Chapter 8 continued

8a: Adjustments for stock, accruals & prepayments

On completion of this topic you should be able to

Differentiate between opening and closing stock Differentiate between accruals and prepayments Construct financial statements for a sole trader with post trial balance adjustments for stock, accruals and prepayments

Independent study
Study Chapter 8 Progress test and practice question(s) as set

Business Accounting

The story so far

Identify, measure and classify the economic transactions of the business Record monetary values in the ledger accounts At the end of the accounting period, balance the accounts and construct a trial balance Make post trial balance adjustments Prepare the financial statements
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Post trial balance adjustments

Although the records in the accounting system may be up to date, some last minute adjustments to the ledger accounts are always necessary at the end of the accounting period
This means that some of the figures in the trial balance will need amending Post means after in Latin, hence the term post trial balance adjustments

In this lecture we will look at the adjustments for

Stock Accruals Prepayments
Business Accounting 3

Exercise 1 Accounting principles revisited

Post trial balance adjustments are guided by UK GAAP and in particular by the following accounting principles
Historical cost concept Accruals concept Prudence concept Consistency concept

Required
Jot down a brief explanation of the principles given by each of these concepts
Business Accounting 4

Solution 1 Accounting principles revisited

Historical cost concept values of assets are based on their original acquisition cost, unadjusted for subsequent changes in price or value Accruals concept revenue and costs are recognised as they are earned and incurred, and they are matched with one another and dealt with in the profit and loss account of the period to which they relate, irrespective of when cash is received or paid

(Continued)
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Solution 1 (continued) Accounting principles revisited

Prudence concept - revenue and profits are not anticipated, but are included in the profit and loss account only if there is reasonable certainty that they will be received. However, provision for all known expenses and losses must be made, whether the amount is known with certainty or is only a best estimate in the light of the information available Consistency concept - there is uniformity of accounting treatment of items of a similar nature within each period and from one period to the next
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Adjustments for stock (inventory)

Stock (inventory) refers to unsold goods

In a manufacturing business, it includes raw materials, work-in-progress and finished goods

Stocktaking is the process of counting the stock at the end of the accounting period to confirm the actual quantities support the figures recorded in the ledger accounts Under UK GAAP, stock must be shown at the lower of historical cost or net realisable value (NRV)
NRV is the price the business expects to get for the stock, less any costs incurred in selling it
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Closing stock and opening stock

In a continuing business, the closing stock at the end of one accounting period is the opening stock at the beginning of the next The value of opening stock at the start of the period and closing stock at the end of the next are needed to calculate the cost of sales in the profit and loss account
Closing stock is also shown under current assets in the balance sheet It is listed first, as it is the most permanent (it takes the longest to turn into cash)
Business Accounting 8

Example Cotswold Coolers Trading account for the year ending 30 June 2006
Sales Less Cost of sales Opening stock Purchases Add Less Closing stock Gross profit 38,500

0 29,000 29,000 (10,000) (19,000) 19,500

Questions 1. Why is there no value shown for opening stock? 2. What is the value of opening stock in the profit and loss account for the year ending 30 June 2007?
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Example

Cotswold Coolers Balance sheet as at 30 June 2006 (extract)

Fixed assets Vehicles (at cost) Current assets Stock Trade debtors Bank Cash 5,000 10,000 6,800 15,100 200 32,100

Question Does the figure of stock in the balance sheet represent opening stock or closing stock?
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Accruals An accrual is an estimate of a liability that is not supported by an invoice or a request for payment at the time when the accounts are prepared (Collis and Hussey, 2007, p. 136) It belongs to the financial period and must be added to the trial balance figure for that expense Jargon alert

Accrual comes from the verb to accrue, which means to increase It is spelt accrual not accural
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Prepayments A prepayment is revenue expenditure made in advance of the accounting period in which the goods or services will be received (Collis and Hussey, 2007, p. 137) It belongs to the next financial period and must be deducted from the trial balance figure for that expense

Business Accounting

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Exercise 2 Accounting for accrued expenses

Cotswold Coolers has paid several invoices for electricity used during the year, which total 1,500 for the 10 months to 30 April 2006 The bill that covers the last 2 months of the accounting period has not yet been received Required
How much would it be fair to charge for the expense of electricity for the year ending 30 June 2006?

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Solution 2 Accounting for accrued expenses

A fair method would be to base the estimate for the two months on the average monthly cost
10 months = 1,500 Average for 1 month Therefore, 2 months = 1,500 = 150 10 = 150 2 = 300

Total electricity expense for the year is: 1,500 + 300 accrued = 1,800
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Exercise 3 Accounting for prepaid expenses

Cotswold Coolers has paid 2,400 in rent and rates during the year ending 30 June 2006, but 10% of this relates to next year Required
How much should be charged for the expense of rent and rates for the year ending 30 June 2006?

Business Accounting

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Solution 3 Accounting for prepaid expenses

First we need to calculate the amount that has been prepaid: Prepayment = 2,400 10% = 240 Total rent and rates for the year is: 2,400 - 240 prepaid = 2,160

Business Accounting

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Exercise 4 Accounting for accruals and prepayments

Accruals

Prepayments
In the profit and loss account, show the expense (excluding the prepaid amount) In the balance sheet, show total prepayments under current assets

In the profit and loss account, show the expense (including the accrued amount) In the balance sheet, show total accruals under current liabilities

Required
Complete the profit and loss account and balance sheet for Cotswold Coolers with adjustments for stock, accruals and prepayments
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Exercise 4 Cotswold Coolers Trial balance at 30 June 2006

Sales Purchases Vehicles (at cost) Trade debtors Trade creditors Bank Cash Rent and rates Electricity Drawings General expenses Interest receivable Capital at start of year 29,000 5,000 6,800 9,100 15,100 350 2,400 1,500 7,000 600 150 _____ 20,000 67,750 67,750 38,500 Additional information Stock at 30 June 2006 10,000 Accruals Electricity 300 General expenses 50 Prepayments Rent and rates 240

Tip: Tick each item as you use it

18

Business Accounting

Exercise 4 pro forma Cotswold Coolers Profit and loss account for the year ending 30 June 2006
Sales Less Cost of sales Purchases Closing stock Less Gross profit Add Interest receivable Expenses Rent and rates Electricity General expenses Net profit
Business Accounting

38,500

29,000 ?) (

?) ? 150 ?

? ? ?(

)? ?
19

Exercise 4 pro forma Cotswold Coolers Balance sheet as at 30 June 2006

Fixed assets Vehicles (at cost) Current assets Stock Trade debtors Prepayments Bank Cash Less Creditors: amounts due within one year Trade creditors Accruals ( Net current assets Total net assets Capital and reserves Capital at start of year Net profit Drawings
Business Accounting

5,000

? 6,800 ? 15,100 350 ? 9,100 ? )? ? ? 20,000 ? ? (7,000)

Add Less

?
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Solution 4

Cotswold Coolers
38,500

Profit and loss account for the year ending 30 June 2006
Sales Less Cost of sales Purchases Closing stock Less Gross profit Add Interest receivable Expenses Rent and rates (2,400 - 240) Electricity (1,500 + 300) General expenses (600 + 50) Net profit
Business Accounting

29,000 (10,000) (19,000) 19,500 150 19,650 2,160 1,800 650

(4,610) 15,040
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Solution 4

Cotswold Coolers Balance sheet as at 30 June 2006

Fixed assets Vehicles (at cost) Current assets Stock Trade debtors Prepayments (240) Bank Cash 5,000

10,000 6,800 240 15,100 350 32,490 9,100 350 (9,450) 23,040 28,040 20,000 15,040 35,040 (7,000)

Less Creditors: amounts due within one year Trade creditors Accruals (300 + 50) Net current assets Total net assets Capital and reserves Capital at start of year Net profit Drawings
Business Accounting

Add Less

28,040
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Conclusions

Post trial balance adjustments for stock

In the profit and loss account, cost of sales is: Opening stock + Purchases Closing stock In the balance sheet, show (closing) stock under current assets

Adjustments for accruals and prepayments

In the profit and loss account show the expense including the accrued amount or excluding the prepaid amount In the balance sheet, show Total accruals under current liabilities Total prepayments under current assets
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