.2 Methods of Calculating Depreciation 6.3 The Depreciation Schedule 6.4 The General Journal Entries 6.5 Posting to the Ledger 6.6 Depreciation and the Financial Statements 6.7 Exercises for you to try 6.8 Procedure on Disposal of an Asset 6.9 Exercises for you to try

6.1 Concepts of Depreciation and Historical Cost

What is Depreciation? Depreciation is the systematic allocation of the cost of an asset less its residual value over its useful life.

Formula: Depreciation = Historical Cost – Estimated Residual Value Estimated Useful Life

Depreciation is an expense for a particular accounting period. Depreciation must be shown in an Income Statement for an accounting period.

Depreciation is not a cash payment and is not seen in the cash flow statement or cash budget. Depreciation does not provide funds (cash) to purchase a new asset.

Important concepts, terms: What is allocation? (allocate) - To divide up and distribute, to apportion, to assign.

What is residual value? The funds that the business will receive when the asset has finished its useful life in the business. It is also known as scrap value, salvage value, disposal value, or trade in value.

What is Historical Cost of an Asset? Original purchase price of an asset plus any costs associated with getting the asset into a position and ready for use.

Example of historical cost: Machine cost $1000 Improvement to use machine $100 Installation (put in) cost $200 Insurance for the year $250

How much is the historical cost of machine? Answer: $ 1 300

Why? $1000 has added to it $100 and $200 which are part of the historical cost and are capital expenditure. Insurance for the year $250 is recurring expenditure and NOT part of the historical cost.

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Capital Expenditure Spending that benefits the business for many accounting periods.

Revenue Expenditure - Expenditure, the benefit of which are used up on the current accounting period. Revenue expenditure is expenditure that must be made again in every accounting period.

6.2 Methods of Depreciation The first step in the calculation of depreciation is to change all GST inclusive amounts to GST exclusive.

GST is the abbreviation for Goods and Services Tax in New Zealand.

If the GST rate is 15% GST inclusive = GST exclusive x 1.15 GST exclusive = GST inclusive/1.15

Eg If equipment cost $17 250 GST inclusive, the Historical Cost to be allocated equals $15 000 i.e. $17 250/1.15 = $15 000

There are 3 major methods of calculating depreciation. The key for management is to select a method of depreciation that accurately reflects the pattern of service provided by the asset.

a. Straight line method: Depreciation is calculated as a fixed percentage of cost each year. Eg.Equipment cost $12,000 and is to be depreciated at 10% per annum. The depreciation expense each year will be $1,200

The straight line method is used when the business expects to receive future economic benefits from the asset evenly over its useful life

b. Reducing Balance Method: Depreciation is charged at a fixed percentage of the carrying amount each year.

Carrying amount = Historical Cost – Accumulated Depreciation

This method is most appropriate in situations where depreciation is greatest in the early years of an asset's life. Some property, plant and equipment are most efficient when new, and therefore contribute more and better services in the early years of useful life. In such case by using the reducing balance method costs will be better matched with income.

Eg Motor Vehicles (cost) $200 000 Depreciate Motor Vehicles at 20% p.a. reducing balance Depreciation Expense: Year 1 $200 000 x 0.2 = $40 000 Year 2 ($200 000 - $40 000) x 0.2 = $32 000

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c. Units of use method: The units of use method of depreciation is used when the economic life of the asset is dependent on the amount of use made of it.

IGNORE GST in this example For example, if a truck cost $55 000 with an estimated resale value of $5 000 at the end of 200 000 kilometres, when it will be dispose of, the depreciation charge per kilometre is 25 cents (i.e. $50 000 / 200 000). At the end of each year the depreciation charge would be determined by multiplying the kilometres travelled during the year by 25 cents. Formula

$50 000 200 000 kilometres = 25 cents per kilometre

If the truck travels 20 000 kilometres in the first year: 20 000 x 0.25 =$5 000

This method perhaps is the most accurate in applying the matching concept because if an asset lies idle for most of the accounting period then depreciation charge will be negligible.

6.3 The Depreciation Schedule The allocation of the cost of an asset during its useful life can be summarized in a depreciation Schedule:

Eg.Equipment cost $12,000 and is to be depreciated at 10% per annum. Accumulated Carrying Amount Depreciation Year Depreciation $ $ $ 1 12 000 1 200 1 200 2 10 800 1 200 2 400 3 9 600 1 200 3 600

Carrying amount = Historical Cost – Accumulated Depreciation. If the asset is sold for less than its carrying amount, a loss on sale will occur. If the asset is sold for more than its carrying amount, a gain on sale will occur.

For example: If the equipment is sold for $8,000 at the end of the third year, what is the loss on sale? If the equipment is sold for $8,500 at the end of the third year, what is the gain on sale?

6.4 The General Journal entries At balance date the annual depreciation expense is recorded as a balance day adjustment. Eg Depreciation is to be provided on equipment $12 000 at 10% p.a. on cost and Motor Vehicles at 20% p.a. on reducing balance. (Motor vehicles cost $200 000 and Accumulated Depreciation on Motor Vehicles is currently $40 000).

Date Particulars 20X1 Mar 31 Depreciation on Equipment 740 1 200 Depreciation on Motor Vehicles 750 32 000 Accumulated Depreciation on Equipment 211 1 200 Accumulated Depreciation on Motor Vehicles 221 32 000 Depreciation provided on Equipment $12 000 at 10% p.a. on cost and Motor Vehicles ($200 000-$40 000) at 20% p.a. on reducing balance.

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6.5 Posting to the Ledger

Equipment 210 20X1 Mar 31 Balance b/f 12 000 Dr

Accumulated Depreciation on Equipment 211 Mar 31 Balance b/f 1 200 Cr Depreciation on Equipment GJ79 1 200 2 400 Cr

Motor Vehicles 220 Mar 31 Balance b/f 200 000 Dr

Accumulated Depreciation on Motor Vehicles 221 Mar 31 Balance b/f 40 000 Cr Depreciation on Motor Vehicles GJ79 32 000 72 000 Cr

Depreciation on Equipment 740 Mar 31 Accumulated Depreciation on Equipment GJ79 1 200 1 200 Dr

Depreciation on Motor Vehicles 750 Mar 31 Accumulated Depreciation on Motor GJ79 32 000 32 000 Dr Vehicles

6.6 Depreciation and the Financial Statements Income Statement (extract) Distribution Costs Depreciation on Motor Vehicles 32 000

Administrative Expenses Depreciation on Equipment 1 200

Balance Sheet (extract) Non Current Assets Notes Property Plant and Equipment 1 Total carrying amount 137 600

Notes to the Balance Sheet (simple format) 1 Property Plant and Equipment Motor Equipment Total Vehicles $NZ $NZ $NZ Cost 200 000 12 000 212 000 Less Accumulated Depreciation 72 000 2 400 74 400 Carrying Amount $128 000 $9 600 $137 600

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6.7 Exercises for you to try (Ignore GST in these exercises)

6.7.1 A business purchased a delivery van for $7 000 and conversion to the business's requirements cost a further $500. The estimated life of the van is 5 years and it is estimated that its disposal value at that time will be $2 250. The business intends to allocate the cost of the van over its useful life by the straight-line depreciation method. Calculate: a the amount (in dollars) to be allocated as depreciation expense each year; b the annual depreciation charge expressed as a percentage

6.7.2 A business purchases a front-end loader for $20 000. It is estimated that the loader will be used for 4 years and that it will have a trade-in value at the end of that time of $4 000. a Show the formula to calculate depreciation, then use it to calculate the annual depreciation charge (in dollars). b Convert the annual depreciation charge (in dollars) to an annual rate per cent of asset cost. c What will be the effect on profit of charging depreciation at the end of the accounting period?

6.7.3 Toorak Quarry purchased a truck for $24 000 and the necessary bodywork cost another $3 000. The accountant estimated that the truck would travel 100 000 kilometres and then be traded-in for $7 000. a Show the formula to calculate the depreciation and then use it to calculate the depreciation charge per kilometre (in cents). b Calculate the amount of depreciation that should be charged at the end of an accounting period during which the truck travelled 40 000 kilometres. c What factor determined the depreciation method you used to calculate the truck's depreciation?

6.7.4 On 1 July 20X1 B.Morton bought machinery worth $10 000. The machinery cost $800 to install and it is estimated that it will have to be replaced in 5 years and its trade-in value will be $2 000. Depreciation is to be charged by the straight line method. a Show the ledger entries to record: i the purchase and installation of the machinery; ii the balance day adjustments for depreciation of machinery on 30 June 20X2 and 30 June 20X3; iii the closing of the depreciation expense to profit or loss each year. b Show how the asset, machinery, would appear in the Balance Sheet as at 30 June 20X2 and 30 June 20X3.

6.7.5 Axtec Recording Studios bought recording equipment worth $45 000 on 1 April 20X1. It was decided that the equipment would be replaced after 4 years when its estimated trade-in value would be $9 000. On 1 October 20X1 another $5 000 worth of equipment was purchased for cash, and it was depreciated at the same rate per annum as the original equipment. a Calculate the depreciation of recording equipment by the straight-line method for the years ending 30 June 20X1 and 30 June 20X2. b Show the following ledger accounts, complete with balance day adjustments, on 30 June 20X1. i recording equipment; ii depreciation of recording equipment; iii accumulated depreciation of recording equipment.

c Show the asset, recording equipment, as it would appear in the Balance Sheet as at 30 June 20X1.

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6.8 Procedure on Disposal of an Asset (Ignore GST in this section) DISPOSAL:  Sell  Trade in  Throw away

EXAMPLE: A business purchased a motor vehicle for $40 000 cash on 1 April 20X0. The vehicle was depreciated using the straight line method at 20% p.a. The Vehicle was sold for $20 000 cash on 1 April 20X2.

PROCEDURE: STEP 1 Calculate any depreciation on the asset from the last balance date up to the date of disposal.

STEP 2 Transfer the asset to a Disposal account

JOURNAL ENTRY: 20X2 Apr 1 Disposal of Motor Vehicle 40 000 Motor Vehicle 40 000 To transfer the motor vehicle to the disposal account.

STEP 3 Transfer the accumulated depreciation to the Disposal account

JOURNAL ENTRY 20X2 Apr 1 Accumulated Depreciation on Motor Vehicle 16 000 Disposal of Motor Vehicle 16 000 To transfer the accumulated depreciation to the disposal account

STEP 4 Record the selling price of the asset (or trade in allowance) in the disposal account

JOURNAL ENTRY 20X2 Apr 1 Bank 20 000 Disposal of Motor Vehicle 20 000 Cash received on sale of motor vehicle

STEP 5 Close the disposal account. Debit balance represents loss on sale Credit balance represents gain on sale

JOURNAL ENTRY 20X2 Apr 1 Loss on Sale of Motor Vehicle 4 000 Disposal of Motor Vehicle 4 000 For loss on sale of motor vehicle.

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GENERAL LEDGER Motor Vehicle 210 20X2 Mar 31 Balance b/f 40 000 Dr Apr 1 Disposal of Motor Vehicle 40 000 0

Accumulated Depreciation on Motor Vehicle 211 20X1 Mar 31 Depreciation on Motor Vehicle 8 000 8 000 Cr 20X2 Mar 31 Depreciation on Motor Vehicle 8 000 16 000 Cr Apr 1 Disposal of Motor Vehicle 16 000 0

Disposal of Motor Vehicle 212 20X2 Apr 1 Motor Vehicle 40 000 40 000 Dr Accumulated Depreciation 16 000 24 000 Dr Bank 20 000 4 000 Dr Loss on sale of Motor Vehicle 4 000 0

6.9 Exercise for you to try

6.9.1 On 1 July 20X0, Accounting Services had the following account balances in its ledger: Computer $5 000, Accumulated Depreciation on Computer $2 400. Accounting Services decided to trade-in their computer on 31 March 20X1 for $2 800 to Business Machines Ltd. The new computer was valued at $6 500 and Accounting Services charge depreciation on accounting machines at 20% per annum on cost. a. Show the journal entries to record the depreciation on the computer to 31 March 20X1 and post to the ledger. b. Show the journal entries to record the trade in of the computer and post to the ledger.

6.9.2 L.Howe purchased a new motor vehicle for $27 000 cash on 1 July 20X0. Howe intends running the car for 120 000 kilometres when he hopes to trade-in the car to Meteor Motors for $12 000. During the year ended 30 June 20X1 the car travelled 40 000 kilometres. Howe decided to sell the car for $15 000 cash on 23 February 20X2 after it had travelled another 50 000 kilometres. a. Show the journal entries to record the depreciation on 30 June 20X1. b. Show the journal entries to record the disposal of the vehicle on 23 February 20X2. c. Show the general ledger accounts for Motor Vehicle, Accumulated Depreciation on Motor Vehicle and Disposal of Motor Vehicle as they would appear after posting the journal entries on 23 February 20X2.

6.9.3 On 1 July 20X0, a business bought office equipment for $7 500 cash. Its estimated life as 5 years and its residual value was expected to be $2 500. Depreciation was calculated by the straight line method. On 30 June 20X2 the office equipment was traded in to EP Engineering for $3 600 on new office equipment worth $10 000. It was decided to depreciate the new office equipment at a rate of 25% per annum on the reducing balance method. a. Show the journal entries to record all the above information up to and including 30 June 20X2. b. Show the general ledger accounts for Office Equipment, Accumulated Depreciation on Office Equipment and Disposal of Office Equipment as they would appear after posting Journal entries on 30 June 20X2.

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6.9.4 Mid-Course Accounting Examination July/September Intake 2010 On 31 March 20X9 the business sells its old delivery vehicle for $4,500 cash. The delivery vehicle was purchased for $27,000 on 1 April 20X4 and has been depreciated using the straight line method at 15 per cent per annum.

(i) Show the General Journal entry to record the depreciation expense on the delivery vehicle for the year ended 31 March 20X9.

(ii) Transfer the asset account (Delivery Vehicle) to the Disposal of Vehicle account.

(iii) Close the Accumulated Depreciation on Delivery Vehicle account tothe Disposal of Vehicle account.

(iv) Prepare the General Journal entry to record the cash received from the sale of the vehicle in the Disposal of Vehicle account on 31 March 20X9.

(v) Show the General Journal entries to close the Disposal Account and record the gain or loss on sale of the delivery vehicle.

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Chapter 7

Balance Day Adjustments

7.1 Accounting Objective 7.2 Accounting Assumptions 7.3 Accrual Basis Concept 7.4 Balance Day Adjustments (excluding GST) 7.5 Reversing Entries 7.6 Exercises for you to try 7.7 Balance Day Adjustments with GST 7.8 Exercise for you to try

7.1 The Objective of Accounting The objective of Accounting is to provide information about the reporting entity that is decision useful to present and potential capital providers.

7.2 Accounting Assumptions Accounting assumptions provide a foundation for recording the transactions and preparing the financial statements.

7.2.1 Explicit Assumption: Going Concern Assumption: The business prepares its financial reports based on the assumption that as far as it is aware it will continue in its present operations into the foreseeable future.

Assets are therefore valued at their worth to the business as a going concern, not at their liquidation value. They are recorded at their historical cost less accumulated depreciation, not at their market price.

If the entity is intending to close or change shape, the going concern assumption is no longer valid. Non-current assets would then be valued at market value or the agreed value of the purchaser.

7.2.2 Implicit Assumption: Periodicity Assumption: In order to provide timely information, it is assumed that the entity’s economic activity can be divided into nominated time periods. This is evidenced in the accounts through the title, eg Income Statement for the year ended 31 March 20X1. This requires the preparer to determine which time period each transaction or event relates in order to resolve any difficult allocation problems.

The periodicity assumption combined with the accrual basis concept gives rise to balance day adjustments.

7.3 Accrual Basis Concept: The effects of transactions and other events are recognised when they occur and are reported in the financial statements of the periods to which they relate.

Accrued Expenses and Accrued Income accounts are created at balance day to comply with the Accrual Basis concept.

Income and expenses often do not fit neatly into an accounting period but may cover parts of two accounting periods, therefore at the end of the accounting period it is necessary to adjust the income and expense accounts in the general ledger to include items which belong to the accounting period and to exclude items which belong to another accounting period. Balance day adjusting general journal entries will be written to take account of these items.

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7.4 Balance Day Adjustments (excluding GST) 7.4.1 Accrued Expenses (Current Liability) Expenses due but unpaid at balance day. Eg. Wages due $500, Interest due on loan $300 Journal entry 20X1 Mar 31 Wages Expense 500 Interest on Loan 300 Accrued Expenses 800 For wages due but unpaid at balance day.

7.4.2 Accrued Income (Current Asset) Income earned in the current accounting period but not received before balance day. e.g. Commission due but not received $600. Journal entry 20X1 Mar 31 Accrued Income 600 Commission Income 600 For commission due but not received at balance day.

7.4.3 Bad Debts written off When accounts receivable fail to pay because they have been declared bankrupt. e.g. Further bad debts are to be written off $560. Journal entry 20X1 Mar 31 Bad Debts 560 Accounts Receivable 560 For bad debts written off at balance day.

7.4.4 Prepayments (Current Assets) Prepayments are expenses which have been paid in advance at balance day. e.g. Insurance paid in advance $250 Journal entry 20X1 Mar 31 Prepayments 250 Insurance Expense 250 For insurance paid in advance at balance day.

7.4.5 Income in Advance (Current Liability) This is a liability because we have an obligation to provide a service for which we have already received cash in the current accounting period. E.g. Rent $2,500 received in advance Journal entry 20X1 Mar 31 Rent Income 2 500 Income in Advance 2 500 For rent received in advance at balance day.

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7.4.6 Accumulated Depreciation (Negative Non Current Asset) Depreciation is the systematic allocation of the cost of an asset less its residual value over its useful life. e.g. Depreciation is to provided on Motor Vehicles $20,000 at 20% p.a. straight line method Journal entry 20X1 Mar 31 Depreciation on Motor Vehicles 4 000 Accumulated Depreciation on 4 000 Motor Vehicles For depreciation provided on Motor Vehicles $20,000 at 20% p.a. on cost.

7.4.7 Allowance for Doubtful Debts (Negative Current Asset) As the accounts receivable may include some bad debts which have not yet been identified, an allowance can be made at balance date. e.g. A business has accounts receivable $20,000. From past experience, the accountant estimates that 3% will not be paid. Journal entry 20X1 Mar 31 Doubtful Debts 600 Allowance for Doubtful Debts 600 To create an allowance for doubtful debts equal to 3% of accounts receivable $20,000.

7.4.8 Inventory of Stationery (Current Asset) e.g. $700 of stationery has not been used on balance day. 20X1 Mar 31 Inventory of Stationery 700 Stationery Expense 700 For stationery remaining on hand at balance day.

7.5 Reversing Entries Balance day adjustments create the following temporary asset and liability accounts in the ledger.  Accrued Expenses  Accrued Income  Prepayments  Income in Advance  Inventory of Stationery (or other consummable items)

On the day following balance day these accounts must be closed and the relevant income and expense accounts reopened.

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The following journal entries show how the adjustments illustrated in 7.4 would be reversed on 1 April 20X1. General Journal GJ89 20X1 Apr 1 Accrued Expenses 800 Wages Expense 500 Interest on Loan 300 For reversing entry Commission Income 600 Accrued Income 600 For reversing entry Insurance Expense 250 Prepayments 250 For reversing entry Income in Advance 2 500 Rent Income 2 500 For reversing entry Stationery Expense 700 Inventory of Stationery 700 For reversing entry

7.6 Exercises for you to try: 7.6.1 The following information relates to Zhang’s Medical Centre Trial Balance at 30 June 20X1 $NZ $NZ Bank 10 160 Accounts Receivable 26 000 Medical supplies on hand 30 100 Vehicles 70 900 Lease of surgery 60 000 Accounts Payable 17 460 Capital - Zhang 95 630 Medical supplies expense 46 050 General expense 63 500 Surgery expense 77 000 Fees Income 285 340 Accumulated depreciation of vehicles 24 000 Wages Expense 27 320 Insurance Expense 12 000 Allowance for Doubtful Debts 600

Adjustments to be considered: 1. Wages $220 owing 2. Bad debts to be written off $300. 3. Allowance for doubtful debts to be 3% of accounts receivable 4. Depreciate vehicles at 10 per cent of cost. 5. Insurance prepaid $400 6. $1 000 stationery charged to surgery expense was on hand.

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Required. a. Prepare the balance day adjustments on 30 June 20X1 in the General Journal. b. Adjust the Trial Balance as at 30 June 20X1. c. Prepare an Income Statement for the year ended 30 June 20X1. d. Prepare a Balance Sheet as at 30 June 20X1.

Advanced Notes to the Balance Sheet The following presentation is required in most Mid-Course Accounting Examinations:

Note 1 – Accounts Receivable $NZ $NZ

Note 2 – Property Plant and Equipment Delivery Machinery Van $NZ $NZ For the year ended 30 June 20X1 Opening Carrying Amount Plus Additions 0 0 Less Disposals 0 0 Less Depreciation Closing Carrying Amount

As at 30 June 20X1 Historical Cost Less Accumulated Depreciation Closing Carrying Amount

Depreciation is calculated on the following rates:

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7.6.2 The following information relates to a flower shop that April Showers set up in Karangahape Road on 1 April 20X1. She has come to you, her accountant to find out if her business has made a profit at the end of the first month.

APRIL SHOWERS TRIAL BALANCE AS AT 30 APRIL 20X1 $NZ $NZ Inventory 2 795.85 Purchases Expense 7 716.30 Goodwill 5 735.25 Rent Expense 462.00 Electricity Expense 105.00 Cartage Inwards 95.35 General Expenses 295.85 Cartage Outwards Expense 195.65 Discount Allowed 92.50 Advertising Expense 456.78 Stationery Expense 565.00 Accounts Receivable 2 040.00 Vehicle Expenses 355.00 Insurance Expense 75.00 Interest Expense 115.00 Bank 1 365.00 Equipment 4 800.00 Motor Vehicle 7 500.00 Drawings 6 550.00 Commission Received 2 500.00 Sales Revenue 16 075.00 Discount Received 98.00 Loan 3 000.00 Accounts Payable 1 513.24 Capital 18 129.29

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Required: 1. Prepare General Journal entries to record the following balance day adjustments as at 30 April 20X1.  Inventory 30 April 20X1 $3 795.75  The amount of advertising due but unpaid is $21  Rent paid in advance: $92.40  Create an allowance for doubtful debts equal to 2% of accounts receivable  Depreciate property, plant and equipment at 20% p.a. on cost  Commission due but not received $118.00  Inventory of Stationery 30 April 20X1 $120.00

2. Adjust the Trial Balance as at 30 April 20X1 3. Prepare a classified Income Statement for the month ended 30 April 20X1 4. Prepare a classified Balance Sheet as at 30 April 20X1. 5. Prepare the closing journal entries. 6. Prepare the reversing journal entries 7. Prepare the following ledger accounts as they should appear from 30 April to 1 May 20X1.  Drawings  Capital  Advertising Expense  Accrued Expenses  Inventory

8. Explain to April Showers the importance of recording Depreciation in the accounts at the end of each reporting period.

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7.6.3 Mid-Course Accounting Examination 2012 This question deals with the Financial Reporting requirements of Mere, a sole proprietor who operates a pet supplies retail store trading as Mokaikai Supplies. You are provided with the following Trial Balance for the fiscal year ended on 31 March 20X2.

Mokaikai Supplies Trial Balance as at 31 March 20X2 Accounts Receivable 4,368 Advertising 354 Discount Allowed 2,350 Interest on loan 1,124 Inventory 39,312 Office Expenses 572 Purchases 130,000 Drawings 2,600 Insurance Expense 1,300 Shop Electricity Expense 5,408 Sales Returns 926 Shop Rent Expense 14,560 Shop Wages Expense 24,960 Office Wages Expense 14,560 Shop Fittings 56,160 Petty Cash 160 Bank 4,030 Term Deposit (4% p.a. due 31.08.20X3) 15,600 Bad Debts 112 Accumulated Depreciation on Shop Fittings 5,610 Allowance for Doubtful Debts 90 Capital – Mere 56,290 Interest Received 292 Sales Revenue 197,324 Accounts Payable 8,950 Loan (6% p.a.due 20X5) 49,900

Ignore GST for this question. Additional information:  Inventory is $78,000 at 31 March 20X2.  The annual insurance premium is $1,200 and one month has been paid in advance.  The term deposit has been invested for 6 months. Record the interest due but not received on reporting date.  Write off further bad debts of $168.  Adjust the Allowance for Doubtful Debts to equal 2.5% of Accounts Receivable.  Depreciate the Shop Fittings by 12% pa using the reducing balance method.  Record any interest owing on the loan.

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Required: (a) Adjust the Trial Balance on page 77 by crossing out the original number and writing the adjusted figure to the left or right as appropriate, to record the adjustments required at reporting date. (b) Prepare an Income Statement for the year ended 31 March 20X2. (c) Prepare a Balance Sheet with Notes to the Balance Sheet for Accounts Receivable and Property, Plant and Equipment as at 31 March 20X2.

7.5 Balance Day Adjustments with GST: GST is charged at the rate of 15 % on sales of goods and services in New Zealand.

1. Sales on credit When a sale on credit for $2,300 including GST occurs the transaction is recorded as shown below:

Accounts Receivable 2,300 Sales Revenue 2,000 GST Payable 300

GST is a liability which the business must pay to the government.

2. Purchases on credit When a purchase of $1,150 including GST occurs, the transaction is recorded as shown below:

Purchases Expense 1,000 GST Payable 150 Accounts Payable 1,150

As a result of these two transactions, the business owes the government $150. Items exempt of GST include:  Financial services: eg Loan, bank charges, interest  Capital and Drawings  Internal payments eg wages  Domestic rent All amounts stated are GST inclusive where applicable.

3. Accrued Expenses eg Accounts owing for Wages $4,000, Advertising $276 and Interest $2 250. Wages Expense 4 000 Advertising Expense 240 Interest Expense 2 250 Accrued Expenses 6 490 For expenses due but unpaid at balance day.

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4. Accrued Income eg A term deposit of $30,000 was invested on 1 January 20X1 at an interest rate of 8% per annum payable every six months. Balance day is 31 March each year. Commission of $552 is owing to the firm at balance day. The invoice was sent on 2 April 20X1. Accrued Income 1 080 Interest Income 600 Commission Income 480 For income earned but not received at balance day.

5. Bad Debts eg A customer who owes $322 is to be written off as a bad debt on balance date.

Bad Debts 280 GST Payable 42 Accounts Receivable 322 For bad debts written off at balance day.

5. Prepayments eg Insurance of $2 576 including GST has been paid 6 months in advance. Prepayments 1 120 Insurance Expense 1 120 For insurance paid in advance at balance day.

6 Income in Advance eg Rent of $1 725 including GST has been received in advance. Rent Income 1 500 Income in Advance 1 500 For rent received in advance at balance day.

Balance day adjustments for Inventory, Depreciation and Allowance for Doubtful Debts do not contain GST entries.

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ACCOUNTING GLOSSARY: Term Unit Meaning Accounting 1

Accounting Entity Concept

Accounting Equation

Accounts Receivable

Accounts Payable

Accrual Basis Concept

Assets

Auditor

Balance Sheet

Carrying Amount

Cash Transaction

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Chart of Accounts

Comparability

Credit Transaction

Current Assets

Current Liabilities

Depreciation

Drawings

Elements

Entity

Equity

Expenses

Faithful Representation

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Going Concern Assumption

Goodwill

Historical Cost

Income

Income Statement

Inventory

Invoice

Journal

Ledger

Liability

Matching Costs with Income

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Monetary Measurement

Non Current Assets

Non Current Liabilities

Periodicity Assumption

Property Plant and Equipment

Reducing Balance

Relevance

Residual Value

Source Document

Straight Line

Transaction

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Trial Balance

Understandability

Units of Use

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